The current scenario is not too different from what we see in history. Now, why do we say so?
Currently, we are seeing:
- Falling US bond yields
- Falling oil prices
- US economy entering into recession
The situation may look worrisome on prima facie, but did you know that the Indian economy never witnessed an economic recovery without the above three conditions.
Let’s go back to history, four times in the last 40 years; the US economy faced a similar situation, i.e. recession alongside falling crude oil prices and bond yield.
As you can see above, in all the four situations (1985, 1992, 2002-03, and 2008-09), we saw a robust economic recovery in India.
Fast forward now to the current scenario, with Brent crude having corrected from $83 per barrel to around $30 per barrel now, U.S. Treasury bond yields now below zero and with the U.S. economy now likely to enter a recession, key prerequisites of an Indian earnings recovery are in place.
The ingredients are there to witness sustained recovery in the future:
- Cheap money
- Since liberalization of India, both FDI’s and FPI’s are essential to finance our growth. Why? Because most of the domestic savings went to gold and real estate. Whenever there is a fall in bond yields, capital inflows from the US accelerate in India.
- Now, real estate as an asset class has lost its charm. Hence, domestic households are also encouraged to invest in financial markets. But having said that, India is still dependent on foreign capital, which will see a boom as we see falling bond yields.
- Declining interest rates in the US are beneficial, as it will only encourage more foreign capital to our country when the panic cools down. Also, this will encourage RBI to reduce the rates on its savings scheme; bank will have to cut deposit rates and also lending rates. This will mean small and medium enterprises will be able to borrow more, which is a need of the hour for spurring growth.
- Cheap oil:
All the above four phases of recovery, i.e. 1982-87, 1992-97, 2004-08, 2009-11 had a common feature – Crashing oil prices at the beginning of India’s growth along with falling bond yields. This fall was mainly triggered by a recession in the US.
With this, two key domestic reforms have also set the scene for a select few companies to benefit from the rapid formalization of the Indian economy.
- Implementation of goods and services tax (GST)
- 50 percent of India’s workforce is associated with the retail sector. Until GST came along, most of these people never paid taxes and hence enjoyed tax-free profit margins of 12-15 percent.
- With the implementation of GST, the profit margins have dropped. This leads to more need for working capital to keep the businesses going, and hence put requests to the bank for borrowing. However, banks prefer organized players such as Asian Paints, Relaxo Footwear and Pidilite as compared to these laggard players. Hence, we could see growth in stock prices of Asian Paints, Relaxo and Pidilite. Now, market leaders are gaining more market share from the laggard or unorganized brands.
Read about other reforms implemented by government which will positively impact your investments here.
- Reduction in corporate tax rate
- In September last year not only did the government cut corporate tax rates from 35 percent to 25 percent, the Finance Minister also said that if companies committed to fresh capex in new entities, they would get a discounted corporate tax rate of 15 percent.
- This means market leaders will spend more on capex plus increased earnings growth. Also, with more profits in the hands of market leaders (Example - Pidilite), we would see them acquiring smaller and weaker companies which would again give a boost to the formalization of the economy.
All the above four points will help India recover as well as grow once Coronavirus panic subsides.
If you ask me, this situation may look worrisome if you are only able to see the tip of an iceberg. But once you look into the past and interpret the data, it suggests that India’s recovery like in the previous four instances is all set to kickstart. But before that, this is where the wealth creation journey starts.