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Business News/ Opinion / Online-views/  Equity allocation and reforms
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Equity allocation and reforms

Demonetisation can lead to more tax compliance, which could in turn reduce the fiscal deficit.

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India is in the process of economic transformation. Two path-breaking reforms—goods and services tax (GST) and demonetisation of high denomination currencies—would take the country to greater heights of growth over the long term. Both these steps have come on the back of over 2 years of reforms in banking, financial inclusion, domestic manufacturing, e-governance, and other such sectors.

Massive reform exercises are never easy to execute. The latest demonetisation exercise, which covers about 86% of the currency in circulation, could hurt short-term demand. The GST could be inflationary when it is rolled out. However, dealing with discomfort over the short term would result in making way for a strong rebound and enduring performance of India Inc.

Both these reforms would have several long-term positives, ranging from fewer bottlenecks to speedier processes, which could improve the ease of doing business. On this criterion, India is improving and has climbed to the 76th spot among 168 countries. The new set of reforms can leapfrog the country to much higher levels.

Demonetisation would have numerous positive effects on the economy. It could help cut out much of the black money and, at the same time, arrest further creation of unaccounted wealth. It would also help the government bring the informal sector within the regulatory ambit.

Cash comprises nearly 3.2% of a household’s assets. Much of this is generated through transactions that are kept out of the formal taxed-economy. Demonetisation can lead to more tax compliance, which could in turn reduce the fiscal deficit.

The overall GDP would benefit as more businesses become tax compliant and fall within the regulated economy. This would improve the tax-to-GDP ratio and, eventually, result in lower tax rates and higher consumption. In fact, these two crucial reforms would set the growth ball rolling at a good speed in coming years.

Other reforms such as e-governance and the introduction of direct-benefit transfers into Aadhaar-linked bank accounts would eliminate waste, increase financial inclusion, and draw more people to mainstream banking channels. Simultaneously, this would increase bank deposits, leading to a probable reduction in interest rates.

Projects in capital-intensive sectors such as power, roads, ports, railways, waterways could become increasingly affordable due to lower interest rates.

In 2015, government unveiled the housing for all scheme, aimed at building 20 million houses by 2022. Loans up to Rs6 lakh would be extended at lower rates.

Besides, banking reforms have been taken a step further when the government created the Bank Board Bureau to revamp banks. Public sector banks (PSBs) are being merged as the government seeks to consolidate 27 PSBs into seven banks. PSB re-capitalisation is now being linked to better banking performance.

The new Bankruptcy Code would create new debt-recovery tribunals and could speed up insolvency proceedings, which could boost recoveries of non-performing assets (NPAs) from stressed companies. All these initiatives in banking would boost credit off-take.

The government is also looking at containing inflation to help long-term growth. While lower food prices could impact (companies)in the short run; in the longer run, lower inflation is far more acceptable as it creates more sustainable levels of growth in the economy.

We are now in an accumulation phase where holding financial assets makes more sense than owning physical assets. Over longer time frames, financial assets would provide better investor experience as compared to physical assets like real estate and gold. This is the accumulation phase that investors cannot afford to miss. Indian investors have just 2.8% of household wealth in equity, while 12.5% is in gold and 56.4% in real estate. Physical assets comprise about 69% of household wealth.

The figures indicate that the growth of financial assets in Indian households would only increase over time as structural changes in the economy lead to much lower and steadier inflation over the coming years. Reforms could lead to higher growth in the economy once it stabilises, more currency enters the Indian market, and investment in infrastructure increases.

The pace of recovery in the economy would be slow at first. In fact, whenever major reforms are initiated, it’s not prudent to pen a number to short-term losses, but to look ahead at the bigger gains, both tangible and intangible.

We may see a negative impact in corporate earnings for one or two quarters, but the next few years will see a strong rebound in earnings as reforms take root and the pent-up demand returns to the economy.

It’s important for investors to invest in financial assets, ignoring the current low-return phase and instead focusing on acquiring more equity and fixed income assets.

Equities are now available at reasonable valuations. Our market valuation tool indicates that we are close to the buy zone. Don’t miss this investment accumulation period; you might not see a similar buying opportunity over an extended period of time.

Nimesh Shah, managing director and chief executive officer, ICICI Prudential Asset Management Co. Ltd.

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Published: 07 Dec 2016, 12:01 AM IST
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