Markets Recover And Push Back Against The Bears
On Monday’s battle between the bears and bulls, the bulls finally won but not before the bears had claimed their share of spoils
On Episode 422 of The Core Report, financial journalist Govindraj Ethiraj talks to Madhavi Arora, Chief Economist at Emkay Global Institutional Equities.
(00:00) Stories Of The Day
(01:19) Markets recover, push back against the bears. How long?
(04:10) Oil jumps as some calm returns to the middle east.
(05:40) Uncertainty in Japan as a snap election has mixed results
(06:56) India’s states are on an unprecedented spree of freebies even as their revenues slow down
(20:59) Tata expands aircraft manufacturing capacity to Airbus light military aircraft
NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on [email protected].
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Good morning, it's Tuesday, the 29th of October and this is Govindraj Ethiraj, headquartered and broadcasting and streaming from Mumbai, India’s financial capital.
A heads up, we will be on a short Diwali news break from tomorrow though we will have special discussion on values based leadership with R Gopalakrishnan and Harish Bhat, both former Tata Group honchos and authors and The Core Report’s weekend edition will host an insightful conversation with Saugata Gupta, CEO of Marico.
Now to the news.
Markets recover, push back against the bears. How long ?
Oil jumps as some calm returns to the middle east.
India’s states are on an unprecedented spree of freebies even as their revenues slow down.
Tata expands aircraft manufacturing capacity to Airbus light military aircraft.
Uncertainty in Japan as a snap election has mixed results.
Markets & More
On Monday’s battle between the bears and bulls, the bulls finally won but not before the bears had claimed their share of spoils.
The indices jumped over 1% during trade on Monday with the Sensex shooting over 1,000 points at one time before sliding down.
The good news, at least for market men, was that the week began well.
The question of course is will this hold ?
Well, the market is still weak and the bouncebacks are driven by sheer domestic supply of funds rather than anything else.
Corporate earnings are definitely down as we have been reporting and a lot of FII selling, of the over $10 billion this month, has been in consumer facing industries, reflecting their outlook as well.
A report from Nomura Securities dated yesterday says Indian urban demand is likely to stay soft.
The report flags fading pent up demand, high interest rates and tight credit but also highlights lower salary increases.
It also points to a slump in passenger car sales, moderation in airline traffic growth and weak demand for FMCG companies.
The Core Report has been highlighting falling car sales for several months now, including the fact that inventories at dealerships have been rising steadily to record levels of over 80 days right now or stock worth close to Rs 80,000 crore.
Back in the market, it is a liquidity driven one. Which also means that bounce backs can be faster than normal.
Using the Hindu calendar roughly from Diwali last year to later this week, local investors have invested a record amount of Rs 4.6 trillion in equities during Samvat 2080 and is the highest amount ever invested by them in any Samvat, data shows, the Business Standard said.
Not surprisingly, this was in stark contrast to investments by foreign portfolio investors (FPIs), who invested a net Rs 90,956 crore in Indian equities during this period.
The liquidity surge has led to the Nifty and Sensex having given a return of 24.5 percent and 22.3 percent, respectively, in Samvat 2080 so far.
This is of course despite the recent 8 per cent correction from the top,
Their best performance was in Samvat 2077, post Covid, when the Nifty and Sensex had surged 40.2 per cent and 37.6 per cent, respectively, Business Standard said, adding the Nifty Midcap 100 and Nifty Smallcap 100 index surging 35.7 per cent and 33.5 per cent.
And finally on Monday, the BSE Sensex finally closed up 602.75 points to settle at 80,005.04.
Similarly, the NSE Nifty 50 ended higher by 158.35 points or 0.65 per cent at 24,380.80.
Smallcap stocks outperformed broader markets, with Nifty Smallcap 100 ending higher by 1.20 per cent. Midcap shares followed, as Nifty Midcap 100 index settled higher by 0.83 per cent.
All sectoral indices ended in green, with banking stocks leading the charge.
