Strategy In search of a turnaround Strategy Team Centrum Broking Ltd. 1 Introduction . In our study of the “downturns” in last 20 years, the current slowdown seems to be the most protracted and severe both in terms of time and its spread. The impact on both rural and urban demand has been unprecedented. While all the past 3 downturns have been either due to exposure of heightened external vulnerabilities or natural calamities, the ongoing slowdown seems to be self inflicted on account of 3 successive shocks in 3 years in the form of demonetization, rolling out of GST in not so phased manner coupled with the blowout of NBFC crisis. The study suggests that no downturn has reversed without the government intervention. However, the magnitude of intervention varies given the severity of downturn and government’s ability to utilize the fiscal space. Summing up, we believe September quarter of FY2020 may be the bottom and since our study reveals that it takes on an average 2-3 quarters for an economy to normalize once government intervention starts, we expect growth to rebound to normalized levels in Q1FY21-Q2FY21. Accordingly in our strategy, we advocate that though the worst seems to be behind us, this is going to be a slow ride towards path of normalization. Given the current government has a political mandate and has acknowledged the slowdown, it will continuously intervene to bring the economy back on track, as evident from the recent announcement of lowering corporate tax rates. In this background, we recommend to reduce cash gradually and look for value investing. In the next few quarters, there will be lot of false starts, giving an opportunity to invest. We further advocate moving away from defensive portfolio and increase weightage to rate cyclicals like corporate banks, Auto etc. Therefore, we are underweight in both IT and Metals, neutral in Pharma and Telecom. Our top picks are a mix of value and rate cyclicals: SBI, L&T, Bajaj Auto, RNAM, Bajaj Consumer and NCC. 2 In the last 20 years, India has witnessed 4 “downturns” 11 10 Impact of 9 demonetization and rolling out of GST 8 7 (% YoY)(% Agrarian crisis due US-China 6 to severe draught Trade and Gujarat War and earthquake NBFC Expected 5 Commencement Crisis to be of taper tantrum around & Caught off in 6% in 4 Higher Inflation 2019-20 Global Financial crisis 3 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 Source: CSO, MOSPI 3 2002-2003 Agrarian crisis due to severe rainfall deficiency 4 Severe rainfall deficiency weighed heavily on the agricultural sector India witnessed the worst draught in more than 25 years during 2002-03 Agricultural and allied activities showed significant contraction 20 15 Rainfall Agriculture,forestry & fishing 10 10 5 0 0 -10 YoY)(% -5 -20 deviation from normal) -10 (% -30 -15 Jun-00 Jun-01 Jun-02 Sep-00 Sep-01 Sep-02 Dec-00 Dec-01 Dec-02 Mar-00 Mar-01 Mar-02 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 Having a substantial share of 22% in the GDP basket… ..agricultural activity contraction exerted downward pressure on GDP 8.00 2002 - 03 Agriculture, Gross Domestic Product forestry & fishing 6.00 22% 4.00 (% YoY)(% Services 2.00 51% 0.00 Industry 27% Jun-00 Jun-01 Jun-02 Sep-00 Sep-01 Sep-02 Dec-00 Dec-01 Dec-02 Mar-00 Mar-01 Mar-02 Source: CSO, MOSPI, IMD 5 Lack of private consumption and government expenditure kept GDP growth subdued Lower farm incomes weighed heavily on rural consumption growth Muted government expenditure weighed on total economic activity 8 Private Consumption 15 Government expenditure 10 6 5 4 (%YoY) (% YoY)(% 0 2 -5 0 -10 Jun-02 Jun-02 Sep-01 Sep-01 Dec-00 Dec-00 Mar-03 Mar-00 Mar-03 Mar-00 However, private investments and exporting activity remained intact and provided cushion to the GDP growth Private Investment 30 Exports 16 12 20 8 10 4 (% YoY)(% (% YoY)(% 0 0 -4 -8 -10 Jun-02 Jun-02 Sep-01 Sep-01 Dec-00 Dec-00 Mar-00 Mar-03 Mar-03 Mar-00 Source: CSO, MOSPI 6 Slumping economic activity warranted efforts by both RBI and GOI