The surprise move by the government to change the constitutional status of Jammu and Kashmir has added an additional negative for the markets as it is assuming the security situation will now remain significantly worse, Christopher Wood, global head of equity strategy at Jefferies, said in his weekly note.

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It will reduce the Indian 'overweight' by a further one percentage point and add to Indonesia 'overweight' where the investment case looks much more straightforward, most particularly on a relative basis, the report said.

Modi issued a constitutional order, without the approval of the Indian Parliament, to remove the autonomous charter and special status of Jammu and Kashmir.

The order has given much greater credibility to the longstanding attack on Modi by his domestic critics that his agenda is to build a Hindu 'majoritarian' state and turn India into 'Hindustan', said Wood.

"This means, for example, that anyone in India can now buy property in the state where 68 percent of the population is Muslim, whereas previously this was not the case. If parliamentary approval was not sought, this would only have been a formality anyway given Modi’s dominant control of the legislature," he added.

Security woes

PM Modi, in an August 8 speech, said that the goal is to boost the Kashmir economy via investment, and there is clearly massive tourism potential in the region. But according to 'GREED & fear' report by Wood, private sector investment will only happen if the security situation is satisfactory.

Stock market-wise, developments in Kashmir have so far proved more negative for the already bombed-out Pakistan market, where daily trading volume is averaging only $34 million so far this year. The MSCI Pakistan Index declined by 11 percent in US dollar terms in the two weeks following the announcement, compared with a 1.5 percent decline in the MSCI India Index; though the MSCI Pakistan Index is up 11.2 percent so far this week, compared with a 1.6 percent decline in the MSCI India Index, Wood noted.

Wood argues that Modi should not have allowed himself to be distracted by the execution of the BJP agenda on Kashmir, which like demonetisation was planned in great secrecy with many cabinet ministers kept in the dark when all the evidence is that the Indian economy continues to weaken. Credit growth has slowed, relative to last year, and tax revenue collection is also down.

Jefferies’ India Activity Index, comprising ten high-frequency activity indicators, declined by 3.7 percent YoY in June and was down an average 3 percent YoY in the three months to June, the lowest level in six years.

That said, 'GREED & fear' is not so sure what Modi can do about the economy in the short term. Some of this slowdown, particularly in the auto sector, reflects the continuing liquidity squeeze in the NBFC space triggered by the default of formerly Triple-A rated IL&FS a year ago, it added.

Time is the best healer

It has also further delayed recovery in the residential property market with problem loans rising in the property developer space. Even banking major like HDFC has seen a deterioration in NPLs and the share prices of higher beta NBFCs, like Indiabulls Housing, have also collapsed.

"In this respect, time is the best healer. Still, there remains one area where government policy could have been much more pro-active. That is the long-festering problem loan issue in the public sector banks, a problem which Modi inherited when he was first elected in 2014 but which has long since become his own problem," Wood explains.

Still what could have happened, but has not happened, is for the public sector banks to have been privatized, or at least for the government to have sold down its controlling stakes, he added.

Earnings estimates have continued to come down over the most recent quarterly reporting period.

Jefferies has revised down the FY20 Nifty EPS forecast by 7 percent since

early July. The one area of strong earnings growth is the corporate banks, said the report, adding that the house continues to have a 10 percent holding in ICICI Bank and Axis Bank in the Asia ex-Japan long-only portfolio. The corporate banks are also by far the biggest weighting in the Jefferies Indian office’s model portfolio, where ICICI Bank, Axis Bank, and Yes Bank account for 19.5 percent of the portfolio.

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First Published:Aug 23, 2019 11:16 AM IST