What is the fuss?
The government of a country makes decisions, and creates policies, to boost the country’s development. These decisions and policies create tailwinds in some industry sectors, which benefit select listed stocks in these sectors. If you track these government actions closely, you can take stock picking decisions in areas with tailwinds, and make disproportionate gains in the short term.
When a company announces a future strategy, it may or may not work out. But when a ruling government, which has a majority in the parliament, announces a budget allocation, or a policy, it usually translates into action. The news of government decisions, or their intention to act, is enough to trigger ground-level actions by companies. Many companies allocate a certain part of their roadmap to develop products that might become relevant after an expected government decision or policy is announced.
In this post, I lay down seven government, and government bodies’ actions, which positively impact stock gains in the short term. Though long-term gains may also be there, the disproportionate short-term gains make tracking these seven government actions interesting. Let’s get started.
Govt Action 1: Change in Repo Rate
The Central Bank, which is RBI for India, uses the repo rate as a tool to control inflation. Oh, and RBI is fully owned by the central government of India, hence this action got its place in this post.
RBI (Reserve Bank of India), has a target of 4% inflation, with some tolerance. However, when inflation rises too high, the RBI increases the repo rate to decrease inflation. Such is the case in 2022 and 2023 when RBI increased the repo rate. As of Dec 2023, RBI has increased the repo rate by a cumulative 2.75% in the past two years.
What is the Repo rate, and how does it impact inflation?
Repo rate is the interest rate at which RBI loans money to banks. If the repo rate is increased, banks will find it costlier to raise money from RBI. This will trickle down to lending rates increasing, as banks will pass down the increased lending costs to their borrowers — corporates and individuals.
Thus, with an increase in the repo rate, overall credit growth slows down in the country. With less borrowing and fundraising, consumption slows down. A decrease in consumption reduces the demand for goods and services. Less demand, same or more supply, leads to a reduction in prices, or reduction in inflation. This is the correlation between the repo rate and inflation. Higher repo rates, over time reduced inflation.
Using Repo Rate for Stock Picking
Small changes in repo rate might not impact stock picking a lot. However, a large increase (>1%), and a long sustained increase (> 1 year), lead to economic impact. When lending becomes costly, people may cut down on luxury and wants. But they will continue to buy essentials, such as groceries, and health checkups. Thus, the FMCG sector (Fast Moving Consumer Goods) might do well in a high repo rate environment.
High repo rate makes corporate lending costlier. However, companies that fund their capex plans entirely by internal accruals will do well. Their competitors, who rely on debt to fund their capex, might delay their plans during a high repo rate environment. Thus, look for companies with low debt-to-equity ratios, who have mentioned in their con call or quarterly earnings presentation that they are funding their capex plans from internal accruals.
Govt Action 2: Corporate Incentives
Government doles out incentives for corporates, to either set up shop in India or make it cheaper for them to produce a good. A good example is the Production Linked Incentive (PLI) announced by the Indian government in 2020. This scheme spans 13 industry sectors. It gives monetary incentives to shortlisted companies. The incentive is given on reaching certain annual sales or manufacturing targets.
The government does this to create jobs and boost a certain industry segment. Such incentive schemes are a clear indicator that the government is thinking long term to boost a sector. More often than not, the initial announced incentive is followed up with additional incentives.
Use corporate incentives to pick stocks
This one is easy. Pick stocks who are shortlisted for government incentives, and who have a good record of execution. After being shortlisted, these companies just have to meet the production targets to get the incentive. Any good company, which is well governed, and has shown smooth execution in the past, is a good stock investment opportunity.
If you want to do better, you can pick stocks during the incentive application process itself. If the company is fundamentally good and has a good history of winning government bids, then it will most likely be shortlisted for the incentive. The period between application and shortlisting is typically one month to a couple of quarters. After the shortlisting decision, there might be a rush in the stock market to buy these company shares. Hence you might be slightly better off buying these stocks after the news of their application confirmation comes out.
The basics of investing are always applicable -> investing in fundamentally good stocks, run by experienced and honest management.
Govt Action 3: Consumer Incentives
Yes, sometimes the government provides incentives directly to consumers like you and me. I am not talking about farmer incentives to get subsidized seeds and fertilizers. But incentives that we use while buying electric vehicles (FAME incentive), or while installing solar panels on our roof.
Via these incentives, the government reduces the financial burden of consumers and drives intended behavior. An electric vehicle is costlier than a petrol or diesel vehicle. With innovation and better energy-storage systems, electric vehicles might become cheaper in the future. But what about now? How to drive consumer buying, when there is a cheaper alternative (petrol/diesel vehicles). Incentives come in, which reduce the price gap between products.
Use Consumer Incentives to pick stocks
This one is also straightforward. Identify the consumption sector where consumer incentives are being given. And then select a good-run company in this sector.
For example, the recent incentives for buying electric vehicles will boost the auto sector. You can either buy a good auto OEM (Original Equipment Manufacturer) stock, such as Tata Motor, Mahindra & Mahindra, or Maruti Suzuki. Or, you can buy auto ancillary companies, which are focused on components needed for electric vehicles. Motherson Sumi, Minda Industries, and Sona BLW Precision Engineering are to name a few.
The second example is the solar roof panel subsidy, which gives as much as 30% as a subsidy. Key top stocks in this field are Tata Power and Adani Green Energy.
The strategy is simple, track upcoming consumer incentives, right from the planning stage. Planning is followed by draft incentive circulation, followed by debates and voting, followed by passing of incentive. The earlier you can identify the incentive being realized shortly, the better stock picking and short-term gains will be.
