Govt. stimulus & resilient flows eclipse weak earnings


  • In a bid to accelerate growth, Govt. has made significant policy announcements over the last couple of weeks (big bang PSU Bank recapitalization, Mega road capex plan and MSP hikes). The INR 2.11trn recap announced which will be implemented over the next two years is significantly higher when compared to the 1.2trn cumulative capital infusion done in PSBs over the past 10 years (refer fig. below). This has positively surprised the markets.
  • Strong domestic flows in equity MFs appear resilient and have propelled equity indices to new highs, despite high valuations (1sd above mean) and US$3bn net FII outflows in Q2. The domestic flows may sustain given the lack of alternative investment avenues (weak real estate and gold market sentiment).
  • However, earnings continue to look weak. Citi analysts now expect ~13% EPS growth in FY18, down from ~17-18% at the start of the year. Given the current quarterly trend, they see furNew Eye on the Market article upload on CWIther downside risk to earnings expectations.
  • Capital infusion by the government into banks over the last 10 yrs.

    Source: PIB India, Citi Research

  • Modalities of recapitalization bond issuance have still not been decided. Depending on the issuing authority, it may remain out of the fiscal deficit calculation but would still increase the Debt/GDP ratio. However, given the long term positive impact, this may get overlooked. Even if the government ensures that the execution is deficit-neutral as well as cash-flow neutral, Citi economists expect the bond yields to rise slightly on account of expansion of total government debt and also due to a slight boost to growth/inflation expectations due to the resolution of supply side constraints.
  • From an equity perspective, Citi analysts believe that given the significant policy initiatives and the continuing domestic flow momentum, market would be more optimistic on recovery regardless of the earnings risk. To factor in this scenario, they have raised the PE multiple to 17.5x (1sd above 10-year mean; earlier 16.5x). Consequently the new Sensex target for Mar-18 is 33,800 (earlier 32,200). Investors may hold their equity allocations and maintain adequate portfolio diversification based on their risk tolerance.



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