Oil Prices Fall
Oil expectedly fell more than 6% on Monday after it emerged that Israeli strikes against targets in Iran avoided its oil, civilian or nuclear facilities, raising once again hopes for peace in the middle east.
Brent fell below $72 a barrel and West Texas Intermediate was near $68, Bloomberg reported, adding there were signs of the market’s political risk premium fading across the board.
Citigroup Inc. cut its Brent price forecasts, citing lower risks from the conflict in the Middle East.
Iran’s missile attack on Oct. 1 had earlier slapped a war premium to oil that at times pushed the global Brent benchmark above $80 a barrel earlier this month.
Nevertheless, prices are still $20 lower than the first session after the Oct. 7 attack that sparked the conflict last year.
The key reason for this is of course weak demand, particularly on the part of China, the world’s largest crude importer and also likely oversupply of crude.
OPEC plans to start gradually reviving oil production in December, and the market is watching for any change to that timeline, Bloomberg said, adding that while the planned output increase in the near-term is small, it will add supplies to a market that the International Energy Agency forecasts won’t be in need of.
Uncertainty In Japan
More geopolitical news, this time from the east.
The Japanese yen dropped to a three month low after a snap election resulted in no party with a clear mandate to lead the country, also the world's fourth-largest economy.
Analysts prepared for days, or possibly weeks, of political wrangling to form a government and potentially a change of leader and comes at a time when Japan faces economic headwinds, a tense security situation fuelled by an assertive China and nuclear-armed North Korea, and a week before U.S. voters head to the polls in another unpredictable election, Bloomberg reported.
The Direct Tax Sweepstakes
Karnataka and Tamil Nadu are among the top five states in India that account for 70% of India's total direct tax collections in the country.
There are 28 states and 8 union territories in India.
The western state of Maharashtra from where The Core Reports comes to you daily leads with a roughly 39% share of all direct taxes paid in India.
Karnataka and TN figure at the second and fourth place, in that order.
Delhi has taken the third place followed by Gujarat, says the Business Standard.
Moreover, Maharashtra, Delhi, Karnataka, and Tamil Nadu have per capita tax contributions exceeding the national average.
States’ Finances
Which sets up a larger discussion on states and their finances.
Remember, we mostly speak of central Government finances and not states when states do half of the spending in all.
India’s centre and state are moving in different directions post Covid.
While the Central government has outpaced its revenue target which in turn has helped it maintain a solid run of capital expenditure or public spending on infrastructure, among others, India’s states have consistently missed revenue targets, forcing them to cut various heads of expenditure, a new report by brokerage Emkay Securities says.
States’ post-Covid consolidation driven by forced expenditure cuts: Centre and States’ fiscal
behaviour has differed in the way they have achieved consolidation post-Covid. Centre has
overachieved on its revenue targets, allowing it to maintain focus on capex while cutting deficits. In
contrast, States have consistently missed revenue targets, forcing them to cut expenditure,
especially capex, sharply– even as their revex growth has been higher than that of the Centre’s
All this becomes more prominent in the context of massive rounds of giveaways in various state elections.
Of the 10 major States to go to polls in 2023 and 2024, nearly every State has introduced new freebie schemes, regardless of party lines.
While Emkay says this is not a completely new phenomenon, the current cycle is unprecedented and can lead to fiscal slippages.
For example, one area where state largesse continues to rise is power subsidies and the study says a handful of states including UP, Rajasthan and Bihar have power subsidy bills that are almost 75% of the entire subsidy bill.
Another interesting insight. States with large populations do not generate more indirect taxes since they have a larger consuming base.
Perhaps this was also somewhat expected but quite likely there was a narrative developed to the contrary.
Anyway, the report says that with GST being levied at the final point of consumption, it was felt large states would be bigger tax payers.
Turns out the biggest GST collections are still with the exporting states like Gujarat, Maharashtra.
So unless actual incomes go up in these larger states, tax collections would not rise as expected.
