Volatility became the trademark for equities in 2016, with key indices Sensex and Nifty seeing wild swings, and eventually wiping off most of the gains registered during the year.
And if indications are anything to go by, the volatility is unlikely to subside anytime soon, with several headwinds on the horizon.
The year began with a sharp pull out of foreign institutional investors (FIIs) from India and other emerging markets. Then came a strong Union Budget, a shock UK vote to exit the European Union, Republican Donald Trump’s surprise victory in the US presidential elections, an interest rate hike by US Federal Reserve, a new governor at the Reserve Bank of India, and the mother of them all, the government’s move to ban currency notes of R500 and 1,000.
The BSE Sensex is down 1.2% as of Monday’s close, while the wider NSE Nifty has fallen 0.50%. This is the second consecutive year that India’s equity markets have ended lower.
In comparison, most Asian markets look set to close the year with gains.
“There are a lot of headwinds. Demonetisation will have a larger impact, and most companies are likely to post 20% to 40% lower profits in January-March, compared to the October-December quarter. Any revival in the economy will depend on the pace of remonetisation. Furthermore, private sector investments still remain tepid and a rise in crude price is a worry for oil importers like India,” said Ajay Bodke, CEO and chief portfolio manager at Prabhudas Lilladher.
FIIs have already been pulling out of the country on the back of a strengthening US Dollar and the Federal Reserve’s decision to raise interest rates by 0.25%. More interest rate hikes in 2017 by the Fed, and Donald Trump’s policies once he assumes office on January 20, could also drive more money out of India and other emerging markets, Bodke added.
Foreign investors pulled out over R16,400 crore in January and February .After a period of moderate activity during the middle of the year, they turned net sellers again, pulling out over R27,700 crore in October alone. However, for the full year, they are still net buyers of R23,539 crore.
A recent tax clarification by the Central Board of Direct Taxes and Prime Minister Narendra Modi’s statement that people earning from the financial markets should pay a fair tax, have only added to investor woes.
The CBDT clarification states that if an investor holding 5% or more in a fund registered as an FPI in India sells or redeems the shares or units, and the fund has at least 50% of its money invested in India, then the investor will be liable to pay tax in India.
“The recent clarification by the CBDT on incomes, which are deemed to accrue or arise from India, and the recent speech of the Prime Minister highlighting low tax on incomes from capital markets and increasing the same are likely to create uncertainty about taxation of capital gains on equities and equity derivatives,” said Sanjeev Prasad, senior executive director and co-head of Kotak Institutional Equities.
Although finance minister Arun Jaitley has clarified since that the government has no plans to levy long-term capital gains tax, investors will have their eyes firmly on the Budget, according to analysts.
Even as FIIs pulled out, domestic mutual funds have been strong buyers this year, mainly due to sustained retail fund flows. Between January and November, equity funds saw inflows of more than R37,000 crore.
Despite the near-term uncertainties, equity markets valuations have turned attractive after the correction, according to some analysts.
“There is a case for a big asset allocation shift for domestic investors to equities – the last time an equivalent valuation opportunity in favour of equities arose was in June 2013. India’s valuation against emerging markets is at a 26-month low,” said Ridham Desai, managing director, Morgan Stanley India.
BNP Paribas also outs India among the “overweights” in emerging markets.
“The demonetisation exercise seems set to slow the economy in the near term, although it could be beneficial in the longer term in bringing a significant part of the economy into the formal sector,” said Manishi Raychaudhuri, head of Asia (ex-Japan), equity strategist, BNP Paribas Securities.
The rupee also weakened to a record low of 68.85 in November as the Fed hiked rates, but recovered some lost ground. The currency was trading at 67.82 on Monday.
Crude oil futures declined to $26 by mid-February, but rose to $53 a barrel on December 26.