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Sujan Hajra of Anand Rathi

It looks unlikely that the US would enter a recession in 2023 and even if that happens, it is likely to be short-lived. But, a serious growth slowdown in OECD countries during 2023 is looming large, said Sujan Hajra, Chief Economist and Executive Director at Anand Rathi Shares and Stock Brokers, in an interview with MintGenie. He said the Indian market will give a positive return in 2023 but it may be lower than the long-term average.

How do you see India’s macroeconomic situation evolving while the West is staring at a looming recession? What are the strengths and weaknesses of our economy?

While the recession in Europe is almost given, the same cannot be said about the US. 

It looks unlikely that the US would enter a recession in 2023 and even if that happens, it is likely to be short-lived. 

That said, a serious growth slowdown in OECD countries during 2023 is looming large. 

In terms of most macroeconomic parameters including growth, inflation and banking and finance, India is doing better than almost all other systemically important countries including the G-20 peers. 

Cross-country comparisons also show that economic policy uncertainty in India is one of the least. 

These are major sources of strength for India. Most global agencies and expert commentators are identifying India as one of the brightest spots in the otherwise gloomy world economic environment during 2023.

One of the biggest worries for India remains the lack of traction in the rural economy while the urban part is doing much better. 

Also, India’s strong growth performance post-pandemic has been driven to a large extent by rapid investment growth. High-frequency data on proposed investment, implemented investment, foreign direct investment, and corporate fundraises from both equity and debt markets, however, suggest a significant slowdown in investment activities in recent months. 

Unless reversed quickly, this can be a new source of worry for the economy. With the slowdown of global demand and increase protectionism, global trade in goods is shrinking in real terms. 

Over 20 percent of India’s manufactured products are exported and over 75 percent of India’s goods exports are manufactured products. 

Consequently, the manufacturing sector in India is not doing well and India’s trade and current account deficits are widening sharply. These have become major concerns for India.

IMF says one-third of the global economy will face a recession in 2023. What are the major factors, in your view, which could cause a recession? How severe and long can it be?

The rapid, synchronised and simultaneous global hike of policy interest rates, withdrawal of liquidity and fiscal tightening during 2022 are the major reasons for the likely global growth slowdown in 2023. 

The lack of restoration of full normalcy in the global supply chain, the ongoing war in Europe and intermittent lockdowns in China until recently are also factors which are contributing to the serious global growth deceleration and likely recession in many OECD countries during 2023.

Despite significant growth deceleration, labour markets in most advanced countries remain unusually strong. 

As a result, concerns of a possible wage-price spiral and the resultant financial instability are factors which are inhibiting central banks from pausing monetary tightening and governments from maintaining fiscal support despite the risk of recession.

Yet, in any country, the authorities cannot disregard strong public opinion. For example, despite China not being a democracy, authorities quickly withdrew lockdown measures In the face of public backlash. 

Currently, in most countries, there is strong public support for policy tightening due to high inflation-led loss of purchasing power. 

However, as growth starts halting, borrowing rates keep rising and job market conditions start deteriorating, public support can reverse quickly. 

This can set the stage for renewed policy support for growth even at the risk of relapse of inflation.

Also, consumer demand for services is yet to recover fully to the pre-pandemic level in most countries. 

With ongoing normalisation, there can be additional demand, especially in the services sector during 2023.

Moreover, since mid-2020, there has been a huge surge in investment in most countries taking the investment-to-GDP ratio well over the pre-pandemic average. 

Efforts by the country to fill the major gaps in the domestic supply chain and national energy security are contributing to the jump in investment activities. 

These are other measures as well to boost domestic production. These steps can also boost GDP in many countries during 2023. 

This is why we think that a recession in the US during 2023 is not a certainty. 

In other countries too, including those in Europe, the recession may not be prolonged.

There is a strong correlation between the market and the economy. Considering this, how do you foresee the course of the market in 2023?

Macro fundamentals such as GDP growth and corporate fundamentals including earnings growth have a strong correlation with the performance of the equity market. 