I reached out to Madhavi Arora, Chief Economist at Emkay Global and author of the report and began by asking her to walk us through the key findings.
INTERVIEW TRANSCRIPT
Madhavi Arora: So, if you look at the poster, COVID, you know, fiscal policy of India, it's very important to see center and state combined because states spend almost 60% of the total expenditure that the federal government overall spends. So, just looking at center and not focusing on what states are doing will give you a very half picture of the fiscal policy of India. And in the end, the fiscal multiplier is the one which actually, you know, have a more medium-term impact on either your productivity or your domestic capital in India and your other factors which impact the consumption theme as well.
So, it's important to see what center and state together are doing rather than just focusing on center, which is where large part of the market focus also generally has been. So, if you look at the pre-COVID period, what happened was that, you know, states post-2013-14 actually asked to take up a large part of their off-borrowing debt wherein they support the state enterprises. There was a massive power restructuring that was happening and states were made to actually take that on their books instead of keeping it on balance sheet in a dirty balance sheet way, which made the state's fiscal look very ugly.
So, there was Senda which was following the fiscal consolidation path. They were trying to move to a 3% fiscal deficit target. States were struggling.
And states generally cannot go beyond a 3.5% fiscal deficit. I mean, they can go a little higher, but they can't borrow more than 3.5% at this point in time from the market. So, very rarely would you see states actually going above 3.5% on an average because they need to fund it from some sources. Market sources being the cheapest ones, they generally stay around 3.5% or below on a consolidated level. But still, they were relatively more expansionary than Senda. Post-COVID, both central and state, because their balance sheet had expanded a lot during COVID due to the spending that they had to do and the debt that India was building up on the public sector, they started consolidating.
So, both central and state started consolidating post-COVID. Central had gone as high as 9.2%. States were also running much ahead of Srinagam. Thus, they started bringing it down towards their organised level.
That means that both of them were contracting their balance sheets. So, that is why when you talk about market players saying that the government hasn't done much in terms of consumption, well, the reason being the balance sheet of central and states were actually contracting. It was more focused towards capital expenditure or revenue expenditure.
And on net, the fiscal deficit was coming down for the country as a whole. Which also means that incrementally, the spending was going lesser and lesser compared to what it was on the period of COVID. Which obviously is understandable also because the economy had improved as well.
Now, the difference in the way central and state were consolidating is very stark. What central was doing, that central was able to get a very high income. You know, the tax revenue growth was much better than what they expected.
We are seeing a massive improvement in personal income tax, you know, owing to policy makers' ability to sort of track the PIT. There's been a massive growth in that front. So, they were able to get a good income.
Thus, the income profile was good. They were able to stay in line with what they were planning to. States, on the other hand, have been struggling on the revenue side, which is where we are trying to focus on as well.
That, you know, some part of the state's money comes from the devolution. Because whatever central earns, that's the strength of most states according to their share. And the rest would be their own tax revenue stream.
And that is where they have been struggling. A lot of states are not able to raise enough tax revenues. And thus, what they were doing was that, they were also consolidating, but they were not able to get the same kind of revenues.
They were cutting their spending. So, both in the capital expenditure and on the revenue expenditure, states were actually cutting their spending. And thus, were able to, you know, generally print in a much lower fiscal deficit than the initially budgeted beginning of the year.
And that has been the way both consolidations of central states have gone, but in a very different manner. Come FY25, there's been a massive change in the political capital in India. We saw the national results also showing the, sort of, less strong mandate for the Modi government and also a little different positioning of states with regard to their, you know, political capital as well.
Of course, the election cycles around states is also something which is happening. And that has basically led to states becoming much more...
Govindraj Ethiraj: So, you've called it unprecedented freebies.
Madhavi Arora: Yeah. So, yeah, the freebies. And they're also keeping a very high capital expenditure because they are not trying to match central capital capex.
So, they have actually built in a 2.5% capital GDP ratio, capital GDP ratio, which is one of the highest in the decade or so for the states. But they're also building in a very high revenue expenditure. Almost seven states have come up with a modified budget post-February-March.
