09/01/2017
ECONOMY AFTER TRUMP AND DEMONITIZATION
The US election in itself was very controversial, as everyone was looking forward to the victory of Hillary Clinton but her “damn emails” reportedly made her lose her won battle, however after the victory of the US Presidential candidate Donald Trump on 8th November led to a panic in investors. Investors in stock market currently regard the Trump Presidency as a relatively low probability development. The predictions by the economists clearly stated that the market would drop down by 10% , causing a huge panic state in the global stock market. The initial jitters however , gave way to strong market rally. The same day , the Indian Prime minister Narendra Damodardas Modi announced demonetization of Rs 500 and Rs 1000 notes, clearly stating them not to be a legal tender anymore leding to an heightened market votalitity.
The impact of these two spread across the asset classes which are discussed in brief as follows :
EQUITIES
The day after demonetization was announced and trump won the US Presidential Election , the BSE Sensex opened with a massive loss of 1300 points although it recovered later. It rallied on 10 November and reported net gains for these two days of trading, only to tank 700 points the next day. On the president elect- trump, market track news on the policy front as the focus is turned towards the US Fed policy meet. After the victory of trump however, the 10- year bond yield in the US has gone above 2%, after a gap of eight months, and the market has started factoring an 80% chance of a rate hike in December, which clearly states that the volatility will return. “The global unfolding of these two events and the market jitters created by them presented a value buying opportunity”. However, the impact of these events is not over and shouldn’t be ignored by the investors. The ripple effect of demonetization cannot be understated. There may be a negative impact on the GDP in the Oct– Dec quarter, as consumption shock gets transmitted into the system. Some rupee appreciation in the forex markets is also expected as notes in circulation will decrease. The sectors with a lower incidence of cash transactions may see rise in investment after demonetization in India. And the sectors with a higher incidence of cash transactions will suffer the most, including real estate, luxury items, jewellery, retailing, logistics, consumer durables, SME/rural lending, etc. Here the point to be noted is 86% of the currency in circulation has become unusable for commercial transactions. Consumption oriented sectors like building materials, consumer durables and retailing will be the biggest beneficiaries in 2017. Long term positive for banking sector due to expected push on CASA and expected increase in fee-based income. Infact , It is best to avoid realty stocks as the sector will be among the worst affected by the demonetization move. The housing finance sector, will also be under pressure. “Housing finance companies are likely to witness some stress on loans given to real estate developers who are likely to face a liquidity crunch in the short term.
Business domains with exposure to unaccounted wealth should be avoided. Even if 20% of the existing Rs 500 and Rs 1,000 notes are not exchanged, it will amount to a permanent wealth destruction of Rs 3 lakh crore. This could impact sectors such as real estate, jewellery and banks. The consumer non-durables sector is also likely to face some heat. While the impact on small-ticket discretionary spending will likely be minimal and short term, high-value items can experience long-term impact. The luxury goods market is likely to get affected as this move represents an erosion of real wealth to a large number of people. Mostly felt in luxury cars, SUVs, gems and jewellery and high-end branded products.
Since Trump has repeatedly said that his government will stop jobs from leaving the US, the BPO and the IT industry may suffer. Trump has talked about restricting entry of skilled labour from overseas countries to protect jobs in the US. So, the IT sector could remain under pressure, at least in the near term.
On the positive side, some export-oriented sectors may benefit if the next US president maintains his view of China as a potential adversary and increases imports.
Gold
Gold has been the most seriously impacted asset by the duo events, investors made the gold glitter more with the rise in their investments in it. The demonetization has boosted Indian investments sentiments such that it has reinforced the belief in gold as a safe heaven. Several households converted their currency into gold after the demonetization move was made public on the 8th of November. Infact several gold jewelers opened their shops uptil late midnight to facilitate the same.
Debt
The debt market reacted positively to the trump’s victory and demonetization effect leading to decline in inflationary pressures as demand comes down in the short term keeping prices in check as the ability to hoard commodities and other assets will be greatly reduced. Improvement in government finances due to shift of the black economy to white—increased tax compliance and better revenues for government— is another positive aspect. The debt market has also started expecting further rate cuts, which, again, is good news for debt investors. “With the household inflation expectations coming down, the possibility of rate cuts is increasing.”
