December seems to be an action-packed month with the winter session of parliament lined up on GST and Land bill while the Fed meeting is lined up on the international front. Whichever way these events unfold, it will have a direct impact on the markets in the fast approaching new year
Step back to mid-2013 when the Indian economy was fragile and the Fed threatened to taper Quantitative Easing (QE), India went through a pretty rough time—currency went down 20%, equities went down in high double digits. Cut to 2015 and India is now at a position where its macro-stability has been the best it has seen in history. Current Account Deficit (CAD) has gone down from 5% to 0% of GDP, inflation has gone from 11% to sub-5%, fiscal deficit has gone from 6.4% to 3.8% and GDP growth has gone from 4% to 7%.
Policymakers in India have delivered— the government and central bank have both played a role in this. RBI helped the cause by keeping real rates positive. The ease of doing business, which is the focus area now, did see a rise in the recent rankings— the best performance in the last six years. It has been a good performance and India enjoys better external stability which is why the rupee has been one of the best performing currencies in the world, and the Indian stock markets have Goods and Service Tax (GST) bill Land bill Opposition parties 18 The Finapolis l DECEMBER 2015 also been one of the best performing ones in the world.
While there is unmistakable sign of improvement in business confidence, global investor optimism about India, there are still signs of slowdown in corporate earnings growth. Yes, earnings growth has not come back even after six quarters of new government, despite enormous anticipation of market participants. The earnings recovery is taking much longer than everyone’s comfort. When one looks back to see the factors for such a miss in corporate earnings, broadly it may be due to two issues: in the first 3 quarters period of the new government, there was very heavy fiscal tightening and it caused growth to slow. But that was a calculated gamble took by the present government as they have realised that without having control on fiscal deficit, it is near-impossible to create conducive environment for sustainable double-digit GDP growth. The other factor that drives earnings is global growth as several Indian companies’ earnings profile has become quite global. As global growth is still fragile, it has got reflected in Indian earnings slowdown. If global demand and revenues are falling, it is natural that earnings have remained subdued, even though the margins have expanded.
At the current stage of India, it needs enormous amounts of Foreign Direct Investment (FDI) to come in. The Modi government has done well on these terms. If you look at recent FDI numbers, it is at a record high, and India now ranks No. 1 in the world in attracting FDI surpassing China and US. For such global inflows into India to remain and multiply, healthy business environment has to be created and sustained.
Prior to Bihar elections, the fear was that if the NDA loses Bihar, it would slip into a populist mode. However, on contrary, NDA is not the one that slips into populist mode, and so an election defeat will only push it to do more reforms. For reforms to be pushed aggressively forward, getting the parliament mathematics and floor management right are quite critical.
The present NDA government has 63 members in the Rajya Sabha, whereas it needs support of at least 163 members to get the constitutional amendment bill passed. NDA has so far, mustered support of 124 members on critical issues such as GST; but it is still short of 39 members to get the bill passed
After a long time, India has got a majority government at the centre but it has got majority in lower house, i.e, Lok Sabha only; and not in the upper house which is the Rajya Sabha. Constitutional amendment bills are required to be passed in both the houses of Parliament. The present NDA government has 63 members in the Rajya Sabha, whereas it needs support of at least 163 members to get the constitutional amendment bill passed. NDA has so far, mustered support of 124 members on critical issues such as Goods and Services Tax (GST); but it is still short of 39 members to get the bill passed. The Congress party has 68 members while left has got 10 members. Together they have enough members to make approving a constitutional bill difficult.
On the back of this political template, NDA government is quite aware that it has to cede some space for opposition parties and some compromises may be inevitable to muster support for critical economic reforms such as GST. The upcoming winter session of parliament is set to offer the market observers great opportunity to sense the likely political strategy of the government for the remaining three-and-half years of their tenure. One may witness that the business of Parliament will show a marked improvement in the winter session. In a democracy, different parties with different agendas have to work together, and that is how it is set up.
Goods and Services Tax
Implementation of GST is going to be a milestone in the direction of indirect tax reforms. In India, there is merely 16% of the population who are tax payers compared to on an average 25% globally. This indicates why big revenue deficit exists in India. Several economists believe that with implementation of the GST Bill, India’s GDP could grow by about 1%. This reflects the significance of this bill and how urgent it is for the Indian economy to implement it at the earliest.
GST is aimed at doing away with more than dozen state and central levies to create a single market. It would be a comprehensive value added tax on the goods and services which would be collected on value added at each stage of sale or purchase in the supply chain. Thus, GST is expected to be more efficient system of taxation and is expected to boost revenue of the center and states.
For industry, the GST adds to ease of doing business, making tax compliance simpler and boost manufacturing by compelling states to be more competitive. For consumers, it is intended to reduce prices with more efficient delivery of goods and services
Presently, goods are liable to VAT, excise and custom duty while taxable services attract service tax. Efforts to bring single indirect tax in the form of GST, was already passed in Lok Sabha and is pending in the Rajya Sabha to be passed. For industry, the GST adds to ease of doing business, making tax compliance simpler and boost manufacturing by compelling states to be more competitive. For consumers, it is intended to reduce prices with more efficient delivery of goods and services.