Govt Action 4: Providing License for key activities and services
The Indian government provides licenses to select companies in sensitive industry areas.
Example 1: License to manufacture and sell explosives. The government has granted license to Solar Industries to produce and sell industry explosives, and defence ammunition. This license cannot be granted to just any company. This area needs to be observed and regulated, to avoid misuse. Hence only a select companies get these licenses.
Example 2: The geospatial policy of India prevents non-Indian entities from mapping Indian locations, and mandates this data to be stored within India. This has given a boost to Indian listed companies such as MapMyIndia, who get unhindered access to sell their maps and geolocation products to banks, and auto manufacturers. Even though as a customer, you can use Google Maps, Apple Maps, or any other map app. Companies prefer to use regulated and valid location services, to avoid any hassle and negative audit observations by the government bodies.
While researching a company, make sure to study if the moat is driven by government policy or a license. If yes, then it is a strong moat, unlikely to be disturbed shortly.
Govt Action 5: Import and Export regulations
The government exercises some control over imports and exports. These are done either to boost domestic manufacturing or prioritize essential domestic consumption vs business profit obtained by exporting. Some examples below help explain this and also show ways of using these opportunities to pick stocks and make short-term gains.
Example 1: Change in Windfall tax on crude
The government increases or decreases windfall tax on crude. This is done considering the international crude prices, to ensure crude oil refining companies do not make higher profits due to international price fluctuations. Windfall taxes also help accumulate money for government expenses.
Companies such as Reliance, when exporting crude oil outside of India, pay windfall tax. More tax means less profit for Reliance, and less tax means more profit for Reliance.
Hence, when windfall taxes are increased abruptly, and kept high for long, crude-producing stocks such as Reliance’s stock price fall. This creates a good buying opportunity, temporarily. When these taxes are withdrawn or reduced, the related stocks’ prices rise up, in response to expected good future quarter profits.
Example 2: Imposing Anti-Dumping Duty on certain products
The government imposes additional duties on certain products, to boost domestic production, and balance competition in situations where a country with a lower cost of production can simply dump its local products in India.
A good case is the anti-dumping duty imposed on solar glass which used to be dumped by China in India. This anti-dumping duty was imposed in 2017 and ended in 2022. The anti-dumping duty required an additional payment of $200 to $300 per tonne of solar glass imported. This tilted the demand in favor of domestic manufacturers. Listed stocks such as Borosil Renewables turned multi-bagger in this 5-year anti-dumping duty period. This stock rose 400%, from INR 205 in 2018 to INR 830 in 2022, before falling sharply after the anti-dumping duty was removed.
Govt Action 6: Budget Allocation to a sector
The Indian government has a massive annual budget. In the 2023 finance budget, the government shared a plan to expense INR 45 Lakh crores, or USD 5.4 trillion. This is massive. What if the government decides to boost a sector, and pump more money into this sector via higher budget allocation? You know where this is going. Let’s see some examples.
Example: Increasing Defence Sector Budget
The Indian government has been increasing the defense sector budget at a fast pace. Combined with this, the government has a sharp focus on domestically manufacturing defense equipment, decreasing reliance on imports. In 2023, INR 6 lac crore, or little over 13% of the overall budget was allocated to defense. New orders were allocated to leading defense manufacturing companies. This included some listed stocks, such as Hindustan Aeronautics (HAL), and Bharat Electronics (BEL). Prices of both these stocks, HAL and BEL, have increased tremendously in Calendar Year 2023, 78% and 34% respectively.
Govt Action 7: Infrastructure Building
Every country’s government focuses on infrastructure development. However, what is different is the focus, pace, and efficiency with which it is done. India has been improving in all three aspects. Below are some examples.
Example 1: Reducing logistics costs by 50%
The National Logistics Policy, released in 2022, aims to reduce logistics costs from 16% of GDP to 8% of GDP by 2020 (refer to the article here). This policy is being implemented by using a combination of digitizing the diverse logistics channels and integrating the end-to-end movement of goods. This will benefit tech-first logistics companies, such as Delhivery in the listed space.
Reducing the time and cost of moving goods will improve the margins of retailers (e.g. DMART), and goods manufacturers, such as FMCG companies (HUL, Tata Consumer Products), Jewellery companies (Titan, Senco Gold), etc.
Example 2: Jal Jeevan Mission
Jal Jeevan’s mission aims at providing drinking water to every corner of the country. This requires the construction of pipelines for water transmission, water quality control measures, and distribution setup. Many infra development listed companies such as HG Infra Engineering (HGINFRA) have received tenders to construct water pipelines.
The government’s push to accelerate connectivity by building highways, doubling the number of airports by 2030, and making India’s railway network future-ready (article), has boosted companies in these respective sectors.
Parting Thoughts
The actions of government, and its bodies, drive the economy in more ways than one. As we see in this post, government actions drive healthy order books, and future revenue visibility for related listed stocks. Investing in fundamentally good companies with tailwinds caused by government actions can help realize good short-term gains. These short-term (3 months to 1 year), can also become long-term gains if the tailwinds persist for many years.
Do note that the fundamentals of investing do not change. Research the company, its management, its governance, execution capabilities, etc. Tailwinds can lift a stock, but it is the fundamental strength that will keep it floating for long and far.
Which is a government action that drove the price of a stock you invested in? Share in the comments below.
Happy Investing!
Disclaimer: This post does not recommend buy or sell for any stock. Please do your research before making stock investment decisions.