Real estate
The real estate is the biggest receiver of black money. The short term impact on the sector would be very serious(adversely). The number of transactions and prices in residential and land markets may see a substantial downward trend. The impact will be felt across the board with tier-2 and tier-3 markets taking a larger hit .With the black money component going away, land prices will fall gradually. This will ultimately benefit the end users by bringing down per square feet prices.
Key macro implications-
We believe that this move is likely to bring down corruption in the economy, increase tax collection, broaden tax compliance substantially and provide a boost to economic growth by amalgamating shadow economy with the formal economy and lead to a marked shift towards organized players.
a) Higher GDP growth as black economy is subsumed in the formal economy- The World Bank in July, 2010 estimated the size of the shadow economy for India at 23.2% in 2007. Various studies now point this number to be higher at 25% (i.e. USD 500-550 billion). A parallel shadow economy generates inflation and reduces revenue inflows for the Government, which could have been otherwise used for welfare and developmental activities. This clampdown on black money would lead to integration of these unaccounted for transactions in the mainstream economy leading to higher reported GDP number.
b) Higher tax-to-GDP ratio from proper reporting of income: Income tax collection is expected to see an uptick as funds earlier unaccounted for enter the banking system and eventually get taxed. On a USD 2 trillion economic base, total unaccounted tax is estimated to be USD90-100billion as against the actual tax collection of USD225-250billion in FY16.
c) Higher household savings in financial assets: Household sector saves either in the form of a) financial assets (40% of total household savings) including currency, net deposits with banks, investment in shares and debentures, life insurance funds, provident and pension funds or b) physical savings (60% of total household savings) including real estate, gold, etc. Historically, savings in physical assets has been higher compared to financial assets. However, with the attractiveness of other asset classes diminishing due to expected fall in asset prices, skew in savings mix is likely to correct favouring financial products. Also, a huge upside can also be expected from the shift in unorganized money lending and informal investment schemes, such as Chit funds, to the formal system, thereby creating a robust demand for financial assets. We further believe that a higher proportion of savings in financial assets would get channelized through equity markets, including direct equity and mutual funds products, due to relatively higher return profile compared to other financial products.
Summary of macroeconomic impact
Macroeconomic Indicator
Short term Impact (H2FY17)
Long term impact (12 month and beyond)
GDP Negative – Consumption and investment demand to suffer due to cash crunch Positive – Rise in consumption due to efficient price discovery and higher investment in economy supported by the rise in tax collection to have a long term positive impact.
Fiscal deficit/ tax collection Neutral – Higher tax collection may come with a lag Positive – Better tax compliance and tax collection on nearly 25% of the unaccounted for funds to help improve fisc position.
Investments Negative – Short term working capital constraints and refinement of upcoming tendering process may cause some delays Positive – Higher tax collection to provide flexibility for increasing investments in creating infrastructure
Inflation Positive – To lower as downward pressure on prices persist due to lower demand Neutral – Unlikely to impact the long-term trend
Digital payment Positive – Higher incentive to use digital payment platforms Positive – Larger population base to be brought on board the digital ecosystem
Sectoral implications: Sudden tightening of liquidity is likely to impact demand across many sectors in the near term. With 86% of the currency in circulation becoming unusable for commercial transactions we believe that the sectors with a higher incidence of cash transactions will suffer the most, including real estate, luxury items, jewelry, retailing, logistics, consumer durables, SME/rural lending, etc. Thus, the widely anticipated demand upturn in the second half of FY17 on the back of good monsoon, pay bonanza for government employees and festive-season buying may see some disruption. Despite near term glitches in specific sectors, expecting significant long-term benefits to emanate from this move. We believe that across sectors a structural shift would be visible due to
a) Rising adoption of high end technology creating a robust digital financial ecosystem- we expect private sector banks to be the key beneficiary of this trend leading to higher fee based income and increase in savings deposits
b) Clear incentivization to shift from the unorganized to the organized platforms – Consumption oriented sectors like building materials, consumer durables and retailing would be the biggest beneficiary of the shift
c) Improvement in transparency leading to better governance standards. – this will have a far-reaching effect across all the sectors in the form of efficient price discovery, higher transactions through the formal system, etc.
Impact of this move on the performance of specific sectors and companies is analyzed below.
