It is a perfect case of tailwinds turning into headwinds.
We alerted on 15th May, 2018 to exit from equities when Nifty was exactly trading at 10900 (click here to see the alert). Nifty is now at a PE multiple of 26.5 which is at a very high historical level from which it has always come down. High valuations may be justified if there is ample scope for growth, but that also looks difficult as the economy is now facing several headwinds, some of which were tailwinds few years ago.
The key issues are –
- A Real Crude Shock
- Weak Rupee
- Under Investment in Infrastructure
- Halted Key Reforms
- Demographic Dividend may turn into Disaster, Ending the India Growth Story
Rising Oil Prices – A Real Crude Shock
Crude above 70 USD per barrel is serious news for Indian economy that relies on imports for nearly 80% of its requirements. In fact India is the third largest oil importer in the world after US and China.
The BJP government had a windfall gain from crashing oil prices in its earlier two years but thereafter the prices are steadily rising and the trend is expected to continue for next few years based on the following concerns –
- OPEC and global protectionism: Since mid of 2015, crude is on a rising trajectory due to OPEC supply cuts, geopolitical events, and US sanctions on Iran. Any deterioration in mid east will further aggravate the situation for India.
- Regulations from 2020 – Even Greater Threat than OPEC: Forget OPEC and Iran, there is an even greater issue that will keep oil prices in uptrend for 2-3 years according to a report from Morgan Stanley which expects Brent to reach $90 by 2020. By January 2020 new shipping rules would require vessels to consume lower sulfur fuels leading to a boom in demand for middle distillates including diesel and marine gas oil. This in turn will trigger demand for more crude. The US shale will not be able to compensate for this as that is not ideal for producing middle distillates, Morgan Stanley noted. This will keep prices at elevated levels even after 2020.
Oil is already above USD 70 and coupled with India’s chronic current account deficit problem, the economy is set to face tough times. Apart from causing reduced energy security and high inflation, it will directly affect industries that rely on cheap oil prices, i.e. aviation, transportation, auto, and chemicals.
A weak currency increases import costs as well as inflation. It becomes a vicious cycle, rising oil prices cause higher deficit, that cause weak currency, which in turn further increases oil import costs…
Government may be forced to reduce excise duty on diesel and petrol to calm the consumers against rising fuel costs and political concerns. This will surely add burden on Rupee.
Rupee also faces a new threat, India’s external debt, the money that Indians have to repay in foreign currency, has ballooned past half a trillion mark that is a serious concern about the strength of currency. And more than half of that is due for repayment in next one year; that is the bigger cause of worry and will definitely lead to more volatility.
USDINR crossed above 68 and is near its all time high. Though we have strong forex reserves this time compared to 2013, but the situation is nonetheless alarming.
Under Investment in Infrastructure
The biggest growth phase in the history of US was just after the World War II, fuelled by building its national highway system.
Similar infrastructure investments in high speed railways, power grids, clean water; were instrumental in fuelling economic growth and building of manufacturing/export sectors in post-WWII Japan, and in more recent times, Taiwan, China, and South Korea.
The proven East-Asian growth model is – attract FDI, build infra and manufacture goods using cheap labor, export cost competitive goods to developed countries. India should have worked on war footings to attract FDI, but due to several restrictions in infra sectors and poor land and labor policies, this has failed. Unless these areas are improved, sustainable long term growth will elude India.
GST is the biggest success of government’s long term reforms, but two most crucial reforms as mentioned above – land and labor, are still to be done. Land reforms will enable states to purchase land for infra and manufacturing. Labor reforms are needed to relax government controls over downsizing. Without these two reforms, infra and manufacturing can never grow. Even the business friendly environment is still not friendly enough.
Demographic Dividend may turn into Disaster, Ending the India Growth Story
Another tailwind is on its way to turn into a headwind.
It was mentioned on this website in one article that unorganized sector jobs may solve India’s unemployment crisis, but the numbers are making this task daunting and almost impossible.
In fact we are sitting on a volcano that is slowly but steadily building up and we will all be there to see it erupt one day.
Look at these numbers –
- About 80% of India’s 470 million workforce are in unorganized sector
- Just 0.41 million jobs were created in 2016-17 against 7 million new workers
- India needs to generate about 15 million jobs every year, but only 5 million jobs were created between 2012 and 2016.
- About 115 million are unemployed, and this will double in less than ten years.
This is the reason we see Jat agitation, Maratha agitation, Patels agitation etc. Social unrest leads to political instability, the greatest risk for markets.