Oil prices have climbed recently to $65 a barrel and traders continue to place bullish bets
Image: Rosa Panggabean / Reuters
1. Will the government abandon fiscal prudence?
The last year of an election cycle is typically fraught with fiscal uncertainty. Despite its stellar performance so far on the fiscal front no one expects the present government to follow a different path. The 2018 budget will, in all likelihood, see the government loosen its purse strings as it seeks to satisfy multiple constituencies—from farmers hit by low minimum support prices to small traders reeling under the implementation of the goods and services tax (GST).
The government’s work on the fiscal front has been exemplary so far. It inherited a deficit of 4.5 percent and has worked overtime to contain it to a budgeted 3.2 percent in 2017-18. At the same time, it has increased capex expenditure while broadly maintaining spends on the social schemes it inherited from the UPA era (the National Rural Health Mission is a notable exception).
The recent tougher-than-anticipated fight in the Gujarat elections, an uptick in food price inflation and higher oil prices have already resulted in the bond markets pricing in some fiscal slippage. Bond yields have risen from 6.5 percent to 7.25 percent in the last month with a recent Bloomberg survey expecting them to rise to 7.5 percent by March.
The risks to fiscal slippage come as much from increasing expenditure as from a revenue deficit. The recent cut in GST rates is expected to result in a revenue shortfall of ₹20,000 crore. And the government may decide to cut excise rates instead of passing oil prices to consumers. Add to that the doles the finance minister could announce in the 2018 budget and the risks to fiscal slippage grow.2. Will oil hit $80 a barrel and stay there?
The recent rise in oil prices to $65 a barrel may not be as spectacular as its collapse in 2014 but make no mistake: Higher oil prices are here to stay. Every few months, crude scales new levels only to spend time consolidating before making another up move. At $65 a barrel, traders continue to place bullish bets.
Two factors will determine the strength of the rally from here on—North American shale oil production and economic growth in Europe and America.
It is generally accepted that at $40 a barrel, shale oil production becomes viable and rig counts rise dramatically. Rig counts in North America have risen 48 percent in 2017 to 909, according to data from Baker Hughes. The longer prices stay up, the more chances of the number increasing.
For the time being, rising oil production has dovetailed neatly with increasing demand due to faster economic growth in Europe and America. In 2018, worldwide crude oil consumption is likely to rise to 99.96 million barrels per day as against a supply of 100.01 million barrels a day, according to the Energy Information Administration. This 50,000 barrel surplus is the tightest in the last decade resulting in oil continuing its climb to $80. A supply shock would only hasten it.3. Will private sector capex pick up?
India’s investment cycle, and as a result growth, is unlikely to pick up meaningfully unless the private sector contributes. The signals emerging from corporate India have, so far, been mixed at best. Saddled with excess capacity India Inc is still working on paying down loans they took in the last capacity expansion boom of 2003-07. For now, capacity expansion will have to wait.
Meantime the government has stepped in. The last budget allocated ₹3,96,000 crore for infrastructure.
It’s not just excess leverage that is holding back private sector capex. Capacity utilisation rates remain at 70 percent, much below the level where companies plan the next round of expansion. In some sectors like cement and steel the situation is particularly acute as utilisation rates for the industry as a whole stand at 60 percent. In some others—coal blocks and mining, for instance—uncertain government policy has prevented the private sector from investing in a meaningful way. The insolvency code will have a chilling effect on investment as scores of small suppliers will struggle to collect their dues.
With six percent growth it should take two years for capacity utilisation to inch up to 80 percent—the level where the next round of expansion is planned. For now, it’s safe to say that private sector capacity expansion is at best 18-24 months away.4. Will cryptocurrencies crash in 2018?
Cryptocurrencies are now the topic of every discussion. Bitcoin, Ethereum and Ripple are the most widely traded. Bitcoin, the biggest of them all, has seen its price surge throughout 2017.
