Does the stock market think that demonetization will have a temporary impact and investors need to look beyond it? This is what the Reserve Bank of India (RBI) believes and it is no doubt what the government would have us believe.
So how has the Indian stock market reacted since 8 November? Sure, the BSE Sensex is a bit lower now since that date, but then there are many other factors besides demonetisation that have affected the markets, not the least of which has been Donald Trump’s election as president of the US and the subsequent rise in US bond yields and the strengthening of the dollar. That has led to funds flowing out from emerging markets and India too has been affected.
The question is: how has the Indian market done compared with its peers?
Chart 1 has the answer, comparing the MSCI India Index with MSCI Asia ex-Japan. As the chart shows, both indices have fallen since 8 November, but MSCI India has done a teeny bit better than MSCI Asia ex-Japan. By this yardstick, demonetisation has had little impact on the overall Indian market.
Now consider chart 2. This chart gives Bloomberg estimates of earnings of the Sensex companies for fiscal years 2017 and 2018. As the chart shows, FY17 earnings have shown a 3.7% drop from where they were on 10 November 2016. Much of the drop happened soon after the demonetisation announcement, as analysts adjusted their estimates for the shock.
But take a look at the FY18 earnings estimates—the chart shows that earnings estimates for FY18 for Sensex companies have hardly changed from the level they were at on 8 November. Rather strangely, the estimates show an initial jump, perhaps because some analysts believed that demonetisation would be good for some companies in the long run. But in the final analysis, they seem to believe that except in the short run, demonetisation will have little impact on earnings growth.
Another way of looking at the effect of demonetisation on the markets is to see whether the premium valuations that Indian stocks have enjoyed over their peers in the Asian region have been eroded. Chart 3 compares the one-year forward price-earnings (P-E) multiple of the MSCI India Index with that of MSCI Asia ex-Japan. The chart shows that the difference between the MSCI India P-E multiple and the MSCI Asia ex-Japan P-E multiple has come down from 4.9 on 8 November to 4.6 now. That could be the impact of demonetisation, but it’s not much.
Taking these three yardsticks, it does look as if demonetisation hasn’t really affected the overall market much and investors believe the impact is temporary, with lower interest rates and more government spending offsetting any adverse effects. Of course, this also indicates that if the negative impact persists, such as if there is a raid raj that affects business sentiment, or if there is greater and more persistent demand destruction in the informal sector, then the market correction is still ahead of us.