Are the GDP growth assumptions surreal?

Fri, 4 Jul Pre-Open

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Ever since the Modi government came to power; expectations of an economic revival have increased manifold. The optimism is on the premise that the reform oriented government will be able to take some quick decisions and will not be at the mercy of its allies to push its reform agenda. Currently, such is the faith in the government that every economic growth indicator appears to have a magnifying impact on the hopes of economic revival.

Allow us to explain this. As per a feature in Livemint; the commercial vehicle industry which was crippled by slowdown has finally changed gears. After a decline over 33 consecutive months, sales of medium and heavy-duty trucks have picked up in June. The reasons for the pickup in demand are improvement in the mining and manufacturing sectors. Barring Tata Motors, all other companies including Ashok Leyland, Eicher Motors, Volvo Eicher Commercial Vehicles as well as Mahindra Trucks and Buses have witnessed a sharp rise in their sales. The commercial vehicle sales; being an important lead economic indicator have raised hopes of a better than expected Index of Industrial Production (IIP) numbers as well. This implies high growth expectations from the three main segments i.e. Mining, Manufacturing and Electricity. Additionally, May export performance too was up by 12.4% YoY; highest growth in the last seven months.

This strong data for several indicators is attributed to feel good factor created by the new government. The government is expected to deal with policy issues with regard to land acquisition, environmental clearances and clear and revive various stalled infrastructure projects. This shall revive investment and spending which will ultimately boost production and output. Based on these hopes, investors' appetite has fuelled for growth and interest rate sensitive cyclical stocks recently helping the Sensex achieve new highs. But is the frenzy justified?

The answer can be given in two parts. On macro level, the above discussed data is just for a month or so. Hence, its difficult to say if it's a clear sign of spurt in growth going forward. Additionally, structural issues such as inflation, fiscal deficit as well as infrastructure bottlenecks will take time to be resolved. Also, rise in spending by the government will not be enough as private sector capex also needs to pick up for a speedy recovery. Coming to the markets, BSE-Sensex has always been a lead indicator of the economy. The stupendous highs that it has achieved in the recent times have equaled its current multiple to its historical average. This implies that earnings growth expectations are factored in to a large extent. Secondly, stocks in Banks, Infrastructure, Industrial and Consumer Goods sector have rallied ahead of their fundamentals. This proves that investors are building high growth assumptions in terms of pickup in demand and investment cycle that will ultimately trickle down to the sectors' earnings. Hence, there is limited scope for further growth to be factored in and therefore the upside is capped to a large extent.

Having said that, the long term prospects remain intact for India as the growth is likely to come in the form of volume pick up, decline in credit cost as well as increase in pricing power. However, investors should have an investment horizon of at least two -three years in order to ride on the economic recovery. This is because the current government also needs some time to solve the inherent issues and get the economy back on track.

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