7 Government actions that drive stock gains in the short-term

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 make 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 that 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, RBI for India, uses the repo rate to control inflation. Oh, and RBI is wholly 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. This was the case in 2022 and 2023. As of March 2024, RBI has increased the repo rate by 2.75% in the past two years.

What is the Repo rate, and how does it impact inflation?

The repo rate is the interest rate at which RBI lends money to banks. If the repo rate increases, banks will find it costlier to raise money from RBI. This will trickle down to increasing lending rates, as banks will pass down the increased lending costs to their borrowers — corporations 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, reduce inflation.

Using Repo Rate for Stock Picking

Small changes in repo rate might not impact stock picking a lot. However, a significant increase (>1%) and a prolonged sustained increase (> one 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. Thus, the?FMCG (Fast Moving Consumer Goods) sector might do well in a high repo rate environment.

A high repo rate makes corporate lending costlier. However, companies that fund their capex plans entirely through 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 that have mentioned in their conference call or quarterly earnings presentation that they are funding their capex plans from internal accruals.

Govt Action 2: Corporate Incentives

The 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 particular 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 that have been shortlisted for government incentives and have an excellent record of execution. After being shortlisted, these companies must meet the production targets to receive the incentive. Any good company that is well governed and has shown smooth execution in the past is a good stock investment opportunity.

If you want to improve, you can pick stocks during the incentive application process. If the company is fundamentally sound and has a good history of winning government bids, it will most likely be shortlisted for the incentive.

The period between application and shortlisting is typically one month to a few 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 sound 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 subsidised seeds and fertilisers. I am talking about incentives we use when buying electric vehicles (FAME incentive) or installing solar panels on our roofs.

Via these incentives, the government reduces the financial burden of consumers and drives intended behaviour.

An electric vehicle is costlier than a petrol or diesel vehicle. With innovation and better energy-storage systems, electric vehicles might become cheaper. But what about now? How do we drive consumer buying when there is a cheaper alternative (petrol/diesel vehicles)?

Government incentives come in, which reduce the price gap between the preferred product and its existing alternative.

Use Consumer Incentives to pick stocks.

This one is also straightforward. Identify the consumption sector where consumer incentives are given, and then select a well-run company.

For example, the recent incentives for buying electric vehicles will boost the auto sector. You can 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 focused on components needed for electric vehicles. Motherson Sumi, Minda Industries, and Sona BLW Precision Engineering are a few.

The second example is the solar roof panel subsidy, which gives as much as 30% as a subsidy. Tata Power and Adani Green Energy are some of the top listed stocks in this field.

The strategy is simple: track upcoming consumer incentives from the planning stage. Draft incentive circulation, debates and voting, and passing of incentives follow planning. The earlier you can identify the incentive being realised 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 Solar Industries a license 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 number of companies get these licenses.

Example 2:?India's geospatial policy prevents non-Indian entities from mapping Indian locations and mandates that this data be stored within India. This has boosted Indian listed companies such as MapMyIndia, who get unhindered access to sell their maps and geolocation products to banks and auto manufacturers.

Although you can use Google Maps, Apple Maps, or any other map app as a customer, companies prefer to use regulated and valid location services to avoid any hassle and negative audit observations by government bodies.

While researching a company, study if the moat is driven by government policy or a license. If yes, 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 to boost domestic manufacturing or prioritise essential domestic consumption vs business profit obtained by exporting. Some examples below help explain this and 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 taxes on crude, considering 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 pay windfall tax when exporting crude oil outside India. 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 a long time, crude-producing stocks, such as Reliance’s stock price, fall temporarily, creating a good buying opportunity.

When these taxes are withdrawn or reduced, the prices of the related stocks rise 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 China used to dump in India. This 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 favour 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 removing the anti-dumping duty.

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 defence sector budget at a fast pace. Combined with this, the government has a sharp focus on domestically manufacturing defence equipment, decreasing reliance on imports.

In 2023, INR 6 lac crore, or little over 13% of the overall budget, was allocated to defence. New orders were allocated to leading defence manufacturing companies.

This included some listed stocks, such as Hindustan Aeronautics (HAL) and Bharat Electronics (BEL). HAL and BEL's prices 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 2030 (refer to the article?here ).

This policy is being implemented by digitising the diverse logistics channels and integrating the end-to-end movement of goods. This will benefit tech-first logistics companies like 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 the 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 sound companies with tailwinds caused by government actions can help realise short-term gains. These short-term gains (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, management, governance, execution capabilities, etc. Tailwinds can lift a stock, but the fundamental strength will keep it floating for a long time.

Which government action drove the price of a stock you invested in? Do share in the comments below.

Happy Investing!

Disclaimer: This post is not financial advice. It represents my personal views from my investing experience. Please do your research before investing.