India under a cyclical slowdown, a cheerful budget is the leverage

The trend of the domestic market in the last two months has been hectic. It began in December 2022 as a result of muted expectations for the Indian stock market in comparison to the rest of the world. The domestic economy is expected to moderate, which will work in contrast to the premium valuations India used to hold in the last three to five years. The negative view persisted in January 2023 due to subdued expectation on Q3FY23 corporate results and union budget.

The world equity market is trending better, presuming that the central bank’s policy will not be as hawkish as stated by policymakers. The market anticipates that inflation will rapidly fall as financial liquidity reduces and supply constraints diminish. Other emerging and developed markets are in a better position too because they are trading at a deep discount after the collapse in 2022 and are in anticipation of a revamp in growth post the pandemic effect.

Allegations against India’s largest conglomerate, Adani Group, are having a sentimental impact on India’s growth story. If proven right, it can have a cascading effect in the short to medium term. The key to addressing the issue is to get an assessment report from the court, government, or a highly credentialed third-party institution, which is difficult to comment on now. Hence, the saga is likely to remain a hanging risk in the minds of investors in the medium-term.

The budget was presumed to be an election-oriented agenda with a focus on the rural economy and low on reforms. However, it is a shot in the arm, as it has come out as among the best budgets ever presented by the ruling government. It meets all the credentials for everyone from rural to urban market as well as individuals to corporates. The government is taking charge of the show by expanding capex, which will have a multiplier effect on the economy. Lack of focus on encouraging saving under the new tax regime could be felt as a setback for many, but it can be expected in the future as it is a good start in providing tax benefits and urging people to shift. The stock market has a concern that capital gain taxes will be rationalized; no action is a blessing in disguise.

Consequent weak financial results …

India continues to have soft corporate earnings expectations. Q3FY23 will be the consequent quarter of weak results. Large blue-chips are forecasted to knock the smallest double-digit earnings growth of 10% on a YoY basis. This is much more subdued compared to the average earnings growth of 30% that Nifty 50 index companies used to record from Q2FY22 to Q1FY23.

However, it is better on a QoQ basis, as corporate earnings were negative at -2% in Q2FY23. There is an improvement on a QoQ basis with 11% growth with uprise in domestic-oriented businesses like cement, telecom, finance, FMCG, infra and power, as a result of reduced input costs and a fall in global inflation.  The US CPI has fallen from 9.1% in June 2022 to 6.5% in December 2022; MoM inflation has remained flat over the last six months. All local businesses that depend on imports; their costs are linked to international prices. Domestic demand continues to be healthy, providing some upside in profitability.

In a nutshell, earnings are slowing. In FY23, Q1 grew by +20%, Q2 was poor at -2%, Q3 is estimated to be +10%, and Q4 is presumed to be similar at 10% to 12%. This will provide a total YoY growth of about 9%, which is lower compared to the 15% the market was hoping for in FY23. In terms of FY24 earnings growth, we anticipate a similar range of 10% to 12%, compared to the market’s expectation of 15%. The market will recognize reality during the year. 

The Adani Saga …

Hindenburg’s report has drawn attention to one of India’s corporate success stories, expressing concerns about the group’s governance and opaque finances. It describes a complicated network of funds and shell companies, some of which are based in Mauritius, and interact with 578 subsidiaries spread through the seven publicly traded firms. Last year, Hindenburg claims, these entities engaged in 6,025 related-party transactions.

The total market value of Adani Group’s 10 listed companies (including Ambuja, ACC & NDTV) was Rs 19.4 trillion on 20th January, which has fallen to Rs 10.9 trillion as of 2nd February. This is a loss of 44% in shareholder wealth. Adani Group used to form 7% of India’s total capitalisation, which is down to 4% today.

The downfall in group stocks is affecting the performance of banking stocks too because of the high lending exposure. The Nifty Bank Index corrected by 8% from its 52wk high. The aggregate loan of top 5 Adani group companies is estimated about Rs2.1 trillion. It is estimated that 60% of the lenders are overseas and 40% are Indian banks. The exposure of private banks is low at 10%, while that of PSUBs is high, accounting for 30%. As a result, the performance of PSUBs has taken the biggest hit. In the last three trading sessions, the Nifty PSU index is down by 10% compared to 5% of the Nifty Private Bank index.

The response by Adani has had a mixed effect on the Adani group stocks and market. The market needs something more, which may be a concrete substance of scientific assessment either by a strong independent third party or government, although the immediate chance of that seems dim in the short-term. In the medium term, the saga is likely to remain a hanging risk in the minds of investors.

Union Budget …surprised everyone

Prior to the budget, the Indian stock market was distracted with low expectations and plausibility of rationalization of capital gain tax in the future. Well, it has jolted everyone, shaking the world, and providing a view that the government is in complete control of the scenario and fully in charge to work forward with more energy.

We rate it as a 10 on 10 budget; it has no populist intentions and is fully focused on capital expenditure driving economic progress, boosting consumption, promoting manufacturing, and tax concessions for all. It has provided all-inclusive packages with the intention of expanding India’s journey in the future. The attraction of the budget is its realistic forecast of the government’s financials, in-line with the short-term slowing in the domestic economy, and exploration of an efficient expenditure plan benefiting all. (For more details, please review our 2023 budget analysis report)

The budget will help save our nation.  However, we need to know that other financial factors like high interest rate, a slowing economy, and high valuations will have implications for the domestic stock market in 2023.

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