Budget Hump?

Climbing wall of worries is a part and parcel of any bull market. The phenomenon of surmounting negative news and keep climbing is what “wall of worries” refers to. This bull market has seen it all. Pandemic could not puncture it, nor regime change in the US. Now, we are in the midst of a formidable second wave in the western countries. Yet, this liquidity driven bull market has thrived, though there are some signs of fatigue in the global markets now with some sort of risk-aversion returning. This, coming at a time when Indian markets are already nervous about the Govt.’s upcoming budget, has set off a serious correction in the Indian markets.

Why is budget giving jitters when many positive long-term reform measures are expected in the upcoming one? Some key proposals include formation of Bank Investment Co. to push through privatization and governance reforms in PSU banks, setting-up of a new Investment Finance Co. to scale-up investments in infra sector and large scale privatization in non-strategic sectors (as cleared by cabinet on 27th Jan). While these are going to be positively supporting the long-term direction, what worries the markets is the buzz around new tax/cess proposals to fund Covid related expenditure. Of course, if they come, it could swing the sentiment negatively in the short-term. But its negative impact on the medium to longer term will be limited unless budget is regressive on reform measures. Not to forget that the budget will lose all the buzz in less than two weeks (going by previous ones).

Looking beyond the budget, the broader direction will be more determined by the flow of liquidity and FII action than anything else. With no change in sight on both fiscal and monetary policies in US, flows will continue to positively surprise. Given this setting, if Indian market corrects sharply in the short-term, it will be a great opportunity to add to the long-term positions as the budget hump is unlikely to change the medium-term direction of the markets.

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Is PLI Scheme a Game Changer?

After many false dawns, Govt. finally seemed to have figured out the framework for boosting domestic manufacturing.

In the era of big-tech dominated virtual world, hard-core manufacturing is hardly the place where one would look for excitement. But, back home here, that is the space that is buzzing with lot of actions of late. Sample this…

  • Apple to bring in more of its global suppliers in the component space (not handset assembly, but the entire eco-system for parts).
  • Dixon to foray into ICT hardware (Laptops, Tablets, Desktops manufacturing in large scale).
  • Tata to invest in a green-field project for phone component plant for Apple (entailing Rs 5000 Cr).
  • Corporates have lined-up significant capital investments in Specialty chemicals/API/ Agrochemicals etc. under PLI.                                                                          

India’s manufacturing has been on a secular decline for long. From 17%+ contribution to the GDP from the start of the decade, it has steadily slipped to an abysmally low level of 13% now. Arguing fiercely about India’s failing manufacturing has been a bit like flogging a dead horse so far. It was considered waste of time and energy as archaic policies, acute under-investment and unproductive cost structures steadily shrunk India’s manufacturing into global irrelevance. This has been the story so far. Not any longer. In a rare coincidence, seemingly unconnected events have come together to conspire a deadly concoction for scaling-up domestic manufacturing in India. Pandemic-induced global push-back on China coming at a time when India has finally figured out a framework for boosting domestic production in the form of PLI (Production Linked Incentives) seems to have done the magic for manufacturing. Concessional corporate tax of 15% for new manufacturing projects, though unveiled last year in isolation, seemed to be miraculously well-timed (in hindsight of course) to make the PLI programs extremely attractive for the corporate chieftains. Similarly, with the end of deleveraging cycle, PLI projects come as a well timed target for the corporates to soak up their high level of cash surplus in their cleaned up balance sheets.

Now, let us come to crux of the story. Why PLI could turn out to be the ultimate panacea for India’s manufacturing? Some seasoned stalwarts have even gone to the extent of calling this initiative as the second industrial revolution for India. Why it has created so much buzz?

If we go back in time, in India, many incentives have come and gone in the last few decades, yet no perceivable progress in the exports or in domestic productions. India had a history of too many incentives with too little impact i.e. MEIS (Merchandise Exports from India Scheme), Duty Drawback, Export Promotion Capital Goods, Tax Rebates and what not. With many of them hitting WTO bumps now, it is dead-end for much of these schemes.