Of course, Maharashtra government is an example. Some of these states have expanded their fiscal deficit. Some have kept all...
But overall, the FGDP-GDP ratio for states pre-these modified budgets was close to around 3%. Now, it is a tad higher than 3%, but nothing too dramatic. Now, what states have done is that they've also sort of tried to be very smart in terms of how they are positioning their fiscal books.
They've kept their revenue estimates or assumptions extremely high. Say, for example, they're looking at SGST growing at 18-20% on an aggregate basis, while center's own CGST is looking to grow at 10-11%. And both of them are coming from the same revenue stream.
They've kept a very unrealistic estimate for their income side, which is where they're able to then show that, you know, we will be able to fund our existing spending, a large part of which is going on non-merit subsidies, and then we will be able to still match 3% fiscal deficit. That is where the struggle is. And states are not only going to be, you know, facing this problem of income side this year, but even in the longer run, if they don't find avenues to improve their revenue side of their balance sheet, they will have problems in terms of raising resources, and they have to be more innovative.
A part of that could be done by improving the GST slab, the state's benefit, but a lot of states have to work on their own tax revenue stream, wherein, you know, they will have to ensure that they at least grow 1.2-1.3x of the nominal GDP to be able to have a much higher tax buoyancy if they intend to really, you know, serve as the kind of revenue expenditure expansion that they are doing in this year, election year.
And half of it would be basically a permanent damage on their balance sheet.
Govindraj Ethiraj: Right. So one of the things you've pointed out, if I got that right, was that 75% of total subsidies at states is for power, discounted power or free power. Is that correct?
Madhavi Arora: Yes. So a lot of states like Punjab, Haryana, almost 90% of the subsidies are oil powers. You're right.
And they will try to expand a bit further around the election period.
Govindraj Ethiraj: Right. Okay. So the other point is that if you were to look at GST collections, goods and service tax, and you referred to it already, you've also pointed out that, you know, if you're a large state, one thought would consume more and therefore contribute more goods and service tax as opposed to small states who may not.
But that's not really happening. What is that telling us?
Madhavi Arora: So basically that sort of tells us that, you know, the way states have propositioned themselves in terms of much higher assumption of, you know, consumption of state getting more collection of GST or rather a state which has a higher population is able to make more money out of GST collection, that has not played out. So it's a very, basically shows that the perception people had that just because you have higher GST collection, also you have a higher populous state or a state which has a much larger population. Ideally, you should get higher tax collection owing to their consumption pattern, but that has not really played out.
So you've seen that five of the most populous states of the six that we sort of covered, which is UP, Bihar, West Bengal and PRS. And actually there's five years taggered growth of GSTs much lower than states like Tamil Nadu, Gujarat, Maharashtra. In fact, even lower than the all-time average of all India average of 11.7%, which is a growth all India countries. In fact, the smallest things like Orissa, Kerala actually have a higher GST collection than the national average as well. Basically that the myth that just because you have a higher population or larger population, you will probably have a higher GST collection that theoretically looks to be logical, but has not really paid out for these states. Even the producer and the investor thesis is also not necessarily played out the way it was assumed earlier.
Govindraj Ethiraj: So as you look ahead now, I mean, this is not about which are the best states to invest in or go and stay in, but that could also be one, let's say angle. You've pointed out that a lot of the capex is really happening on the Eastern side as Eastern part of India as compared to the Western part of India. And that seems like a good thing.
Even if Western India or Southern India is slowing down, it's because they're already higher in terms of on-ground capital investment. But if you were to look at now the consolidated picture, how are things looking to you? I mean, what are you seeing, let's say a few years down the line?
Madhavi Arora: You know, with regard to the public policy on capital expenditure, until a decade ago, states used to be actually a much higher portion of the capital GDP ratio, capex GDP ratio compared to that percent. This is generally, you know, though capex are close to around 2.2 to 2.3% of GDP or even more in certain years, while center used to be generally around, you know, 1, 1.5% of GDP. Last five years specifically, if I say so, there's been a switch in the way center states' behavior have been.