In the one month from November 1 to December 1, 2017 the price of bitcoin surged from $6,750.17 to $10,859.56 apiece, up by 60.9 percent, according to virtual currency news website CoinDesk. But the price of bitcoin has been sliding since it touched $19,966 on December 17, 2017 after the launch of bitcoin futures on the Chicago Mercantile Exchange.
Investors who believe that the price will be much higher in 2018—and there are many of them—have this explanation for their optimism: As mining bitcoin becomes difficult, because of more competition, miners will only do so if the prices move higher. There’s talk of bitcoin touching the $100,000 mark in the next year or two. Based on that assumption, gung-ho investors expect bitcoin to trade closer to $500,000 before it finds stability.
Beyond such speculation, though, the reality is that there is no fundamental way to analyse where the price of bitcoin will be in the future.5. Will vCs pick B2B startups over B2C ones?
Serving business needs as opposed to consumer requirements seems to be the new mantra for Indian startups. And investors are lapping it up. For two reasons: One, serving businesses tends to be more sticky and, two, customer acquisition costs reduce dramatically.
Between 2007 and 2011, B2B and B2C startups went hand in hand. About 1,976 B2B startups were founded in these four years, marginally lower than the 2,234 B2C startups, according to Tracxn. But as startups chased top lines and a user base gave them bragging rights, the balance tilted heavily towards B2C startups between 2012 and 2015.
These were the rah-rah days of consumer internet. Most of these startups were left stranded after investors tightened the purse strings beginning 2015, citing poor returns.
Today, B2B ventures are back in the reckoning. They possibly did not double revenues every year, but didn’t splurge on customer acquisition either. Instead, they chugged along with a steady revenue stream. The likes of Freshworks, Zoho, Fractal Analytics and Capillary Technologies have emerged as successful B2B technology startups in India.
While the number of B2C startups founded in 2016 plummeted to 4,753—almost half the 2015 number —the number of B2B startups in 2016 dropped just 29 percent to 1,722 from the year before.
Besides, a few profitable exits for investors in the B2B segment—Citrus Pay was acquired by PayU, Skyhigh Networks bought Mcafee, Arkin sold to Vmware —have also swayed the sentiments in favour of B2B startups. That trend can only accelerate in 2018.6. Will Indian startups consolidate?
With venture capital scarce, Indian startups are being nudged to explore the option of consolidation. Tracxn data shows a sharp spike in mergers and acquisitions in India since 2015. For instance, there were 436 M&As between 2015 and December 2017, almost three times the 152 M&As in the eight preceding years.
In some cases investors nudged their portfolio companies to merge to form a larger entity. Case in point: Flipkart’s acquisition of Myntra facilitated by Accel Partners and Tiger Global Management.
The pace of M&A is likely to increase in 2018, with venture capital firms leaving no stone unturned to salvage their investments. VCs such as Kalaari Capital, IDG Ventures, Nexus Venture Partners and Matrix Partners raised their first funds in 2006 and 2007. Most of these firms, which were supposed to return money to their investors in 10 years, have sought an extension of about two years.
While exits through initial public offerings are few in India, venture capital firms have little choice but to push for M&As or stake sales to strategic buyers. 7. Will GDP growth rebound to 7.5 percent in 2018?
In the last year, India’s economic growth has suffered due to the twin shocks of demonetisation and the implementation of GST. Now as the effects of both fade, there is every chance that GDP growth will rise in 2018.
After decelerating to 7.3 percent in the quarter ended September 30, 2016, GDP growth kept falling in the subsequent quarters as small businesses struggled to deal with the abolition of high value currency notes. The implementation of GST from July 1, 2017 meant that businesses went slow on placing orders to be able to take advantage of the input tax credit that GST allows. As a result, growth slid to 5.7 percent in the first quarter of this fiscal. Growth has begun to rise since then.
Consumer spending, which makes up about two-thirds of GDP growth, has remained robust as consumer goods companies and car makers report over 10 percent growth in year-on-year sales. While export growth has been subdued, that is equally a result of delayed GST refunds, which resulted in working capital issues for small exporters. The next few months could see these irritants smoothen out.
