Why is Sensex rising: Why is Sensex rallying despite poor health of the economy?

NEW DELHI: Equity benchmark Sensex has been hitting fresh record highs on a daily basis even as high-frequency macro-economic data continued to show acute pain in the economy.

Sensex rallied for the seventh straight sessions to Monday but closed a notch lower on Tuesday. On Wednesday, it hit a new peak at 40,469, and added another 50 points in Thursday’s morning trade to top the 40,500 mark.

This, even as latest data suggested a two-year low manufacturing PMI reading in October and a 19-month low services PMI reading for September.

Auto stocks, which were on the forefront of market’s revival last month on signs of early demand revival, have since lost momentum. But the benchmark index continues to rise.

Analysts say expectations of more government measures to speed up economic recovery have been the prime market driver.

History of three recent slowdowns in India suggests government intervention is a must for the economy to revive. In the ongoing slowdown, the government has already shown its intent to boost the economy by announcing a slew of measures and slashing corporate tax.

On Wednesday, Finance Minister Nirmala Sitharaman unveiled a Rs 25,000 crore AIF to help the distressed real estate sector. A day earlier, she said the government would soon use its strong electoral mandate to usher in the next wave of reforms, and not to miss the bus this time.

This commentary has made investors to expect more measures from the government in the coming days.

“No downturn has reversed without government intervention,” Centrum Broking said in a research note. “But the magnitude of intervention varies given the severity of downturn and government’s ability to utilise the fiscal space,” it said.

The government did not compromise on spending during 2012-2013 slowdown, even as it reduced fiscal deficit sharply by nearly 1 per cent of GDP from 5.9 per cent to 4.9 per cent. On the monetary policy front, RBI slashed cash reserve ratio by 200 bps and repo rate by 100 bps during this period.

Earlier during 2008-2009 global financial crisis, the government announced a complete waiver of loans for marginal farmers. An across-the-board 4 per cent in ad valorem CENVAT rate cut was also announced.

“The government had accorded approval to 37 infrastructure projects worth Rs 70,000 crore alone and extended export credit for labour-intensive exports and improved pre- and post-shipment credit availability,” Centrum Broking said.

Also, IIFCL was given the responsibility to refinance up to 60 per cent of commercial bank loans for PPP projects, involving total investment of Rs 1,00,000 crore over an 18-month period.

RBI also cut CRR and repo rate by 400 basis points each, even as reverse repo fell by 250 basis points.

During the 2002-2003 agrarian crisis, corporate tax was cut to 40 per cent from 48 per cent, spending in public infrastructure was increased sharply by Rs 37,919 crore, and credit flow to the agriculture sector through institutional channels was increased to Rs 75,000 crore.

Many economists see GDP growth at sub-5 per cent in September quarter, and full-year growth anywhere but below 6 per cent.

Data showed aggregate September quarter PAT growth for the 387 companies that have announced results so far is 17 per cent, led by financials, and largely helped by the tax cuts, which has balanced out the drop in tax growth at 14 per cent.

In the next wave of reforms, the Modi government is widely expected to tweak to income-tax rates, long-term capital gains (LTCG) and DDT, among others, to prop up the markets.

“The stock market has high expectations of a cut in individual income-tax and/or GST rates. Several consumer-discretionary (automobile) stocks have rallied on the back of rising expectations of a fiscal stimulus to consumption. However, it remains to be seen if the government will further risk India’s fiscal position, given the continued weak tax revenues and likely Rs 1.45 lakh hit on corporate tax revenues,” said Kotak Institutional Equities.

Centrum Broking believes September quarter of FY2020 may be the bottom for India, as its study showed it takes on an average 2-3 quarters for an economy to normalise once government intervention starts, “We expect growth to rebound to normalised levels in Q1FY21-Q2FY21,” it said.

About 80 per cent of the gains that Sensex makes typically come in the two years following the general election, said Saurabh Mukherjea, Founder and Chief Investment Officer, Marcellus Investment.

“Clearly, we are in an environment where the market is discounting economic reforms. And in spite of a weak state of the economy, the market is now focussed on other reforms that the people believe are likely to be announced in the next six months or so. So it is land reforms, labour reforms, income tax cuts, potentially dividend distribution tax cuts that people are rightly focussing on. This is something we have seen in India before,” Mukherjea told ETNOW.

The corporate tax rate has already started reflecting in the second quarter earnings of India Inc. On the monetary policy front, RBI has cut the policy rate by 135 basis points since February this year. At 5.15 per cent, the repo rate is not at lowest level since March 2010.

“The government appears keener to revive investment demand. It may have to deliver follow-up reforms in areas of factors of production and general governance. India’s ranking in ‘Ease of Doing Business’ has improved further; however, it still lags considerably in areas of contract enforcement, property registration, starting business and paying taxes,” said Kotak Institutional Equities.

The recent tax cut has resulted in shifting ‘tax paid’ to ‘profits’ within corporate GVA. Besides, it has resulted in providing non-dilutive ‘zero cost’ growth capital and prospects of higher amounts of buybacks (and dividends), thereby improving EPS growth outlook and sentiment, said ICICI Securities.