There is an expectation among investors, both domestic and international, that the Indian GDP is on a long term high growth path. Over the last decade, India has moved from a $ 1 trillion GDP to $ 2.2 trillion currently. In this period, India has moved from being the 12th largest GDP to now being the 6th largest. The Prime Minister recently spelt out a vision to reach a $ 5 trillion GDP by 2025. However, sentiment at the ground level is more sanguine. The average business seems far less optimistic, given the economic slowdown over the last 5 years. Volume growth has been muted (less than historical averages) for many businesses, and overall revenue growth has also been slow, with price increases difficult to come by. The capital goods cycle is yet to gain any traction, with several industries sitting on surplus capacity. The banking sector is grappling with the historical bad debt situation, which is preventing banks from lending adequately to the economy.
In all this picture of economic gloom, we are seeing the first signs of an uptick in corporate earnings performance as evidenced by the quarterly results over the last 2 quarters. The performance of many bellwether companies has been good, even after factoring in that the growth is being compared to the December 2016 quarter, which was affected by demonetization. Moreover, many companies are also guiding for improved performance going forward as well. This suggests that the economy may be getting over its demonetization and GST blues and could be heading back to its normal 7-8% real GDP growth phase. This would be aided by the NPA resolution and bank recapitalization which is under way. In addition, in some of the core industries, we have seen the gap between supply (over supply had built up) and demand beginning to reduce. As demand converges towards supply, we should see the capital goods cycle recovery kick in. We should warn here that it is early stages yet and one will need to observe corporate performance for a few more quarters before we can firmly conclude that the economy is getting its mojo back.
The Indian equity market, on the other hand, seems to be pricing in a firm economic recovery – the valuations are on the higher side, and the mood is buoyant, thanks to the strong domestic inflows into equities. The capital raising environment for companies is also quite strong, with nearly $ 20 billion of fresh capital being raised, either directly into companies or through offer for sale. A strong capital market, can partly catalyze the economic recovery, by contributing the risk capital required for the capacity build up in the economy. The government also needs to do its bit, by investing larger sums into infrastructure projects, both in rural and urban areas.
Given where the market is, at the moment, it is important for these green shoots of economic recovery, to take roots and grow. If we don’t see the next couple of quarters building on the strength over the past couple of quarters, we can see markets give up some steam. Valuations are getting exaggerated in some areas of the market and some sort of correction or consolidation of the market would perhaps be healthy as well.