Nifty may scale 20400 levels by March’24

Summary

Nifty earnings may be boosted by improving macro, huge fiscal/infra stimulus, growing affluent middle class, RBI/Fed pause, and higher USDINR

India’s benchmark stock index Nifty closed around 18633.85 Tuesday, at a 6-month high on US debt limit provisional deal optimism and hopes of a Fed/RBI pause/pivot coupled with an FII buying boost. So far, the Nifty EPS trend in Q4FY23 is subdued at around 861 against Q3FY23 levels of 850. The FY22 Nifty EPS was around 809, while the market IS expecting around 875 in FY23 (Q4FY23); i.e. an annual growth of around +6%. For FY23, at around 875 estimated EPS and an average PE of 20, the fair value of Nifty should be around 17500.

At the present trend rate, the projected FY24 Nifty EPS may be around 927 (assuming +6% annual growths), and at an average PE of 20, the projected fair value may be around 18020. Further, if we assume 6-10% annualized growth in Nifty EPS in FY25 (depending on actual Fed/RBI rate action, Russia-Ukraine war, and inflation trajectory), projected Nifty EPS may be around 957-1020, which translates to a fair value of Nifty around 18550-20405. As the financial market usually discounts 1Y EPS in advance, Nifty may scale 19050-20405 by June’23-Mar’24.

The subdued Nifty earnings are due to lingering global macro-headwinds, geo-political tensions and resultant sticky elevated inflation, both locally and globally and higher borrowing costs are affecting discretionary consumer/corporate spending, affecting earnings. If inflation comes down and RBI/Fed goes for pause/pivot; i.e. rate cuts in early FY24 (ahead of the general election), Nifty EPS may grow around at least +10% CAGR rate on an average considering huge fiscal/infra stimulus, growing affluent middle class, and higher USDINR (growing policy/macro divergence between RBI and Fed)-positive for export savvy Nifty blue chips (almost 60% of Nifty earnings comes from export).

India is now enjoying scarcity premium not only among EMs but also DMs due to political & policy stability (Modinomics), the mantra of reform & performance, and the appeal of 6D (development, demand, demography, democracy, deregulation, and digitalization). India has strong banks & financial system due to a strong capital buffer and regulatory system. India’s low external debt and manageable trade deficit are a huge advantage compared to many EM peers.

But going ahead, India also has to bring proper political reform, especially on the political funding aspect, proper policy for population control, and more targeted infra stimulus (transport-specially railways and social infra-especially quality medicare and education). Thus the scope for future improvement in GDP and GDP/Capita is immense. This, along with a deluge of quality companies, good business models, growing deleveraging, and impeccable/credible management, the Indian stock market may outperform not only its peers (EMs) but also many DMs.

The next move of Nifty from around 18700 to 19050 levels (around the lifetime high) will depend upon RBI/Fed rate action. On Wednesday (17^th May), in an interaction/prepared speech during the CII conclave, RBI Governor Das refused to assure a pivot (no further rate hikes) or another pause in June and indicated another +25 bps hike in June. Nifty retraced after RBI Governor’s comments/speech.

RBI Governor Das refused to assure CII conclave request for a pivot/pause in June:

Fed increased the repo rate by +500 bps in the last year, whereas core inflation was reduced only by -100 bps, in line with a 2Y bond yield increase of about +150 bps. Fed was already behind the inflation curve from early 2021 when the economy opens fully after the 2020 COVID disruption. Fed should have started to normalize its ultra-loose monetary policy in early 2021 rather than terming higher inflation as transitory and starting the process (telegraphing about QE ending and potential rate hikes) in late 2021. In the process, Fed created synchronized global inflation/stagflation as almost all major G20 central banks usually follow Fed policy action for currency (USD) and bond yield differential. The late action of the Fed coupled with supply chain issues and policy paralysis in the White House created synchronized elevated sticky core inflation globally (except in China).

Fed may hike +0.25 bps in June for a terminal repo rate of +5.50% and go for pause (not pivot) in July and September to assess the impact of higher rates on inflation and the labor market; if core inflation still doesn’t drop substantially, then Fed has no option but to go for another +25 bps hike in November and December for a terminal repo rate +6.00%. Fed may also indicate the Dec’23 terminal rate at around +6.00% with an indication of a pause in Q3CY23.

If Fed goes for another hike of +25 bps in June, then India’s RBI has no option but to match the Fed’s cumulative hike of +50 bps in May and June with a hike of +25 bps in June. If Fed continues to hike even after June’23 to +6.00% by Sep’23 (in case U.S. core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). In that scenario, RBI may like to keep the repo rate at 7.00% to 7.50% in CY23, depending upon the Fed rate action; as USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the narrative) to control imported inflation.