In addition to the base effect, real GDP growth will also be aided by a decrease in the GDP deflator. As commodity prices and inflation rise, expect nominal GDP growth to rise faster decreasing the GDP deflator. Indeed, in the quarter ended September 30, 2017 growth began to inch up. GDP growth stood at 6.3 percent in the period.8. Will the Nifty index hit a new high?
As the Nifty index hit a new high in 2017 the question on many investors’ mind is how much higher can it go? While the markets have been aided by domestic retail investments—they’ve been buying while their foreign counterparts have been selling—without a concomitant rise in earnings, there is always the risk of a sell off. For now, the simple answer to this question is yes, but there will be more volatility and uncertainty for the Nifty to sustain at record highs.
Three issues will determine stock market trends this year: Economic growth, corporate earnings and bond yields. In addition there is the outcome of elections in four states and the impact of global economic growth as central banks start to scale back the stimulus and liquidity they have been providing in recent years.
India’s economic growth is likely to sustain in coming quarters, which will boost corporate growth, but high non-performing assets (NPAs) of Indian banks and increased competition in telecom will mean some companies may see weaker earnings growth.
India’s structural reforms involving the GST, bankruptcy code and RERA, though positive, will also heighten uncertainty relating to growth.
The fallout of the state elections of Karnataka, Madhya Pradesh, Rajasthan, and Chhattisgarh will also impact the stock markets. If the BJP wins these elections investor sentiment will hold firm; but any reversal will lead to a nervous stock market. The Nifty index has risen nearly 30 percent in 2017 fuelled largely by sentiment and domestic retail investors who’ve put in ₹1,36,000 crore in 2017. A repeat could see a new high hit in 2018.9. Will bank NPAs worsen?
Bank NPAs are likely to go north before they head south. The Reserve Bank of India (RBI) has factored this in its financial stability report of December 2017. Though the pace of growth of gross non-performing assets (GNPAs) is starting to slow, the levels will continue to rise in 2018. The RBI data indicates the GNPA ratio may increase to 11.1 percent by September 2018.
Despite this, managements of most private and public sector banks have said that the tough times are coming to an end.
The recent government announcement to recapitalise state-owned banks with up to $32 billion of fresh funds could be positive in several ways. Banks will be in a position to lend more and resolution of bad loans will also be possible in some cases. The ability of these banks to raise capital on their own could also improve in coming years. Bank credit has grown by 8.6 percent in November 2017 against 7.5 percent a year earlier, according to RBI data.
Through much of 2017, banks in India have been announcing higher provisioning to deal with bad loans, which have continued to place pressure and hurt profitability in recent quarters. While stress continues in infrastructure, steel and mining sectors newer areas like telecom are emerging as potential trouble spots in 2018.10. Will mid-cap valuations sustain in 2018?
Mid-cap stocks jumped over 44 percent in 2017, outpacing large cap, blue-chip stocks. Robust buying by domestic retail institutions has fuelled the bull rally further. Most of the mid-cap stocks invested are companies whose businesses are largely locally focussed and where liquidity in the stocks is not so high. Some of the hot stocks in the Nifty Midcap 100 index include Vakrangee, Federal Bank, Bharat Forge and Voltas.
Considering that factors such as corporate earnings growth, state assembly elections and bond yields will impact how the broader markets will fare in 2018, it is fair to say that mid-caps will be at greater risk than large-cap stocks.
The valuations for most of these stocks are already stretched, but any decline in stock prices could pull mid-caps down faster than the large-caps. Most equity fund managers are quietly advising their clients to move their investments into large-caps or even liquid and/or balanced funds, fearing that mid-caps could be hit the sharpest when a correction comes.
Mid-cap stocks are unlikely to sustain at their current valuations and could witness much of a rollercoaster ride in 2018, with sharper troughs and peaks, which could have little or nothing to do with the fundamentals of these companies.
(This story appears in the 19 January, 2018 issue of Forbes India. To visit our Archives, click here.)