However, the strength of such correlation faces considerable fluctuations depending on the phase of the business cycle. 

During the major part of 2022, GDP and corporate earnings growth (on a year-over-year basis) were strong in many countries including India and the US but the equity markets remained mainly in the corrective mode. 

Consequently, the price-to-earnings ratio came down. These were in line with the fundamentals since the rise in interest rates increased the discounting rate and thereby brings down corporate valuation estimates. 

That is, in the face of rising interest rates, valuation multiples got derated in most parts of 2022 despite strong corporate earnings performance.

As most countries are likely to reach the peak of policy rates in the first half of 2023, the world may have seen the peak of discounting rate since financial markets have already factored in continued monetary policy tightening in the first half of 2023. 

It is possible that in 2023 corporate earnings growth in India and elsewhere would continue to slow down but the discounting rate may start coming down in the expectation of future rate easing. 

That is, valuation multiples might start getting re-rated. Therefore, the likely deterioration of corporate earnings and GDP growth in 2023 does not necessarily imply that the equity market will be in a corrective mode during the year. 

Like each of the last seven years since 2016, we expect the continuation of positive returns on Indian equities during 2023 as well although the return is likely to be lower than the long-term average.

What sectors can outperform in 2023? Are banking stocks near the end of their bullish phase? Is value coming back to the IT stocks?

In the Indian equity market, investment themes and financials were in flavour during 2022 while consumption themes and globally oriented sectors did relatively badly. 

In the initial part of 2023, the same themes might continue but eventually, with the likely pickup in rural consumption, greater investor caution and relative value play, the consumption theme is likely to come in more prominence. 

At the same time, with rising interest rates, the impact of increased global protectionism on export-oriented sectors and the likely slowdown of growth during 2023, both investment theme sectors and a part of the financials can start underperforming.

Stronger growth in China can increase demand for commodities and this might improve the situation for some of the global cyclical.

With a strong run in the recent past, public sector banks may come under pressure in the equity market during 2023. 

With the likely slowdown of credit growth and contraction of net interest margin as the liability side of banks’ balance sheets increasingly get repriced during 2023, even frontline private sector banks can turn market performers. 

Among financials, smaller private sector banks and non-banking financial companies including asset management companies may start looking more attractive during 2023.

A relatively steady business model, lower volatility in earnings growth and generally high-quality corporate governance are major attractions of Indian IT companies. 

The underperformance of technology companies in the US and the fear of recession in OECD countries, the predominant market for Indian IT companies, led to the underperformance of these companies in 2022. 

Also, the strong outperformance of Indian IT companies during 2020 and 2021 led to stretched valuations. 

Although the valuation multiples have come down as compared to 2021, from a medium to long-term perspective, the valuations of Indian IT companies have yet to turn very attractive. 

If the US does not face a recession in 2023 and the recession in Europe turns out to be shallow, both of which we expect, the IT companies are likely to come back in flavour during 2023, especially if the rupee keeps depreciating against major hard currencies.

How should retail investors trade in this market? What points should they keep in mind before picking stocks for investment?

Since 2016, retail investors in India are increasingly taking equity exposure indirectly through the schemes of mutual funds rather than direct exposure in the equity market. 

For investors who lack the expertise, discipline and other resources including time to build a diversified equity portfolio on their own, investing in diversified equity-oriented mutual funds schemes is a much better option than investing directly in the equity market. 

By very nature, the volatility of the equity market in the short term can be high which creates the risk of capital loss, especially for concentrated portfolios. 

At the same time, due to the superior risk-adjusted return, equity assets are ideal for long-term wealth creation through the compounding of relatively high annual returns.

Once again, mutual fund schemes rather than direct equity become a better option for retail investors on these considerations as well.

However, for many retail investors, direct equity investing is psychologically exciting. 

Our advice to such investors is to earmark a part of the portfolio, preferably a relatively smaller part, for such direct equity investments. 

For this part of the portfolio, return expectations should be realistic, the investment horizon should be relatively long, preferably three years and above, and the investor should have a considerable risk appetite.

