/ India

Budget 2016

To start off with the blog, we want to go over the impact of the budget on the market for the next one year. This budget has evoked very mixed responses from observers, ranging from excellent to unimpressive. Very few are of the opinion it is a bad budget however, as compared to the previous year. We go over some sectors and stocks-


Roads and highways are big priorities for this government, and they are making a lot of efforts to push up the pace of highway construction. Currently, they claim to be constructing 30km of highways per day. This is a record of sorts for India, and the pace of awarding contracts is expected to pick up further. This is likely beneficial to cement companies and other contractors involved in road engineering. This also bodes well for real estate and logistics companies in the longer run.
On the downside, a few big names like Larsen & Tourbo have massive revenues from the Middle East. Due to the social unrest and budget deficits, Saudi Arabia, Qatar, UAE have drastically slowed their infrastructure spending, and this is going to act as a drag on earnings for several quarters.

PSU Banks

Last year, the problems with PSU banks were already apparent, yet very little capital was committed to help resolve the issues, nor was there any follow up action by RBI or the banks themselves for recovery of loans. The last one year, all of this has started, and the process of cleaning out the rotten books is well underway. Given this background, there is likely to be some bounceback among the PSU banks, but overall demand for new loans from corporates remains sluggish, and consequently, is unlikely to produce any lasting rally in this sector.

Iron and Steel

This was a sector severely affected by cheap Chinese imports. Starting from 2009, the Chinese stimulus added huge extra capacity to an industry already reeling from overcapacity. Meanwhile, investments made from 2006-08 started coming online making the problem even worse. The world has yet to recover from the glut of excess steel, and several countries are starting punitive trade barriers to help their domestic companies. US recently imposed a steep 200%+ tariff on Chinese imports. Most of the rise in steel prices from 2004 was driven by the unprecedented boom in China, and this is unlikely to repeat anywhere else in the world, much less in India. As a result, this sector still has some time before it sees growth.


Maruti has been one of the best performing large auto companies for the last few years. The drop in the Japanese Yen further helped margins and drove the stock to a record high. The Yen depreciation has stopped for now, and sales are stagnant. M&M is heavily dependent on rural sales for its bikes as well as tractors. While the monsoon was terrible the previous two years, it is expected to be normal this year. A good harvest in the mid year would mean good sales growth for M&M, but is a couple of quarters away.


The big reform in the last one year in this sector has been transferring the debt from the power companies to state governments. This reduces the interest cost and could provide the much needed margin to get to breakeven. Raising power tariffs is sorely needed, but politically tough. However, reducing bottlenecks in the supply chain and reducing interest costs are also big positives, and help the bottomline.


IT continues to see little growth, with the exception of Infosys. A lot of revenues of the IT industry depend on IT spending in US, and with the US economy still in a tepid 2% growth, this has grown very slowly. Oil and Gas, industrial manufacturing are cutting costs, and this may lead to further cuts in IT projects. Cloud computing, big data analytics, AI, network security are big areas, but do not form a substantial component of earnings for any listed Indian IT company.


The FMCG sector has seen some unexpected surprises in the last one year.Nestle got its noodles banned, and the controversy continued for a while as testing was underway. This has had a huge impact on their stock price, and is yet to fully recover. Meanwhile, a new fast growing player is capturing market share very aggressively- Patanjali. It is also unlisted, and the uncertainty about the impact on market shares of other players is keeping a lid on their prices.


This has been a great sector to be in a portfolio since the 2008 crisis. As healthcare spending continues to grow, and the Rupee depreciates, the sector's profits have gone up substantially. The last one year has seen unprecedented activity from the US regulators and notices served to manufacturers. While this is stable in the long run, the uncertainty due to US government agencies makes this a risky sector.


The positive factors driving the markets right now are:

  • An expectation of a normal monsoon- a large portion of the population directly or indirectly relies on it for income, and a good monsoon ensures low food inflation, and higher rural incomes.
  • Enabling the banks to use their real estate and other holdings as eligible for capital ratios was a big move, and helps cushion the banks against being forced to raise capital at rock bottom prices, or very expensive yields.
  • Bank actions against wilful defaulters- SBI has filed a suit against Mallaya, of Kingfisher Airlines, to block the compensation offered to him as he is a guarantor for his company's debt, and has failed to repay the bank. This may set the trend in motion for PSU banks to move against other debtors. While this is a good start, it remains to be seen if SBI recovers a significant amount of the debt.
  • Extension for the RBI governor- The current term for Raghuram Rajan ends in September 2016. So far the government has not indicated if they will extend his term. Certainty in this regard will help stabilize the currency.
  • Global macro - Most of the Eurozone, Japan are struggling with deflation. Japan recently auctioned a 10Y bond at negative yield. China's slowdown has also reduced demand considerably. Getting growth through trade is at best, tough, at worse, impossible in such economic conditions. The biggest driver of growth- the US economy, is also growing sluggishly at barely 2%, 9 years after the last recession. The Fed is unlikely to hike rates soon when the rest of the world is near deflation, but even the current rate does not indicate an economy in an upswing.
  • Ultimately, all returns depend on either a price/earnings ratio expansion, or earnings growth, and ideally both. Currently, almost every major economy is trying to grow through exports as structural reforms are unpopular politically. Central banks are doing their bit by devaluing currencies to stay competitive. When everyone tries to devalue and export, nobody wins, and everyone loses. This is the most divergent monetary policy positions in a long time, with Japan and Switzerland at negative rates, Europe , UK at near 0, and US hiking from 0.25 when growth is slow. In such a scenario, earnings growth is unlikely, which leaves multiple expansion. Multiples have already peaked, and while nothing stops them from expanding again, they are likely to mean revert lower before going higher again.