It’s raining bad news on Dalal Street though there has been a letup in the monsoon downpour in Mumbai. Since early July, the benchmark S&P BSE Sensex has lost nearly 5% of its market value. Foreign portfolio investors (FPIs) are fleeing the Indian market. The rupee is hovering below 70 against the dollar and there is a fear it might slip further. Gold prices are on the rise due to safe-haven buying. Weak corporate earnings in the June quarter, coupled with core sector growth falling to a four-month low of 2% in June, strongly suggest a slowdown.

Such a suggestion in May and June would have attracted puzzled looks. Markets were pumped over expectations of a stable government at the centre. On May 23, as news flowed in of the National Democratic Alliance under Narendra Modi returning to power with an even larger majority than 2014, the Sensex surged to a record high of 40,124.96 points. The National Stock Exchange’s Nifty 50 also breached the psychological mark of 12,000 points to hit its all-time high of 12,041.15 points. The euphoria reached a crescendo on June 4, the 10th day of Modi 2.0: The 30-share index Sensex vaulted to a new all-time high of 40,312.07 points.

Not even the festoons remain from that party now. The Sensex is barely 1,100 points above its lowest point in 2019. The short-to-medium term outlook does not look good, say experts. “In 2008, corporate profits were 7.5% of gross domestic product (GDP), which has today whittled down to less than 3%,” says Raamdeo Agrawal, joint managing director and co-founder, Motilal Oswal Financial Services. “The worst is not over yet.”

The stock market has traditionally been considered an indicator of a country’s economic health. While a rising market indicates future growth, a fall suggests all is not well. Signs of a slowdown in the economy had begun to surface as early as September 2018, says Anish Teli, a former analyst with Morgan Stanley who now runs a private portfolio management outfit. Teli says the automobile sector, the mainstay of the manufacturing sector and one of the largest organised employers, first reported weak numbers for the September 2018 quarter. Most people put it on bad festive period sales and called it a one-off. It was only after the March 2019 quarter when all automobile companies posted bad sales, that companies realised the problem was much bigger. Fortune Indias cover story in April, ‘Clear Air Turbulence’, analysed the simmering doubts in the economy.

For the next couple of weeks, the election din drowned fears about the state of the economy as the market seemed more anxious to see a stable government at the Centre. Says Agrawal, “The market celebrated the majority that the BJP government got as it thought it would come up with strong policies to grow the Indian economy.” The market’s expectations were reflected in its performance in the run-up to the Union Budget. It closed June at 39,394 points— losing over 900 points from its peak.

The returns delivered by the Sensex—the worst-performing market among major economies—so far in 2019.

When the Budget was unveiled on July 5, it turned out to be unremarkable for business: It proposed higher taxes on the superrich, laid out few sops for companies, and did not have a larger plan for achieving its $5-trillion economy goal in the next five years. Yet, surprisingly, the market held up.

Weak corporate results in July once again signalled problems with the economy. The automobile sector was in the doldrums and the finance sector, which played an important part in market rallies in recent years, too did poorly as it emerged that the liquidity crunch triggered by the Infrastructure Leasing & Financial Services crisis persisted. Credit ratings agencies continued to downgrade players like YES Bank. India’s best valued non-banking financial services company Bajaj Finance said it was holding back loans to small- and medium-scale enterprises, which were already struggling to find capital from banks to run their business. Agrawal says consumer companies are also in trouble. Sector giant Hindustan Unilever said its rural sales have slowed considerably over the past two quarters.

the Sensex in July lost over 2,800 points, or about 7.2%, and in the first week of August, the index shed 790 points, with only a few gainers. Yet the Sensex is trading at 453 points (or 1.2%) above its lowest point in May, the month of the general election when it rallied 2.5%, its best in six months. As of August 13, the Sensex is 8.31% more than what it was in December 2017. The fact is the spikes in June were just aberrations.

However, that would just be an oversimplification; a few events suggest that the issues which the markets were concerned about might have become worse. First, and perhaps the most important, nobody is sure how fast the economy is growing. On June 11, Arvind Subramanian, former chief economic adviser to Prime Minister Modi, wrote in an article in The Indian Express that the country’s GDP growth between FY12 and FY17 was overestimated by around 2.5%. During that period, India’s economy grew at 4.5%, and not at the government’s published number of 7%. A restatement of economic numbers will throw the future projections of companies and analysts to the wind, especially those which capital investment companies propose to make to grow their business. “It appears that we may be headed to a real GDP growth of 3%,” says Teli.

Says Nirmal Jain, chairman of IIFL Finance: “According to the World Bank, India has slipped one notch to the 7th position among large economies by GDP. It is a wake-up call for the government to go all out to accelerate growth and that’s the only way to lift the poor and farmers economically and socially.”

Second, FPIs have pulled out substantial monies from the market. Interestingly, in the run-up to the 2019 general election, FPIs pumped ₹33,981 crore into the equity market in March (the highest in five years) and ₹21,193 crore in April, while mutual funds were net sellers—₹7,396 crore and ₹4,600 crore in March and April 2019, respectively. But in the past two months, the FPIs have withdrawn $2.5 billion or ₹17,723 crore prompting a sell-off, though domestic financial institutions led by Life Insurance Corporation (LIC) turned big buyers. There is speculation that the sell-off came after the Budget changed the tax status of trusts that managed FPI investments to a higher tax bracket.

Graphic by Rahul Sharma.
Graphic by Rahul Sharma.