Sector Impact Factors Impact on companies under coverage:-
Real estate- Negative Negatives
• Project ex*****on delays: Black component in real estate transaction would reduce impacting working capital availability with the builders
• Lowering of demand: Micro markets with high investment demand to suffer the most in the medium term.
• Price correction: Reduction in land cost and lowering of demand to put pressure on prices.
Positives:-
• Shift towards organized players: Curb on cash transactions will impact unorganized players, creating a shift towards the organized segment
• Efficient price discovery: Transparency in the system will lead to efficient price discovery for genuine buyers Long term positive for organized players like Godrej Properties
Banks Positive Negatives
• LAP portfolios to suffer: LTVs on LAP loans to rise making these assets riskier
• Retail portfolio slowdown in short-term: Banks may have to relook underwriting processes for retail and rural financing for the next few months implying potential slowdown
• Asset quality dip:a) Cash based EMI collection to be impacted leading to higher NPLsb) Rising risk on the LAP portfolio due to asset value contraction leading to high LTVc) Small business owners (SMEs/MSME) will find difficult to make payments on time
Positives:-
• Liability profile to improve- CASA improvement as unaccounted cash finds way in the mainstream banking system
• Higher fee income: Higher e-transactions, rising demand for credit and debit cards to result in higher fee income for the banks equipped with latest technology Long term positive for IndusInd Bank and Axis Bank due to expected push on CASA and expected increase in fee-based income.
NBFCs Negative Negatives:-
• Pressure on LAP portfolio: May slow down due to rising risks
• Rural lending slowdown: Lending to rural markets would be impacted as collection is mostly in cash
• Asset quality dip:
a) Cash based EMI collection to be impacted leading to higher NPLsb) LTVs on LAP loans to rise making these assets riskierc) Small business owners (SMEs/MSME) will find difficult to make payments on time
Positives
• Demand pick up in CD financing: Cashless transaction will spur demand for CD financing options Pressure expected in H2FY17 on the LAP, SME and rural portfolios of Capital First, Bajaj Finance, Edelweiss and L&T Finance but over 12-15 months this trend is expected to even out.
Housing Finance Negative Negatives
• Loan growth to slow down: Anticipated project delays and overall price correction to impact loan book growth in the medium term. However, in the long term it is a positive for the HFCs due to rising eligibility limits and no cash component in transactions.
Positive
• Current Portfolio: May not be impacted as most lending is to genuine home buyers Negative for the loan book growth in the medium term for Repco and DHFL, asset quality however may remain intact.
Cement Negative Negatives
• Indirect impact on demand: – 60-65% of consumption is by the real estate sector, therefore demand may be impacted due to expected slowdown in the real estate sector
• Pricing pressure – Cement companies may cut down prices to tackle low demand, a rising cost scenario does not bode well for profitability of the sector. Neutral impact on Ultratech as we expect demand contraction from housing to be compensated by the rise in infrastructure demand. Also, despite pricing pressure co. is expected to report better profitability supported by improving efficiency.
Building material Negative Negatives
• Demand slowdown: Demand for building materials such as tiles, sanitary ware, plywood, laminates, etc. would see an indirect impact due to lower demand from the real estate segment.
• Pressure on receivables: Companies focused on tier-2 and 3 cities/towns, where a large part of the transaction is on cash basis, may face cash crunch in the short-term
Positives
• Move towards organized segment: Sector to benefit from the shift towards organized players Long term positive for building products players due to increasing shift in trade towards organized players including Cera Sanitayerware and Greenply.
Retailing Short term negative Negatives
• Gold and jewelry- Demand for gold and jewelry is expected to drop as traditionally large unaccounted cash transactions are a common occurrence in this segment
• Consumer Durables- Most consumption is B2C and ticket size is small prompting cash transactions (70-75% of current sales), temporary dip in volumes expected
Positives
• Discretionary items– Demand for high-value luxury items may not be impacted as PAN disclosure is mandatory for Rs 2 lakh plus transactions, even currently.
• Non-discretionary goods– Demand is sticky, therefore no long-lasting impact anticipated on these products
• Move towards organized segment in jewelry – Curb on cash transactions will be a huge positive for the organized players. Neutral for the luxury watch retailer, KDDL as plus Rs.2 lakh transactions already have a mandatory PAN disclosure requirement.
Long-term positives for the Consumer Durable plays, like Havells and Crompton Greaves Consumer electrical due to increasing shift towards organized segment.