Such investors should identify stocks with strong long-term fundamentals, either through their own detailed research or under the guidance of expert portfolio advisors, and remain invested in such companies for a considerable period of time to fully rip the benefits of equity investing. 

Equity investing brings in healthy long-term returns while speculation in stocks can inflict irreversible damage to the portfolio of retail investors.

What are your expectations from Budget 2023?

During the forthcoming Union Budget, we expect the major focus to be on agriculture and allied activities, infrastructure and manufacturing activities under the PLI scheme. The renewable energy-related segments may get considerable attention. 

Apart from further simplification and procedural changes, we do not expect significant changes in the Budget regarding direct taxation. Some readjustment in the capital gains tax across asset classes is possible. 

In any case, most indirect taxes apart from customs is outside the direct purview of the Union Budget. 

While the intention of the government would be to effect significant fiscal consolidation, the process might remain slow this year resulting in a fiscal deficit for the next financial year being pegged around 5.8-5.9 percent of GDP.

The discontinuation of free additional food grain distribution outside the PDS would substantially reduce effective food subsidies while making the food grain under PDS free would marginally increase outgo on this account. 

In order to boost rural income and employment, funds freed-up from food subsidies may get deployed in other rural-oriented schemes. 

With rural demand being behind urban demand in the recent past, we expect the Budget to take measures to alleviate this situation. 

Improving productivity in agriculture and allied activities coupled with rural employment generation are also likely to be the focus of the budget. 

We also expect a greater focus on production-linked incentive schemes with more sectors coming under the ambit of this project and additional budgetary allocation under the scheme.

We have seen many policy measures in the last few years which have kept the Indian economy on a strong footing despite challenges. What more could be done on the policy front at this juncture?

The Indian economy has made tremendous progress in the last 25 years. From being the 16th largest economy in the world in 1996, India has become the fifth largest in 2021. 

India is set to become the third-largest economy in the world in the next five to seven years. 

One of the biggest reasons for an optimistic outlook on India is the tremendous demographic advantage the country will have for the next several decades. 

Yet, to fully harness this advantage, there is an urgent need to drastically improve the skill level of the Indian workforce.

While various schemes for training the workforce in line with the industry requirements and the new education policies are the moves in the right direction, a lot more needs to be done in these areas including a significant increase in budgetary allocation on education and training.

For various reasons including the direct and indirect dependence of nearly half of Indians on agricultural income, considerations of national food security and overall price stability, agriculture continues to be extremely crucial for India. 

The lack of investment since the 1990s has been one of the major reasons for low productivity in Indian agriculture. 

This is creating rural distress and in turn, limiting India’s growth potential.

Unlike industry and services, structural reforms have largely bypassed Indian agriculture. While the farm bills passed by the parliament tried to address some of these areas, the withdrawal of these acts has once again created a void. 

Productivity-enhancing agricultural reforms remain extremely essential for India’s future. Yet, the experiences in the recent past suggest that for the success of such reforms, it is important to build broad-based public opinion in support of such measures.

India’s rapid progress in the last 25 years has not been confined only to the relative size of the economy or sectors. 

India has made rapid progress in infrastructure including roads, power, telecommunications, aviation, railways and ports.

There has been a considerable deepening of institutions including the legal system and regulatory frameworks. 

India’s global ranking in terms of external sector indicators including a share in global trade, foreign exchange reserve and attractiveness as a global investment destination have improved tremendously. 

While India has made important progress in terms of human development indicators such as longevity, infant and maternal mortality, health and hygiene, literacy, financial inclusion and gender equality, in terms of global ranking, India’s current positions are not commensurate with the standing of the country in other areas. 

It is important to alleviate various gaps in these areas. A sharp increase in budgetary and other public allocations as also appropriate legal and regulatory changes are necessary for these areas.

Disclaimer: The views and recommendations given in this article are those of the analyst. These do not represent the views of MintGenie.

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This is the relationship between economy and financial markets 

First Published: 13 Jan 2023, 08:21 AM IST

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