Numbers from the June quarter reflect widening divergence between markets and macros


The sharp contraction in India’s gross domestic product (GDP) in the June quarter reflects the widening divergence between equity markets and the weak macro economy of the country.

Government data released on Monday showed that the Indian economy contracted by a record 23.9% in the first quarter of fiscal 2021, mostly due to the covid-19-induced lockdown.

In stark contrast, however, Indian equities surged almost 20% in the first quarter, mostly riding on foreign liquidity that is gushing into equities worldwide. The equity markets, so far, have stayed unhurt by the weak macros but the record first-quarter contraction in GDP suggests that corporate earnings recovery will be an uphill battle amid valuations that appear overheated and low fundamental support to equities.

“Now the markets will look for the GDP recovery in the remaining months of FY21. However, this would not be strong enough to offset the shock from Q1. The base effect will push up growth in FY22,” said Naveen Kulkarni, chief investment officer, Axis Securities.

Kulkarni said markets will now watch out for how economic activity pans out and the direction of high-frequency indicators in the aftermath of Unlock 4.0. He added that a timely monsoon has also boosted optimism of improved kharif sowing, supported by reverse migration aiding labour availability in rural areas.

With the growing number of covid-19 cases in the country and location-specific lockdowns in the wake of the virus spreading rapidly to rural areas, corporate earnings growth is at risk in an already struggling business environment, said experts.

Suvodeep Rakshit, vice-president and senior economist at Kotak Institutional Equities, said, “Going forward, given the gradual improvement in activity indicators (remaining well below pre-covid levels), the growth recovery will be gradual and contracting for all quarters in FY2021. Further, growth recovery will also be hinged to the curb of the spread of covid and removal of even localized lockdowns. The choice for the government will be on whether the consumption or the investment side needs to be pushed. Given the limited fiscal space and the need to stimulate a more durable growth, growth recovery will be gradual and is likely to continue into the first half of FY22.”

In the June quarter, Indian companies’ quarterly earnings and sales hit at least a 22-quarter low in the three months to June, dimming hopes of an immediate recovery with covid-related disruptions likely to persist in coming months.

Combined adjusted net profit slumped 74% in the June quarter from a year earlier, while net sales declined 26.5%, according to a Mint analysis of 970 listed firms in the manufacturing and services sectors. This is the worst earnings slump since the quarter ended 31 March 2015. The Mint study excluded oil and gas, and financial services companies as they follow a separate revenue model.

Lower raw material prices, pared down employee costs and other cost-cutting measures appear to have protected margins of various listed companies compared to previous expectations of a severe impact of the lockdown on profitability. However, the cost-cutting measures would depress revenues and pinch consumption, analysts fear.

“Going forward, it appears that July was worse than June and the initial data for August is also not very encouraging. There would be another contraction in Q2FY21; however, what needs to be seen, and as we have always feared, the turnaround from late CY20 could be much slower than the general expectations,” said Nikhil Gupta, economist, institutional equities, Motilal Oswal Financial Services Ltd.

With risk-reward for Indian markets turning unfavourable with steep valuations and weak corporate earnings, foreign liquidity inflows will be critical to keep the markets rally intact.

Foreign institutional investors (FIIs) bought Indian shares worth $6.35 billion in August after a net purchase of $1.15 billion in the previous month. This is the highest purchase of Indian shares by FIIs since September 2010 when there was a net inflow of $6.37 billion. Domestic institutional investors, however, sold 11,727.66 crore worth of shares in August, the highest ever sell-off by domestic investors since March last year.

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