Thus the RBI Governor again reminded the market on the 6^th April MPC statement about the real rate of interest of +4.50% in Feb’2019 (when RBI starts the pre-COVID rate cut cycle to support economic growth); in Feb’2019, the RBI repo rate was +6.50%, while headline CPI was around +2.00%, but core CPI was around +5.25%. Thus the actual real rate of interest about core CPI was around +2.25% in Feb’2019 against Rajan’ (former RBI Governor) preference of around +1.50% (1.00-2.00%).

India’s RBI may also hike +0.25% on 8^th June if Fed goes for another +25 bps hike on 14^th June. Unlike RBI, Fed does not attempt to surprise the market and is sharing/providing appropriate forward guidance through not only official Fed communications but also regular Fed talks. Thus by 31^st May (the Fed blackout period begins), the market as well as RBI should know with almost 100% certainty whether Fed will go for another +25 bps rate hike on 14^th June.

If Fed refrains from any rate hike on 14^th June, then RBI may not go for any hike on 8^th June and may continue to be on pause until core inflation does not spike abnormally. Going by the trend between RBI and Fed rate action since Jan’22, RBI may go for a +25 bps rate hike every alternate meeting if Fed goes for similar +25 bps rate hikes in every meeting (in a hypothetical scenario).

Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 0.50-1.50%; as India’s core CPI is now averaging around +6.00%, RBI may keep the terminal rate between 6.50%-7.50% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, RBI may keep the terminal repo rate around 6.50-6.75% if Fed does not go beyond +5.50% and India’s core CPI stays below +6.50%.

Ahead of May’2024 general election and also various state elections, the main challenge/incumbency factor for the ruling BJP/Modi admin is sticky inflation, especially for food and duel/energy/LPG gas cylinder and unemployment/under-employment despite huge development activities/infra stimulus and anti-corruption initiatives/platform. Thus the government is also under pressure to manage price stability to promote sustainable economic growth and prosperity.

Higher inflation in India is a structural issue associated with black/unaccounted money, supply chain issues, and also higher demand for a rapidly increasing population. As a central bank, RBI may control/reduce demand by higher interest rates, so that the constrained supply can match reduced demand and control inflation to some extent. But at the same time, supply-side actions are also required by the government/fiscal authority to ensure higher/adequate supply at reasonable prices/profit margins to ensure price stability.

India’s inflation eased sharply in April mainly due to higher base effects (y/y), but surged sequentially (m/m):

On 12^th May, the MOSPI (Government) data shows India’s annual inflation (CPI) slowed sharply to +4.7% in April from +5.66% sequentially, the lowest since Oct’21 and just below the market expectations of +4.8% amid lower food and fuel cost coupled with higher base effect.

On a sequential (m/m) basis, India’s headline CPI jumped +0.51% in April, the biggest increase in 6 months and equivalent to a +6.0% annualized rate. In April, India’s annual core CPI also eased sharply to +5.20% from +5.80% sequentially, in line with market expectations.

Overall, the 3M rolling average of headline CPI and core CPI is now around +4.8% and +5.8% respectively. A personal channel check shows inflation may have bounced back sharply in May amid elevated logistic costs, extremely hot weather conditions, and sticky supply chain issues.

India now needs targeted structural reform to improve productivity:

India also pays around 45% of its tax revenue as interest on a public debt against China’s 5.5%, the EU’s 5%, the US's 9.5%, and Japan’s 15%; almost 80% of India’s tax revenue goes to meet the interest on public debt and salary/pension expenses for government employees. This is a red flag and thus global rating agencies are not upgrading India. India needs to improve its productivity and GDP/Capita, which is now among the lowest in the G20 universe. India needs to lower its sticky & elevated core inflation trajectory for low inflation, and a low-interest rate environment for sustainable economic development and prosperity.

India now needs a huge infra stimulus to modernize its slow railway to at least a semi-high speed category, able to serve the huge population properly, which will bring development and economic prosperity. In 1975, the average railway speed between India and China was almost the same; but now in 2023, India still stands around 55-75 km/h, while China jumped to 120-150 km/h (except bullet trains). Thus India needs to improve its vast railway infra for a modern railway system for the masses to improve ease of transport/travel, business, and living.

