As has now been spoken about ad nauseam, investors are worried about the long-term growth outlook for India. What is India's true structural growth rate? How quickly and to what level will growth rebound in FY22, after the pandemic shock? Was Indian growth truly overstated as Arvind Subramanian seems to imply?
The debate on growth is an important one, and depending upon what comes out
of this debate, India seems either very attractive or not interesting at
all.
The growth dynamics affect most of our long- term macro variables. Debt
sustainability being the most critical. If India does not get back to at
least 10-11 per cent nominal gross domestic product (GDP) growth, then the
country will have real issues in trying to stabilise public debt ratios.
Similarly, without stronger growth, one does not see how the tax revenues
will be in place to permit greater public investment and maintain fiscal
sustainability. Even from the narrow lens of the stock market, there is a
correlation between economic growth rates and corporate profitability (both
growth and level). Unless we get growth to accelerate over the coming
years, it is unlikely corporate earnings will meet expectations. In the
absence of an earnings acceleration, the outlook for market returns is
bleak. Just take a look at the last five years. Between FY15 and FY20, the
Nifty delivered a compound annual growth rate (CAGR) of only 1.7 per cent.
This modest number was derived from an earnings CAGR of 2.7 per cent,
dividends of 1.4 per cent and a valuation derating of 2.4 per cent (source:
Motilal Oswal). Valuations are procyclical and multiples also move up or
down with growth rates and confidence in the growth outlook. If we don't
see economic growth and earnings pick up in the coming years, we are
destined for another period of mediocre market returns.
It is now a consensus view that for growth to pick up in India, its
financial system needs to be fixed. We have undergone a series of shocks to
all segments. The asset quality review forced the banks to disclose and
provide for all bad assets. Frankly the public sector banks (PSBs) never
recovered. Then we had the IL&FS crisis, which effectively wiped out the
business model of non-banking financial companies (NBFCs) and housing
finance companies. No longer able to access debt markets, their structural
funding weaknesses and asset liability mismatches came to the fore. After
the Yes Bank fiasco, the smaller private banks are running scared, some
have got beaten down to below book and have to pay a large risk premium for
deposits.
Unfortunately, the way markets are behaving, investors seem to have given
up hope of the financial sector recovering from the Covid-19 shock anytime
soon. Price action does not indicate that investors believe that the
financials will lead us out of this economic slump.
Current valuations seem to imply that we are in for an extended period of
weakness on both asset quality and earnings for the vast majority of the
financial system. This does not bode well, for without a recovery in the
financials, I do not think the economy can bounce back.
This is for the simple reason that the financials have been the
worst-performing major sector year-to-date. Most of the major banks are
down between 30 per cent and 45 per cent and all the laggards in the
BSE-200 index are financials. There is not one major financial stock that
is up for the year.
One can understand why the financials led the way in the Covid-related
sell-off. The sector was over-owned by foreigners, who did all the selling
in the market meltdown. It was natural that they would sell what they
owned. This is where the bulk of their profits were. The sector accounted
for almost 42 per cent of the Nifty, and was thus ripe for a correction.
What has been worrying is the inability of major banks to claw back their
losses, as the markets and economy have started to normalise.
Investors are getting spooked by the extent of the capital issuance in the
space. Every major financial institution is raising equity and the ticket
size for each is between Rs 10,000 crore to Rs 15,000 crore. What do these
banks know that we don't? Is the rise in credit losses going to be so
severe that they all need to raise capital at the same time? That too at
not the best prices for most. Some are issuing such deep discounted rights,
that they are literally forcing their shareholders to subscribe.
Are the non-performing assets once the moratoriums end, expected to surge
to such an extent? Rather than comforting investors, the surge in issuance
is worrying many. There is another associated concern of the relevance of
the numbers being reported. If we continue to have most loans under
moratorium, what is the relevance of the earnings number being reported?
How to value a bank, if one does not know what its asset quality and
profitability are truly?
The markets are saying that we don't think the banks will rebound quickly.
Their growth and profitability is unclear and too difficult to model. This
has implications for the market's view on the economic recovery as well. In
fact, the markets' price action is consistent with a weak economy and the
lack of confidence in a strong V-shaped recovery. The best performing
sectors year-to-date are Pharma and IT services, both export-oriented and
classic defensives. The worst sectors, besides financials are, real estate,
autos and capital goods. All domestic cyclicals. Such sectoral rotation, is
consistent with a lack of confidence in future growth prospects.
The government has done a lot to stabilise the financial sector and address
the risk aversion— from huge liquidity infusions to credit guarantees for
small and medium enterprises to targeted longer-term refinancing
operations. The time has now come to address the elephant in the room. The
PSB model is clearly not working. Except the State Bank of India, no PSB
can raise external capital. Most seem either unable or unwilling to
compete. We need to fundamentally reform their governance, incentive
structures and improve their competitiveness.
The NBFC business model is broken, it will not come back in a hurry. We
cannot have only five or six banks fund our growth aspirations. The system
has to be deeper and stronger. PSBs are important and have to be a part of
the solution to reviving the economy. They cannot be a permanent fiscal
drag on the government.
Yes, we will have to recapitalise them. However, this time the recap must
be accompanied with genuine reform as to how the banks are run.
Privatisation may be politically too difficult, but surely we can reform
their governance without privatisation. Markets are convinced the PSBs have
little hope. More broadly, the markets are negative on the entire
financial system. The government must prove the markets wrong.
Get Best Bank Nifty Option tips for intraday trading to make money here
as we have the best research and analysis team in India.
You
should Trade Less But Trade Accurately & this is Achieved with our Tip.
