By Invitation. Who says the economy is recovering?

For a year now, my colleagues and I have challenged the cosy consensus that the economy is recovering in India and the stock market is set for a long bull run. In my view, neither of these happy events is taking place; nor are the next twelve months likely to bring better news for the Indian economy or the Indian stock market.

The Indian banking system will remain mired in pain for all of FY17 on the back of the two-fold problem it faces — the first related to new disbursals and the second to the existing assets. Over the past decade, around 90 per cent of India’s capex has come from five sectors which have become synonymous with a murkier shade of capitalism — power & infra, metals & mining, telecom, oil & gas and real estate.

It is unlikely that crony capitalists will now embark upon borrowing and spending exercises in FY17. Hence it is hard to see the banking system growing out of its current woes. At best, I see system credit growth at around 12 per cent over FY17, FY18 and FY19. While for PSU banks as a whole 17 per cent of their assets are stressed (that is, NPAs plus restructured plus written-off), a staggering 32 per cent and 24 per cent of loans to medium and large corporates, respectively, are stressed. It seems inconceivable that in the current economic landscape and given how crony capitalists tend to behave, the PSU banks will have any great success in recovering these monies. Premised on such a bleak assumption, I believe that the shareholders’ equity depletion of PSU banks will run into FY17.

Two developments over the past month, however, have given some hope. One, the RBI has provided some relief on the definition of regulatory capital by relaxing rules on consideration of three balance sheet items (revaluation reserves, foreign currency translation reserve and deferred tax assets) towards CET1 capital, reducing the need for capital infusion into PSU banks by $4-5 billion. Two, Vinod Rai, the highly respected former Comptroller and Auditor General (CAG) of India, has been appointed as the chairman of the Bank Board Bureau. Given his fearsome track record as the CAG, he is likely to drive administrative and operational changes in the banking system, in our view. But the core problem of PSU banks’ re-capitalisation remains unaddressed. Unless the Finance Ministry steps in with a credible banking recap plan, this will continue to remain an issue in FY17 as well.

Apart from the banking sector woes, the Indian economy also faces a challenge from the worsening liquidity situation in the money markets.

Under stress from rising NPAs on their balance sheet, banks have curtailed working capital finance to corporates as a result of which the latter have turned to the Commercial Paper (CP) market. This, in turn, has led to a spike in the three-month CP rates since the beginning of 2016 (the three-month CP rate has risen from 7 per cent to over 9 per cent in the first ten weeks of the year). In the coming days, the liquidity situation will also face additional pressure from the government’s heavy borrowing programme (both on and off balance sheet) in FY17;

The government plans to borrow to the tune of ₹1.9 trillion ($28 billion or 1.2 per cent of the GDP) via issuance of quasi-sovereign bonds by public sector enterprises like HUDCO and NHAI over FY17. Hence, even if 10-20 per cent of the quasi-governmental bonds are subscribed to by retail investors, there is likely to be a marked reduction in domestic equity inflows. In the absence of FII inflows to offset the reduction in DII (domestic institutional investor) flows, liquidity availability in the money market could be a bigger challenge than the consensus is expecting.

So, can legislative action provide a meaningful impetus to the Indian economy? Although the Aadhaar Bill is expected to go through in the current session of Parliament, the Bankruptcy Code Bill has a 50 per cent chance at best of going through in this session, given the Government’s reluctance to increase its own burden towards PSU banks’ recapitalisation. The GST Constitutional Amendment Bill seems unlikely to go through in the current session as the government and the Opposition still don’t see eye to eye on this Bill and since this is a constitutional amendment, the NDA does not have the numbers in the Upper House to get this Bill through without Opposition support.

As far as the monetary policy is concerned, the Ambit Economics team’s modelling process suggests that CPI inflation will average out at 5.5 per cent, year-on-year, in FY17, broadly in line with the RBI’s projection of 5 per cent year-on-year inflation by end-FY17. However, given that there is a high possibility that the Centre’s fiscal deficit will exceed our initial expectation of 3.8 per cent of the GDP, we expect rate cuts of the order of only 25-50 basis points for FY17. This is yet another area where the Ambit view is at odds with the glib consensus that seems to characterise the Indian stock market.

The writer is CEO, Institutional Equities, Ambit Capital and the author of Gurus of Chaos: Modern India’s Money Masters