On 18^th May global rating agency S&P affirmed India’s 'BBB-/A-3' Sovereign Credit Ratings; Outlook Stable:

·         India's economy is performing well amid challenging global conditions. We anticipate sound fundamentals to underpin growth over the next two to three years

·         The government will likely maintain elevated fiscal deficits and a large debt stock despite ongoing consolidation efforts

·         We affirmed our 'BBB-' long-term and 'A-3' short-term foreign and local currency sovereign credit ratings on India

·         The stable outlook on the long-term rating reflects our view that India's strong economy and healthy revenue growth will support its weak fiscal settings

·         The stable rating outlook reflects our expectation that India's sound economic fundamentals will be sufficient to offset the government's weak fiscal performance, helping to sustain elevated government funding needs and a high-interest burden over the next 24 months

·         Downside scenario:

·         We may lower the ratings if: (1) India's economic growth slows materially, on a sustained basis, such that this negatively affects its fiscal sustainability; or (2) changes in net general government debt, general government debt to GDP, or the government's interest burden materially exceed our forecasts, signifying a weakening of the country's institutional capacity to maintain sustainable public finances

·         Upside scenario:

·         We may raise the ratings if India's fiscal metrics dramatically improve, on a sustained basis

·         We may also raise the ratings if we observe a sustained and substantial improvement in the central bank's monetary policy effectiveness and credibility, such that inflation is managed at a durably lower rate over time

·         The sovereign credit ratings on India are anchored by the country's dynamic, fast-growing economy, strong external balance sheet, and democratic institutions supporting policy predictability and compromise

·         These strengths are counterbalanced by the government's weak fiscal performance and burdensome debt stock, as well as the economy's low GDP per capita

·         Institutional and economic profile: India's economy charges ahead despite global uncertainties

·         India's economy is set for real GDP growth of about 6% this year, which compares favorably with emerging market peers amid a broad global slowdown

·         Investment and consumer momentum will underpin solid growth prospects over the next three to four years

·         The economy has more moderate exposure to a slower external backdrop than regional peers

·         India's economy has emerged from the pandemic-driven downturn into a rapid recovery phase; Two straight years of above-trend real GDP growth illustrate this

·         The pace of economic expansion is normalizing toward a more sustainable level. The fiscal year ending March 31, 2024, will also be subject to comparison with a strong year-ago base

·         Nevertheless, the economy maintains good momentum. We anticipate solid consumer and investment dynamics will propel real GDP growth to 6% in fiscal 2024 and 6.9% in fiscal years 2025 and 2026

·         Surging capital expenditure (capex) by the central government and, to some extent, by state governments will help to revive investment and spur construction activity

·         Based on budget plans for fiscal 2024 and our expectation of strong revenue growth, we believe this support will continue during the current fiscal year

·         Improvements in payrolls (as reflected by data from the Employees' Provident Fund Organization) throughout calendar 2022 suggest India's labor market has strengthened. This will also act as a tailwind for consumption over the coming quarters

·         The performance of the Indian economy in the past several years highlights its historical resilience

·         Our projections for solid growth against increasing external headwinds are also predicated on the country's constructive structural trends

·         These include healthy demographics and competitive unit labor costs

·         Additionally, we believe India's corporate and financial sectors have stronger balance sheets than before the pandemic

·         India is making gradual progress in resolving legacy bad debts in the financial sector, alongside ongoing enhancements to its 2016 Insolvency and Bankruptcy Code

·         India's introduction of a goods and services tax in 2017 continues to bear fruit. Total receipts surged 21.5% to more than Indian rupee (INR) 18 trillion under the program in fiscal 2023

·         The coalition government led by the Bharatiya Janata Party (BJP) retains a healthy majority in the Lok Sabha, India's lower house of parliament. This supports the government's efforts to implement economic reforms. That said, major new reforms are unlikely over the next 12 months until the 2024 parliamentary elections are over

·         The central government is increasingly tilting toward spending on capex in its budgets in the past three years. Following surges of 27.8% and 26.1% in total effective capex in fiscal years 2022 and 2023, respectively, it is budgeting for another 30.1% rise in allocations for fiscal 2024

·         Although India's public finances remain weak, strong growth in allocations to capex boosts the quality of the government's fiscal programs. More effective capex programs should help to alleviate India's widespread shortfall in physical infrastructure capacity. Over time, this would support the productive capacity of the economy

·         The Indian government also re-emphasized its production-linked incentive (PLI) scheme in its recent budget. It is making larger allocations to the electronics and information technology sectors, as well as automobiles and components. Such incentives will likely increase foreign investor interest in India's manufacturing sector, which has also become more attractive to foreign firms looking to diversify supply chains in the region