The reason why it is being delayed in the Rajya Sabha, has more to do with politics than economics. We have a democratic form of government wherein the political party with majority rules the nation. But many a time, a single party fails to acquire majority on its own. Thus, it has to depend on the support of other parties or most of times from opportunist allies to form the government and a situation of policy paralysis arises. The Congress is opposed to states being given power to impose 1% tax over and above the GST rate. Also, it wants alcohol and petroleum products to be included in the new tax regime.
Given the urgency of the situation, it becomes the duty of the government to win over the support of opposition parties to see that GST bill sails through the Rajya Sabha. Opposition parties should also do away with their approach for economic growth and together they should ensure that not only is the bill passed, but also it is made enforceable from 1st April 2016.
This time around, the government has been making claims of getting the bill passed in the Rajya Sabha with the support of opposition parties. It has been giving signals to accommodate the views of opposition parties and amend the bill suitably. Government already has approached opposition parties. But, it does not appear to be an easy task, given the time constraints on one hand and uplifted sentiment of opposition parties after the victory in Bihar election.
Even if GST is passed in the Rajya Sabha, more than half of 29 states will have to ratify the same before the Parliament passes another enabling bill to implement the new tax regime. We should hope that good sense will prevail on both ruling and opposition parties and consensus is arrived with regard to passing the bill and making it enforceable soon, even if the given time line of 1st April 2016 is not adhered to.
It is of paramount significance that GST bill is passed to create a fertile business environment. Global investors understand and have got confidence with regard to huge business opportunities Indian economy offers wherein they can multiply their invested money.
Land Bill
The land bill was another important reform, but the subject is quite sensitive considering the enormous interests involved in the matter. Eventually, the states will decide on this subject—this is exactly what happened with labour reforms. Wherever there is concurrent law-making power, the reforms will happen at the state level.
One of the key aspects in the last 18 months is a sense of competition amongst state government to attract investments into their respective states. The state governments realise that the only way to keep public happy is through growth. If that has to be achieved, they have to sustain reforms at state levels – that too better and faster than the competing state governments – to attract global money into states. This is a healthy trend of doing reforms, which is bottom-up, rather than top-down. Top-down reforms work only in certain areas. It does not work in contentious areas like land and labour, where there are diverse opinions and several local factors.
The government will continue to push forward with reforms and the next big thing will be the bankruptcy code, and that will be the significant contributor towards the ease of doing business. So, upcoming winter session of parliament in December is likely to become centre- stage for all these events to unfold.
US Central Bank Likely to Move on Interest Rate: Global Game in the Hands of Fed
One other crucial event to watch out for is the Fed meeting on 15-16th of December. Janet Yellen, Chairperson of Federal Reserve, while deliberating on October Fed policy had given a strong signal with regard to effecting interest rate hike during forthcoming December Federal Open Market Committee (FOMC) meet depending on the assessment of incoming economic data. Since then, there have been data releases which have been largely favorable to mixed nature. However, data pertaining to the job market and inflation have shown substantial improvement in the US economic situation. Improvement in US job market has had cascading effect in the sense that manufacturing, housing, consumer spending, trade - all experienced smart recovery thereby providing strength to the US economy. However, there are some sectors like Retail Sales, PPI and Industrial Production have remained laggards in the process. Nonetheless, it seems that objectives with which different variants of QE policies were introduced at different levels and years have strengthened the economy.
The manner in which the US economy has recovered from the 2008 crisis and has started experiencing all-round growth, it appears that it is going to be a sustaining growth and hence, QE has been big success there. The confidence gets reflected in the voices of majority of Fed members who support the move of raising interest rate during December meet and see diminished risk from contracting Euro Zone, Chinese and Japanese economies on the one hand and geo-political tension on the other, which is obvious from the release of FOMC Minutes.
However, there are still some members of FOMC which consider the situation being not that ripe enough to affect rate hike at this stage and feel the need of closely monitoring the incoming data releases. As things stand today, Fed remains on course for rate hike and any chances of differing on rate hike depends on the incoming economic data of the poor showing if the geo-political situation is aggravated substantially.
Conclusion
The relative story of India remains strong. India is enjoying overweight position in the portfolios of several global investors vis-à-vis other emerging markets. The slowdown in other emerging markets such as Brazil, Russia and China is partly helping India to get overweight from global investors.
However, the rest of the emerging world looks extremely attractive on headline valuations, compared with India. On the medium-term basis, we feel India can retain its valuations premium as it has a better growth story. In the next 12 months, on a relative basis, India should continue to do well, and on an absolute basis, may be the returns will be better than what they have been in the last 12 months. Economic growth is expected to steadily improve. Hopefully in 2016, GST will also be done and implemented, and that will bring about change.
December seems to be an action-packed month with the winter session of parliament lined up on national basis and Fed meeting lined up on international basis. Whichever way these events unfold, it will have a direct impact on the markets in the fast approaching new-year of 2016. We are in a modest return world and let’s hope India will stand-out with high returns in this modest return world.
Written By: Jagannadham Thunuguntla