Great uncertainties confronted economic forecasters in 2017. Early in the year, there were endless debates on the pace of remonetisation and the duration of economic disruption it caused. Then came the tumultuous transition to the Goods and Services Tax (GST), which subsumes 40% of India’s total taxes and, thus, significantly impacts economic growth as well as fiscal health. Separately, the unexpectedly rapid pace of build-up in the new insolvency pipeline, and recapitalisation of public sector banks brought uncertainty into the outlook for the banking sector. This, as the economy continued to adjust to low food inflation which depressed farm income growth, and the arrival of a real estate regulator, which slowed down the new launches.
All this while, aided by the strongest global economic recovery in seven years, continuing accommodation by developed market central banks, and several sector-specific trends (the expectation of continued market share losses by government-owned banks to private sector banks, or reduced competition in the telecom sector) the market showed remarkable strength and stability. Strong inflows into domestic equity mutual funds supported these trends, though a meaningful market impact, in our view, was only in the stocks of smaller businesses.
CY18 should see improving visibility, at least on the economic front. Recent changes to GST should make the transition smooth. As supply chains settle down, they may also restart thinking about new investments. Central and state budgets presented in February-March are likely to have explicit GST forecasts, reducing confusion in the market: this year bond investors still do not know what is the target for GST revenues! Going forward, as GST rates get further recalibrated, the risk of inadvertent fiscal easing or tightening is likely to be lower. If GST delivers more revenues than the taxes it subsumed were expected to, it acts as fiscal tightening, and vice versa.
As insolvency cases reach their time-bound resolution, the uncertainty on how much loss needs to be booked, and by whom, will also be behind us. The government will also be able to allot the announced recapitalisation amount to various banks, separating the growth-capital part from the loss-compensation part. While it might take several months more for the new owners of these assets to put their resolution plans into action, visibility on new investments is likely to improve. The inflation outlook, clouded by the recent surge in vegetable prices and the worry about the impact of higher crude oil prices, is likely to clear up, one way or the other.
That is not to say that 2018 would be totally devoid of uncertainty. The upcoming general elections in 2019 are likely to keep the market overly sensitive to political developments. There are several important state elections during the year, and there has been some debate in the media about the general elections being brought forward as well. Separately, as global growth momentum picks up, the stance of various central banks, thus far relatively predictable, may change. The direct impact on equities may not be negative, but these changes may raise volatility if bond yields rise, bond investors book losses, and some of the assumptions behind the once-again flourishing structured products and deals are questioned.
The fiscal health of many countries could also get affected by higher interest rates, though improving growth should also be helping their tax revenues. Lastly, with the political transition complete, as the Chinese government restarts the adjustment of its economic model in response to record high levels of debt and over-reliance on investment, the economic ripples may not be contained within the country.
Credit Suisse global strategists believe 2018 should be a year of positive return for global equities, with only gradual withdrawal of accommodation from central banks (their action would be akin to taking the foot off the accelerator as economic momentum improves, and not about applying the brake). That should be supportive for Indian equities too. However, in a reversal of trends seen after FY12, the sectors that are likely to outperform would be the ones exposed to global trends. On the other hand, the revival in the domestic economy built into current estimates is likely to be pushed further out into the future, driving underperformance of sectors exposed to this growth.
