As the month of June came to an end, India ushered in a new economic reality and became only the seventh country in the world to have nationwide Goods and Services Tax (GST). The rollout of the GST regime was in the making for over a decade, which was effected through an amendment to the Constitution and five supporting laws being passed by the Parliament and the state assemblies. GST rollout has brought renewed hopes of providing further stimulus to India’s economic growth. It was anticipated that markets would trade cautiously around the GST rollout as investors try and gauge the short term impact it could have on the earnings of the companies. Nifty ended down around 1 percent for the month.
The global rally in equity markets continued with MSCI world index reaching new highs in June. Rising equity markets and low volatility raise the question as to whether investors are becoming too complacent, especially on the backdrop of elevated political tensions across the world. Current volatility is low because investors seem to be comfortable with the rate of Fed’s tightening policy, situation in China and favorable outcomes in Europe where there has been no swing towards populism, even though the German and Italian elections are still to be negotiated. A sharp drop in oil prices or greater than expected Fed tightening still could threaten the risk rally.
From a domestic stand point Indian economy which started the shift towards a formal economy with demonitisation took one more step forward with the implementation of GST. We had witnessed a slump in GDP growth in the last quarter due to the demonitisation effect and it was anticipated that growth would be normalized in a quarter or two. Now, with the big-ticket tax reform–GST–taking atleast a few quarters to settle in, it will result in a slightly more stunted growth going forward. The impact would last for a quarter or two as companies stabilize and get a hang of the new tax regime. GST will increase the government’s revenue in the long term, as tax compliance increases and GDP growth is bolstered. The new regime will be structurally positive for the country which In turn will significantly improve the efficiency of doing business and eventually corporate earnings.
Indian equity markets have remained rock solid for the first half of the calendar year. Earnings number for the March quarter finally showed some improvements especially with double digit revenue growth. However, with the onset of implementation of GST, businesses were trying to clear current inventories by offering discounts before the new tax was implemented. Corporate earnings are expected to take a hit for first few quarters until the new tax law is absorbed by the market. Indian markets over the last year have been surging with the support of increased liquidity from domestic and international markets. Even though the macros have improved significantly, meaningful improvement is yet to be seen in corporate earnings. Despite the long term growth drivers being in place, the current risks lie in the lofty valuations that have factored all positive outcomes, and the slow revival in earnings could play spoil sport. From a risk reward point of view, equities seem to be less favorable from a short term point of view. We recommend adding to equities slowly from a medium to long term horizon, which is looking pretty good.