GOI kept the fiscal deficit at elevated levels by the end of FY 2003 RBI lowered benchmark rates by 50 bps in FY 2003 Fiscal Deficit (% GDP) 14 6.5 16 12 6.0 10 14 5.5 (%) (%) 8 12 5.0 6 4.5 4 10 4.0 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 CRR Bank rate Prime lending rate (max) RHS . MONETARY RESPONSE: Reserve Bank of India adopted expansionary monetary policy, in response to the slowdown. RBI reduced Bank Rate by 25 bps from 6.5% to 6.25%, followed by the cut of 75 bps in the cash reserve ratio and a 50 basis point reduction in the LAF repo rate. Responding to the Reserve Bank’s initiative, banks switched over from tenor-linked prime lending rates (PLRs) to benchmark PLRs (BPLRs). As at end-March 2003, BPLRs were lower by 50 basis points. FISCAL RESPONSE: Government of India in 2002-03, kept the fiscal deficit at elevated levels (~6% GDP) to arrest economic slowdown. Reduction in corporate tax rates for companies from 48% to 40%, . Pushing up investment in public infrastructure sharply by INR 37,919 crore, . Reduction in interest rate for rural infrastructure loans, . Increasing total credit flow to agriculture sector through institutional channels to INR 75,000 crore Source: RBI 7 Sharp rebound in FY 2004 on account of surplus rainfall and efforts by RBI and GOI As 2004 delivered surplus rains, agro activities gathered momentum Efforts by RBI and GOI along with better monsoon aided consumption 5 10 Private Consumption 0 7 10 -5 4 8 -10 1 6 -15 -2 % YoY (% YoY)(% 4 -20 -5 -25 -8 2 % deviation from normal from deviation % 0 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 Jun-00 Jun-01 Jun-02 Jun-03 Sep-00 Sep-01 Sep-02 Sep-03 Dec-00 Dec-01 Dec-02 Mar-00 Mar-01 Mar-02 Rainfall Agriculture (RHS) Mar-03 Lower rates and higher capex helped in accelerating investment GDP rebounded sharply as all attributes showed signs of recovery 10.00 15 Private Investment Gross Domestic Product 8.00 10 6.00 5 (% YoY)(% 4.00 (% YoY)(% 0 2.00 0.00 -5 Jun-00 Jun-01 Jun-02 Jun-03 Sep-00 Sep-01 Sep-02 Sep-03 Dec-00 Dec-01 Dec-02 Mar-00 Mar-01 Mar-02 Mar-03 Jun-00 Jun-01 Jun-02 Jun-03 Sep-00 Sep-01 Sep-02 Sep-03 Dec-00 Dec-01 Dec-02 Mar-00 Mar-01 Mar-02 Mar-03 Source: CSO, MOSPI 8 2008-2009 Global Financial Crisis 9 Real GDP growth collapsed on account of global contagion World GDP contracted on account of international banking crisis The plunge in world exports contracted external demand Bloomberg World GDP Tracker 15 70 7 10 50 5 5 30 3 0 -5 (%YoY) 10 (%YoY) SAAR) 1 -10 -10 -1 -15 QoQ -20 -30 (% -3 -5 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 World Export Indian Export (RHS) Slumping export activity disrupted business sentiments too Real GDP growth witnessed the steepest slump 12.00 23 Private Investment Gross Domestic Product 19 10.00 15 8.00 11 6.00 7 (% YoY)(% (% YoY)(% 4.00 3 -1 2.00 -5 0.00 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Source: Bloomberg, CSO, MOSPI 10 Economic activity witnessed a sharp contraction on broad based weakness across all sectors The decline in growth in agriculture and industry, however, was more prominent compared to services. Industry 14 Agriculture,forestry & fishing 15 9 10 4 5 (% YoY)(% (% YoY)(% -1 0 -6 -5 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Slumping urban and rural demand contracted private consumption Services did not decelerate much and thus limited downside Private Consumption Services 13 14 11 12 9 10 (% YoY)(% 8 (%YoY) 7 5 6 4 3 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Source: CSO, MOSPI 11 Sharp moderation in growth warranted appropriate fiscal and monetary policy response GOI opted for aggressive fiscal policy in order to reverse the downturn RBI lowered repo rate by 400 basis points over a period of 7 months Fiscal Deficit (% GDP) RBI Policy rate (Repo rate) 7.0 9.0 8.0 5.0 7.0 3.0 (%) 6.0 5.0 1.0 4.0 Jun-06 Jun-07 Jun-08 Sep-05 Sep-06 Sep-07 Sep-08 Dec-05 Dec-06 Dec-07 Dec-08 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Mar-06 Mar-07 Mar-08 Mar-09 .