The finance minister has since held discussions with them, but it is not clear if they sold off on account of the additional tax liability or because of the problems they saw with the economy. Says a CEO from a foreign brokerage house, requesting anonymity: “Indian markets are still small in the global scheme of things and if entry and exit is onerous, only a handful of large investors will invest here. The idea should be to attract capital easily.”

Another decision to increase public holding in listed companies by reducing promoter holding has also had a bad effect on retail markets. Brokers say that several companies will be forced to make an offer for sale in the market which will suck away retail capital. The government’s decision may help in the long run to increase the free float—shares held by public investors—of good companies in the market but in the short term the decision has added to the negative sentiment. “The market was particularly spooked by the government’s proposal to cut the maximum allowable ownership stakes of promoters to 65% from 75%,” said a note from Kim Eng Securities India. Its analysts said the proposal is estimated to affect 1,000 companies with a total market value of about ₹4 lakh crore, of which about 10% would need to be sold.

In 2008, corporate profits were 7.5% of GDP, which has today whittled down to less than 3%; the worst is not over yet.
Raamdeo Agrawal, joint managing director and co-founder, Motilal Oswal Financial Services.

But the elephant in the room is growth and earning issues. The forecast for earnings, which largely drives the Sensex, for the current year and the next year is bleak. In its July 15 note, Kotak Institutional Equities’ analysts Sanjeev Prasad, Sunita Baldawa, and Anindya Bhowmik wrote that they are not sure whether earnings multiples of ‘growth’ stocks will hold up at current levels in case the Indian economy were to see a prolonged slowdown or settle at 5-6% real GDP growth rates. In their opinion, the Indian market has held up reasonably well despite the sharp downturn in the domestic economy, possibly due to steep declines in global and domestic bond yields and hopes of an economic revival. “We are reasonably comfortable about the sustainability of the first two drivers while we have our reservations about the third one,” the trio says, as they believe the on-going slowdown in the economy might reflect certain structural challenges, which might last a while.

So far, the economy has been chugging along fine as there were two growth drivers—rising private (household) consumption led by declining household savings rate; and increased government spending led by high consolidated fiscal deficits. In the Kotak report, the analysts said these drivers might be running out of steam—as already evidenced by the warning put out by companies like Bajaj Finance.

Further, the pain in the financial system is not going away in a hurry. Companies faced with falling demand and lack of capital, especially from public sector banks, are expected to postpone any investment in new capacities. The Kotak report further says that liquidity and solvency issues of the non-banking financial sector are unlikely to be resolved soon and are likely to percolate to other parts of the financial system given the deep connection between real estate companies, housing finance companies, and bond markets. “Admittedly, it will take more than just a few quarters of earnings disappointments and downgrades to dent their multiples,” the Kotak analysts wrote. “However, the de-rating can be quite severe, as [it] happened in the case of automobile stocks once the market reconciled to a longish period of weak volumes.”

$2.5 Billion 
The amount foreign portfolio investors withdrew from Indian markets in the past two months.

If the growth stocks begin to lose ground, that will further wreck the indices. In the recent rally starting May, much of the increase in the Sensex came from just 15 odd stocks like Reliance Industries, HDFC Bank, Bajaj Finance, and Axis Bank, while during the same period mid-caps continued to lose ground. A recent report by Mumbai-based Equinomics Research and Advisory, an investment advisory firm founded by market veteran G. Chokkalingam, says that of 2,000 actively traded stocks, 82% fell between 10% and 98%, while 47% crashed over 50% from the peak of January 2018. “Collectively, all stocks other than the 15 large index stocks have lost around ₹24,00,000 crore in market value,” Equinomics notes. In terms of indices, the S&P BSE MidCap and the S&P BSE SmallCap have fallen by 19% and 29%, respectively, since January 2018.

India has been the worst-performing market among the major economies so far in 2019. While the Sensex has given just 3.7% returns so far in 2019, Brazil’s Bovespa has delivered 13.6%, and China’s Shanghai Composite index gave 15.6%. The S&P 500 and the Nasdaq have delivered healthy returns of 15.2% and 19%, respectively, so far in 2019. The Sensex had delivered 5.9% in 2018. Experts agree that the slowdown couldn’t have come at a worse time. Global markets are flush with funds and negative interest rates are almost the norm globally. Yields on sovereign bonds issued by Greece, which is still in a severe financial crisis, are at 2%. Says Motilal’s Agrawal: “It shows the distance financial investors are willing to go to get a meagre return.”

Investors are also flush with funds. In a recent filing, Warren Buffet’s Berkshire Hathaway said that it was sitting on a cash pile of $122 billion. India was expected to be the beneficiary of the ongoing trade tussle between the U.S. and China. So far the gainers seem to be only a sprinkling of chemical exporting companies like Aarti Drugs and Vinnati Organics. Major manufacturing contracts that other Indian firms should have got have gone to countries like Vietnam and Taiwan.

Corporates are aware of the situation and seem to be prepping for tough times. Carborundum Universal, ranked 454 on the 2018 Fortune India 500 list, in its post-results’ analyst call on August 1, said what we are seeing now are “only bits of a slowdown”. “Our general sense is this is far deeper than what everybody is willing to talk about or accept,” Carborundum Universal’s managing director K. Srinivasan told analysts. “This is going to continue at least for three to six quarters, so we must be mentally prepared that this is not going to come back very quickly.”

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