UTI AMC group 
Beyond the Second Wave
28 May, 2021
Resilient Equity Market
Indian equity markets have resolutely defied the social devastation wrought by the second wave of Covid. Markets typically price the known risks to perfection and the economic impact of the second wave seemingly falls in the category of known risks. This week, India’s market capitalization crossed USD 3 trillion for the first time, a testament to India’s core strengths. Investors are looking past the short-term disruption to the enduring structural growth drivers.
In the past twelve months, foreign investors pumped an unprecedented USD 34 billion into Indian equities. Evidently, no one wants to be excluded from the ferocious recovery rally, the likes of which we witnessed in 2020. Domestic Investors continue to invest regularly into Indian equities even as foreign Investors apprehensively trade in and out on a tactical basis.
Economic Momentum
Despite the humanitarian tragedy of the second wave, the Indian economy continues to grow at a rapid clip. We forecast the GDP growth for 2021 to be around 9.5%, making India world’s fastest growing large economy. The lockdowns this year have been sporadic and restricted to some states. Statistics show that the reduced individual mobility has not really hampered economic activity. Most of the states that imposed lockdowns allowed construction and manufacturing sectors to operate as normal.
Overall, businesses and consumers seem better adjusted to the restrictive environment this time around. In the coming weeks, as vaccinations accelerate and restrictions are gradually eased, we foresee pent-up demand to induce a strong recovery. In addition, the government is planning a new round of stimulus package to support the vulnerable segments and promote job creation.
Hidden Megatrend
A defining feature of the Indian economy over the past few years has been the consistent shift of businesses from the unorganized sector to the organized sector. This megatrend was triggered by the enactment of the Goods & Service Tax (GST) in 2017 and has been accelerated by the disruption caused by the pandemic. Introduction of GST forced millions of small businesses which operated informally to declare their presence to the tax authorities. This recognition of small businesses has enlarged not just the tax revenues but also the size of India’s formal economy.
These marginal players with precarious profitability have been severely challenged by the lockdowns. In nearly every industry, these local businesses have been losing market share to the larger established companies with strong operating margins. This natural Darwinian megatrend is creating an ever expanding universe of large-scale sustainable businesses – a foundational resource for India’s equity markets. The number of Indian companies whose market value has exceeded a billion dollars has touched an all-time high of 335, exceeding that of countries like Germany, France, Canada or South Korea.
Exports – A New Engine of Growth
Historically India’s economic might has been predicated on consistency of domestic consumption. However, of late, the Government is actively cultivating exports as a strong second engine of growth. The geopolitcs of US-China trade wars has given impetus to this campaign and India has rapidly developed a policy framework for encouraging export-orientated manufacturing.
As global corporations de-risk their China dependency and relocate some of the supply chains, India is aggressively incentivizing them to manufacture in India. In March’21, India recorded the highest ever merchandise exports with a 58% year-on-year growth and the trend continues in April. While Engineering goods and Pharma have been primary contributors to the surging exports, gems, jewellery and grains like Rice & Wheat are also trending higher. India is capitalizing on the global disturbances to strategically expand its export footprint.
Interest Rates & Currency
The real challenge to the growth story is potential increase in interest rates on rising inflation risks led by a spike in commodity (agriculture, metal, oil) prices. Given the optimistic monsoon outlook for this year, we don’t expect food inflation to be persistent. As such, we expect inflation to remain within RBI’s ‘comfort’ band of 2% to 6% .
Thus, RBI continues to inject liquidity into the system to contain credit costs, particularly for SME borrowers and Micro-finance lenders. The Indian Rupee was the best performing Asian currency during Q1 of 2021 however it has slipped with the outbreak of the second covid wave.
Our view is that the INR will remain range-bound against the USD between 72-74 this year. Short-term outflows caused by foreign portfolio investors (FPIs) are not likely to be material while FDI inflows will continue to be strong. Once normalcy resumes post the current lockdowns, FPI inflows will recover along with growth expectations and policy support.
With exports becoming increasingly relevant as a growth driver, it is unlikely that the RBI will allow INR to strengthen.