Needless to say, in this back-drop, one needed an innovative scheme that is both WTO compliant and exports-oriented at the same time. Here is where one sees Govt.’s smart thinking in the structuring of PLI. With elevated hurdle (production threshold) over which the incentives kick-in, indirectly it pushes the companies under PLI to export the excess production (beyond the domestic demand). This way, Govt. has managed to kill two birds with one stone. Smart-thinking doesn’t stop here. It runs in the innovative structure for the distribution of incentive amount. Govt.’s usual way is to distribute the available quantum across all the players, without any linkage to efficiency. It is far from usual for the PLI structure. Incentives are distributed to the three or four largest players (not to all) selected thro’ bidding process, that too only for the incremental production beyond threshold. This seems the most efficient way of using the scarce financial resource, given the limited fiscal elbow-room for the Govt. 

Going by the success of PLI in mobile production and by the growing Corporate’s interest in other sectors such as consumer electronics, specialty chemicals, agro chemicals, textiles etc., at last, Govt. seemed to have hit on something that could genuinely turn out to be a game-changer for the domestic manufacturing, though it is still early days. In terms of its impact on the medium to long-term growth potential, CLSA in its recent report, estimates that it could add close to 1.7% (170 bps) to the GDP growth from year 2027, given the large outlay of 2 lakh crores over next five years towards PLI. In the interim, the expectation is that it will add up to 40bps to the growth from FY22. This is not small, given the current low base of manufacturing in the overall GDP (80 to 90bps: 13% of average GDP growth of 6%). In summary, it is a big relief that India has finally found a way to up its manufacturing game in the world stage and in the process, to up its long-term growth potential to over 8%+. Interesting times to watch out for.

This article of mine was published in the online edition of Economic Times (21/01/2021). Glad to share the link: https://government.economictimes.indiatimes.com/news/economy/opinion-is-pli-scheme-a-game-changer/80384104

Monday Blues? (Market View)

In a heavily over-bought markets, small fears can get blown out of proportion. In such situations, sharp technical pull-backs are inevitable. This is precisely what we saw towards year-end. With market on one-way rally since Nov, it was technically heavy when the second strain news (viral strain) hit the market. Sharp technical unwinding that followed led to a flash crash on 21st Dec (Black Monday). Since the crash brought back memories of March mayhem, many investors started wondering whether this is time to pull out, esp. when the benchmark indices are trading at life-time highs.

The fear that frets many investors is this: when Nifty and Sensex are trading at life-time highs amid fundamental dis-connect between economic reality and market sentiment, is it not risky to stay invested esp. in small and mid-caps? Investors need to understand that small and mid-caps perform with a lag. While the initial leg of the rally is led by benchmark indices, action shifts to broader markets in the later leg of the rally. Going by past cycles, we may be in for a big surge in small and mid-caps like the one witnessed between 2015 and 2017. This does not mean that there will not be corrections on the way. Brutal volatility like the one we witnessed on Black Monday will come and go, not once, but many times. One should be prepared for such Monday Blues. But that is unlikely to affect the overall positive medium-term trend for the broader markets. Any such interim corrections should be grabbed as an opportunity to build long-term portfolios.

On the dis-connect between fundamentals and economic reality, one needs to understand that the markets are forward looking and hence driving with a rear-view mirror (looking at the economic slump of 2020) will be unwise and will be self-defeating. As highlighted in our earlier blog posts, in the eyes of global investors, India’s even modest growth outlook will look extremely attractive in the back-drop of  scarcity premium for growth on account of ample liquidity amid slowing global economies. Not stopping with this, with the stunning turn-around that may be unfolding in India’s domestic manufacturing because of effective implementation of PLI and other structural reforms (labor and farm bills), India story can catch the fancy of global investors not in the too distant future.

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