·         Progress in building India's manufacturing sector over the long run will also be contingent on further liberalization of India's labor market, in our view (labor reform). Should the measures adopted by some states become more permanent, with broadening participation by more state governments, they could help to spur the creation of higher-earning manufacturing jobs

·         Flexibility and performance profile: Strong external balance sheet to weather global trade headwinds as the government gradually heals weak fiscal settings

·         Despite strong revenue gains, India's fiscal consolidation has trailed that of regional peers at a similar rating level. Nevertheless, we believe the general government will gradually pare down its sizable deficits over the next few years, to about 7.3% of GDP by fiscal 2027

·         While revenue performance in the past two budget cycles had been impressive, a rise in government expenditure partially offset the benefits

·         India's central government revenue significantly outpaced its budget estimates for fiscal 2023. It increased by 10.5%, in our estimation, largely on the back of a surge in tax revenue. Revenue growth could cool in fiscal 2024 as the economy downshifts to a steadier rate of growth following two years of above-trend expansion

·         India differs from most regional and global peers in that its state and local governments also run persistently high deficits. We anticipate that aggregate state shortfalls will decline to below 3% of GDP by fiscal 2025. Nevertheless, in combination with central government deficits that will track above 4.5% of GDP, we forecast India will maintain high general government fiscal shortfalls averaging 8% of GDP through fiscal 2027

·         The government is progressing toward the divestment of nonstrategic government-related entities (GREs). However, it has budgeted for more conservative "Other Capital Receipts" of INR600 billion (US$7.3 billion) for fiscal 2024, down from its INR650 billion target in the initial budget for fiscal 2023. This suggests a continued slowdown of divestment proceeds

·         Over time, the successful privatization of a wide variety of nonstrategic GREs could help to foster a more competitive environment and higher productivity

·         Divestment proceeds, which we treat as below the line, partially moderate the effects of deficits on the general government's balance sheet

·         We believe India faces a shortfall in the provision of basic goods and services, particularly in the more rural parts of the country. India will likely need to improve its physical infrastructure to raise its investment potential and competitiveness. The high financial cost of addressing this shortfall constitutes a future liability to the sovereign, although the central government is increasingly making such expenditure

·         A higher emphasis on capex in recent budgets should support faster improvements in infrastructure. The government is also pursuing ambitious investment targets under its National Infrastructure Pipeline program

·         We forecast overall net general government debt will stabilize just below 85% of GDP over the next three years. This is higher than India's pre-pandemic net debt stock of 75% of GDP, but well below the pandemic peak of greater than 90%

·         We include recapitalization bonds issued to inject capital into public sector banks on the general government's balance sheet. Our calculation of the government's debt also includes the liabilities of Indian Railway Finance Corp; at slightly more than 1% of the GDP

·         The Indian banking sector has more than 20% asset exposure to the government sector, primarily through the ownership of government securities. Banks have been important participants in financing the government's higher deficits since the onset of the pandemic. But their elevated exposure may also indicate a diminished capacity to lend more to the state without crowding out private-sector borrowing

·         India's strong external position highly supports its credit profile. Despite a return to current account deficits over the past two years, the country retains a modest net external creditor position. Current account deficits are likely to moderate over the next few years as domestic demand stabilizes and the weaker rupee boosts competitiveness. Higher commodity prices are an enduring upside risk to our current account projections

·         The government's limited external debt position also moderates currency and capital flight risk, in our opinion. We project net external financial assets held by India's public and financial sectors will average 2.8% of current account payments through fiscal 2027. We expect gross external financing needs to average slightly less than 85% of current account receipts plus usable reserves, reflecting manageable external trade and capital flows

·         The Reserve Bank of India (RBI) has made progress in lowering inflation following the introduction of the central bank's medium-term inflation target band in February 2015

·         Inflation has generally remained within the RBI's boundaries of 2%-6% in recent years, burnishing its record of inflation management

·         As of April 2023, inflation has also fallen back to within the central bank's target range, after a period of high price pressures in 2022

·         Sustained deceleration in price growth may allow the RBI to conclude its monetary tightening campaign, and consider a moderately easier stance before the end of fiscal 2024

Technical View: SGX Nifty Future (18385 CMP)

Looking ahead, whatever may be the narrative, technically SGX Nifty Future now has to sustain over 18600 for a further rally to 18725*/18850-19050*/19125 in the coming days (Bullish side).

On the flip side, sustaining below 18550/500-400/300, SGX Nifty future may again fall to 18225-18150/18100*-17925/17775 and 17550*/17300-17000/16800* and 16650* in the coming days (bear case scenario).