States have actually been, you know, the capex GDP ratio have been a tad lower than 2% most of the time. In fact, you know, somewhere hugging 1.4, 1.6% of GDP. And center, on the other hand, has been actually increasing its capital expenditure ratio to the highs of close to around 3% plus.
And in fact, this year they have, they're planning to do a capex GDP ratio of around 3.5%. And they said, as I said, states are also trying to increase their spending on capital expenditure. So that's one more, but, you know, if I look at the last five, seven years, the center and states combined capex GDP ratio had not increased as one would think so, because states were actually cutting their capex while center was increasing its capex. So the combined public sector, you know, capex GDP ratio was actually not as high.
It was still close to 6.5% or something. Didn't really change just because center took large part of the backing off from the states and states were more busy, you know, cleaning their books, especially with regard to the power sector reform, which had led them to take those debt on their books. So there was a difference in the way center state spending has been happening.
And now I think last year was the first year when we saw states also trying to sort of catch up with center. Most of the times for states, capital expenditure is a residual item. They generally do it in the fourth quarter of the year, in the fourth, in fact, in the month of March itself, around 20% of the overall capex of states generally used to happen.
And states tend to generally undershoot their initial budget by around 21.5% on an average. So last year was an anomaly year, wherein states had actually front-loaded their capex in line with center. They were pushed to front-load their capex in the first half of the year and they were also led by busy, busy states.
States were almost able to achieve 90% of their budgeted target, which I think this year is going to be a difficult task because insofar states are actually lagging, the capital growth has been negative in the first five months of the year. For center also, it has been much lower, partly on account of the fact that they couldn't spend an early part of the fiscal year going into elections. The second half of the year, if states actually intend to really catch up on their budgeted capex, they'd probably have to go 40% capex on a my-and-my basis for the rest of the year.
Same with the case with center, around 30% plus. The center may be able to still achieve that. So I think second half of the year, you will see some capex projects being in noise, but I think states will have a difficult time catching up on their budgeted capital expenditure, especially because they are struggling with the revenue side.
So whatever revenue they're getting from the center or from their own tax revenue, they might be focusing more on doing freebies and subsidies and actually expanding the capital a bit. So I think overall, center and state combined, capacity ratio is budgeted to go higher this year, but we'll see how it plans out because if there is going to be strain on state's budget because of revenue side or because of higher expenditure on subsidies, capital expenditure will be a residual like.
Govindraj Ethiraj: Right, Madhavi. Thank you so much for joining me.
Madhavi Arora: Sure. Thank you.
More Aircraft Manufacturing In India
Some manufacturing news, Prime Minister Narendra Modi and Spanish PM Pedro Sanchez inaugurated the Tata Advanced System (TASL)-Airbus facility to manufacture C-295 military aircraft in India on October 28.
The TASL-Airbus facility is the first such private sector final assembly line for military aircraft in India, PTI reported.
A total of 56 aircraft were to be delivered out of which 16 are being delivered directly by Airbus from Spain. The remaining 40 will be made in India at the facility.
The C295 aircraft was initially manufactured by Spanish aerospace company CASA.
It is now part of the European multinational Airbus Defence and Space division.
The C-295 is a transport aircraft which has the capacity to carry up to 71 troops or 50 paratroopers. Known to be a superior aircraft, it can also be used for logistic operations to locations that are not accessible to current heavier aircraft.
The aircraft will replace the Indian Air Force's Avro-748 planes.
The aircraft can airdrop paratroops and loads, and also be used for casualty or medical evacuation.
The defence ministry in September 2021 had signed a Rs 21,935-crore contract with Airbus Defense and Space SA, Spain for supply of 56 aircraft.
The first C-295 medium tactical transport aircraft was delivered to India in September 2023.
