Equity Markets: Is the Optimism Justified?
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The US has a new President. World has hope for a COVID vaccine to be delivered to all and the stock markets across the world are celebrating ushering in Diwali and festive season. Dow Jones, NIFTY, Sensex and markets across the world are reaching all-time high.
Yet as you look around, there is no economic euphoria. Companies aren’t showing record profit, rushing to expand capacities. Consumption is not scaling up and overall consumer confidence remains low.
Henry David Thoreau wrote famously in his 1854 book Walden, “The mass of men lead lives of quiet desperation.” It would be apt to describe Indian economy as living in ‘quiet desperation’ for last several years. GDP growth has been anemic for several years and most recently the economy shrank by 23.9 per cent in Q1FY21 recording its worst ever contraction. Risk aversion in banks is at its peak and the economy is stifled by lack of credit.
One look at movement of NIFTY for the year would indicate that the COVID era was more a blip for the markets, which is over and now we are looking at a brave new world.
While NIFTY can juggle its constituents and get back to showing a winning chart, can the Indian economy too replace its old guards—with new companies to fill the gap in manufacturing, employment and propel the economy back to 8 per cent-plus GDP growth?
Well it won’t be that easy. Doubts persist if our core industries such as cement, steel and power are ready to get back to any capacity expansions. Employment generators such as construction/real estate industry are still nursing their wounds. Tech revolution is driving retail industry growth, however, it cannot compensate for the other sectors.
The biggest challenge to growth is lack of ‘animal spirit’ in the economy. The traditional businesses have been deeply impacted in last several years and have lost their appetite for investments and taking risks. The agenda for most of these is to drive down the debt levels and none is betting on an expansion/diversification. We don’t hear of any new player taking up a green field project.
On the other side are the new age businesses where we see the young entrepreneurs changing the landscape by disrupting the old order and thinking scale? However, this disruption is deeply capital consuming, which they lack. Hence, post a lifecycle of early stage to maturity—what is emerging is an extremely polarized industry with a few players, who dominate the market and controlled by few large private equity players/corporates.
Availability of credit
The other big impediment to growth is the lack of evolved debt market. India is a deeply capital starved economy. While the tech boom has meant startup equity being available for promising ventures, we still do not have debt markets to support our businesses. Banks who own bulk of credit in India, have traditionally been risk averse, have supported the existing businesses houses over the last decade and have lost heavily. Now they are in no mood to take any risks.
The risk of losing money should be a fundamental requirement and not an avoidable nuisance. Credit should be available to most participants at a price reflecting the risk. What we are seeing is a gush of money to top borrowers at all-time low rates while other businesses struggle to get any credit.
The recent scheme by the government of India to provide loans to MSME and other sectors is a welcome step to get credit flow going, but what is also needed is a development of a much deeper debt market. NBFCs have served this useful purpose to ‘boldly go where no bank has gone before’. This important market participant should continue to use innovation to help disseminate credit to most needy sectors.
What is the market discounting?
Equity markets are most efficient in absorbing information and adjusting the prices accordingly. What they seem to have decided that notwithstanding these challenges, the Indian economy has fundamentally a number of positives going for it to be able to propel the stock prices higher. It helps that we have a world full of liquidity and low interest rates and this capital is seeking destination at this time. However, as investors, one should stay focused and nimble as India has a tightrope to walk on.