The recent promise for the markets and the economy all started in September 2019 with the cutting of Corporate tax rates. This event, which we’ve referred to in many of our write-ups in the past 24 months, is very significant because it marks a shift in government policy away from boosting share of labor compensation in GDP and towards boosting share of corporate profits in GDP. The story goes back to 2006/07 when MNREGA was introduced. That event shares the same significance as the corporate tax rate cuts of 2019: it marked a shift away from boosting share of profits in GDP and towards increasing share of labor compensation in GDP. MNREGA and the seminal shift in change of policy came at a time when corporate profits as a share of GDP were booming – the figure at that time was around 7%. The govt of the day chose to transfer some of the profits to the labor class. This unfortunately in India never augurs too well in the medium term. India is a country with excess labor and any move to artificially boost money in the hands of the masses results in inflation. This is eventually what we got in India soon after we reached a 10 GDP growth in 2010; inflation reached double digits in the years to follow and our growth story came to a screeching halt. Creating investments, and hence capacity, and hence jobs, and hence wage increases and then finally demand, is a better way to create a virtuous cycle in India. This is something that happened between 2003 and 2007 as a consequence of a strongly supply side regime under Vajpayee.

The reason it’s taken a while for policy makers to shift policy away from what clearly does not work for India is purely political compulsion. Clearly in a country like India where you have supply constraints and excess labor the better outcome always comes from boosting share of corporate profits and being supply side oriented with policy. But there can be serious political ramifications. Remember that with this method you must use spending power and elbow room with policy making to support businesses and help them boost profits. Whilst in the first method you can pass on freebees to the masses. Remember how the Vajpayee govt turned a fledgling economy into a sustainable 8% growth economy but their political tenure came to a screeching halt. The opposition come to power simply by offering voters freebees.

The event of September 2019 so far hasn’t been a one off. The govt has decided to be distinctively supply side oriented despite Covid. We’ve seen measures recently such as new labor laws, new farm laws, the Production linked incentive schemes, the waiver of retrospective tax and the telecom package which are clearly supply side in spirit. If this commitment to being supply side and boosting share of profits in GDP stays, then I feel we could reach 5% corporate earnings to GDP ratio (from the current 2.5%) over the next three years. This increase to 5%, combined with a over-all GDP growth rate of about 6% to 7% post FY22, should see your listed space easily clock a earnings growth rate of around 25%.

The risk to our our base case where the best is yet to come, is if corporate earnings do not improve the way we expect it to. The reasons for this could be threefold: it could be a India govt policy shift away from being supply side and boosting share of profits to GDP, it could be a global event, or it could be an unexpected event outside the realms of our imagination such as Covid. We actually feel that as time goes by, the taper and rate hikes from the US are probably lesser of a threat to this bull-market. The tightening from the Fed has historically been a worry only when growth is weak. Let’s take two examples in history – one from 2004 and 2007 when the fed raised rates multiple times and none of those rate hikes caused any upheavals in the market. Let’s look at another time – 2013 when growth was weak. Mere talk of a taper from the Fed caused Indians markets to fall significantly. We always hear talk or read of the jargon: a less sustainable liquidity driven rally and a robust and sustainable fundamentally driven rally. What we’ve seen so far is clearly a fundamentally driven rally due to increase in corporate profits. And if profits are to grow the way we expect them to grow, notwithstanding the risks mentioned above, we feel that markets can go up despite the inevitable taper and rate hikes around the globe that everybody is talking about.

Another factor that in our opinion is likely to be a huge positive for Indian markets is tax collections. Macroeconomic stability exists when key economic relationships are in balance—for example, between domestic demand and output, the balance of payments, fiscal revenues and expenditure, savings and investment, and most importantly fiscal revenues and expenditure. Tax collections influence macro economic stability. India, from the evidence that we have on hand so far, is set to see a big upside surprise on this count. Improved collections mean better macro stability and improved macro stability in an emerging market usually means foreign flows into the country. We won’t go too much into detail on this at moment but you’ll definitely hear from us soon on this count. We stay very optimistic about markets in the medium term and we believe that the best of this bull-market is yet to come.