2015, Mid-Year Market Outlook - INDIA

PART FOUR

Market Drivers: In-depth View

INDIA

Realities: India's Economic Health

As a general comment we can say, Indian economic health has vastly improved and promises more for the next 5 to 10 years. 

In 2013, still under the ‘old’ coalition government, the economy had run out of steam, just in the same way that the government had run out of ideas as to how to improve it.  Likewise, Indian stock markets had underperformed. 

By early, 2014, the economy struggled keeping the pace. Change was in the air.

With a general election looming, punters started to bet on the prospect of a new government and India’s stocks entered a strong recovery phase, despite global headwinds and in stark contrast to other BRIC nations, Brazil, Russia and China.

Falling oil prices and inflation below 6% helped a more independent Reserve Bank of India (RBI) cut interest rates. This was well received by the markets, stimulating economic growth and credit uptake.

In May 2014, the BJP party won the election with an outright majority, surprising most observers. It is the first time in 30 years that a single party can form the national government of India. The most credit for this resounding victory must probably go to its new charismatic leader, - now - President Narendra Modi. He won on the promise of sweeping reforms, favouring business and foreign investment.

With a strong political mandate, he is endowed with the clout and the will for striding changes, riding a on a new sense of achievement, power and confidence.  On the world stage, India has already demonstrated enhanced business acumen and continuing improvement of its infrastructure.

Indian Reform Program

Key drawbacks hampering India’s progress were - are - high inflation and corruption. The reforms are tackling these and more. They are key to reaching the 6% growth target, “cleaning up India”, not just in terms of corruption but also in the literal sense, its cities and countryside. The reforms strive to further improve corporate governance, attract foreign companies and capital to set up shop, doing away with previous ownership restrictions. 

The leadership hopes it can enhance social security and harmony. As a guiding principle to creating an environment of social protection and welfare, President Modi referred to the writings of Kautilya’s ancient ‘Arthashastra’ (around 300 B.C.):

“In the keeping of his subjects lies the king’s happiness…good is, whatever pleases his subjects.’’

The reforms envisage (as I understand it!)

• an inclusive society, no longer segregated by race, gender or caste, 
• closing the gap between rich and poor, and 
• seeking to avert future “brain drain”, by fostering Higher Education for more of its citizens and worthwhile jobs for its post graduates.

As for plans on urbanisation and infrastructure, the reforms must take into account the 32% of population already urbanised as of 2013 (a trend that continues uninterruptedly). They want to live in ‘smart cities’, ‘economic corridors’, and enjoy the benefits of better quality housing, good facilities and convenient transport. 250 Million Indians, counted as Middle Class citizens in 2013, and its rapidly growing business communities harbour high expectation and the President will do well, not to ignore them.

Indian Drawbacks

The reforms require quite a few sacrifices, like the Land Reforms.  Local voices, I converse with regularly, mention “Red tape (+bribes + greed), slowing the transfer or sale of land, needed to build houses and roads.”  Moreover, they see low penetration of goods and services hampering progress.

The huge diversification present in the Federation of Indian States adds controversy: being the world’s largest democracy can mean that reforms may not proceed as quickly and encompassing as planned. At times, individual states may see their interests in conflict with national government targets.  It can lead to a “them & us” confrontation, fuelling social discord and perpetuate imbalances.

India is hardly a homogenous, easily tamed entity.  Yet, PM Modi steers a fast pace of tough reforms. 

• What if he finds opposition? 
• Will he stick to reforms & targets, or relent and see setbacks & higher inflation? 
• How to overcome socially divisive realities like the caste prejudice, or - the North-South divide? 
• How to avoid religious strife in a multi-ethnic country when the ruling party represents and potentially favours the “Hindus”. 

To his credit, the new president comes across as a pragmatic leader, taking a no-nonsense approach. When overzealously adoring supporters built a temple with him as the residing ‘deity’, he quickly moved to demolish it.

A less easily controlled influence on Indian affairs, and financial markets in particular, is the impact of foreign investors on its asset valuations. Having been a darling of foreign investors for many years, Indian stocks tended to rise and fall when foreign investors buy or sell. This has led to the BSE SENSEX 30 (Mumbai stock exchange) becoming the most expensive index amid BRIC nations earlier in March, this year. 

Indian Stock News (with an update to June 2015)

Since August 2013, Indian stocks have recorded rapid gains: These can be attributed to the lavish inflow of foreign investment in the anticipation of BJP election win, – then the landslide victory, followed by the honeymoon period afforded to the new government, causing massive rallies in Indian equities. (See chart BSE SENSEX 30, below.)

Over this period, the Sensex was up 69% (February 2015) reaching a giddy 30,000 points.

UPDATE JULY 2015: Since then, markets showed exhaustion and prices tumbled, correcting some 12%, - nothing too serious, especially when we see investors holding on to their investment and the index rebounding even against the downward trend of global equities in May and  June.

Following this corrective move, are Indian shares prices still too high? Are expectations of much higher company earnings for 2015 unrealistic?

Given the enormity of the reform, the benefits will be great, too. It is just a question of time… I recommend taking a medium term view (if your strategy permits) and practise patience.

Indian Equity Performance...

Data Source: Chartnexus; BSE SENSEX 30 from October 2013 to June 2015.

India’s sustained equity rally is unmatched by other BRIC  nations’, China, Russia and Brazil. India is on a different cyclical path, creating its own economic and social momentum. It may look pricey, but is still worth keeping.

If we look at the correction from March till June in more detail, it may appear as though the move is incomplete. But, when considering a 3-month view, i.e. till September, the outlook remains positive. A more sizeable correction may follow in the 4th quarter, when global markets may be displaying greater correlation - to the downside.

Indian Fund Performance

Source: iFAST financial, arbitrarily choosing a variety of Indian equity funds and comparing performances in 2014. The correlation for returns is very high, despite the often different investment strategies. Only during the first leg of the May 2014 rally do the higher risk funds outperform. Over the whole period the differences at the beginning are the same as at the end!

In SGD terms, India funds delivered respectable returns, i.e. the currency volatility (SGD/Indian Rupee) did not distract from the overall fund performance. Pricey, and still worth buying.

India in 2015 Expectation Summary

• With the change in politics, India is “open for business”, longer term. 
• The equity rally is sustainable, though benefits from reforms don’t surface overnight, needs patience!
• The likely Investment Formula working in our favour: 

Re-rated equities & bonds + foreign investor darling = expect more upside, long-term

Bottom line advantages

• A New Branding: “MAKE IN INDIA”, highlighting the improved investment environment. 
• Enriched middle class spends on property, comfort & luxury. 
• A strong government and an independent central bank cooperate to make reforms run smoothly and fulfil expectations. 
• Interest rates (on February 2015) were still at a high 7%.  I predicted early rate cuts. This is already happening, easing credit lines. 
• There will be new issues of RBI bonds, and plans to launch infrastructure projects. 
• Since 2013, the RBI has a new remarkable chief, Raghuram Rajan, who was voted “Governor of the Year”, an accolade of Central Banking Awards 2015, reported in January 2015. 
• His mandate is to lower the trade deficit and inflation, build on reserves, and ensure a stable economy and banking system. A capable man, expected to fulfil his duty impeccably, as recent pre-emptive action has shown. 
• Does GREECE worry him with respect to Indian interests? “Hardly”, he proclaims. 

Last updated July 5th, 2015.