Despite election results, MSCI India outperformed both MSCI Emerging Markets and MSCI Developed Markets in December.

Summary

• Prime Minister Modi and his government suffered worse than expected state election results as well as the surprise resignation of the governor of the Reserve Bank of India (RBI) in December. Despite this news, MSCI India outperformed both MSCI Emerging Markets and MSCI Developed Markets. Smaller and mid-cap indices outperformed over December, but posted significant underperformance for 2018 as a whole.
• Economic data on the month was generally positive, particularly consumer price inflation which increased 2.33% YoY in November 2018 against expectations of a 2.58% rise. Lower food prices were the main cause of the fall, but core inflation (excluding food and fuel) also moderated, prompting the RBI to leave interest rates on hold.
• Many of the headwinds India has faced over 2018 have begun to turn over the last few months. The crude oil price and US dollar weakening, state elections now behind us and liquidity issues in the financial sector normalising all should mean that India will start 2019 on better footing.

Fund activity

India’s December equity market returns and outperformance surprised many, especially as we saw the unexpected resignation of the RBI governor Dr Urjit Patel as well as PM Modi’s party doing worse than anticipated in five state elections in the first half of December. Markets quickly viewed the change at RBI as ultimately being positive for the prospects for economic growth and earnings and this, in combination with the continued fall in crude oil prices and strengthening of the Indian rupee, was enough to encourage inflows from foreign investors as well as continued domestic buying. The Fund posted modest outperformance in December.    

Foreign portfolio investors remained buyers for the second month in a row, buying stock worth US$476m, although 2018 as a whole saw one of the largest outflows for many years at US$4.4bn. Domestic mutual funds on the other hand bought over US$17bn of stock over the year. Despite strong domestic inflows the mid and small-cap indices had an annus horribilis, significantly underperforming large-caps.

We made one complete sale and one new purchase for the Fund. We introduced Mahindra & Mahindra into the portfolio which is a large automobile and agricultural product manufacturer and also old Navkar Corporation. We held Navkar since 2015, a stock which plays into India’s growing global trade as well as improving domestic logistics. However the stock has been underperforming for some time as the market has become concerned that competition from bigger, better capitalised global players has significantly increased. We decided to exit the stock despite attractive valuations as we believe the new competitive environment the company is facing means there are better ways to play the improving domestic economy.

We have introduced Mahindra & Mahindra (M&M) into the Fund. The company began operations in 1945 assembling jeeps from the US and has traditionally been considered conservative with good corporate governance. Today the business is diversified across many sectors and geographies but the core business is focused on automobiles, farm equipment and automotive components predominantly in India. We like M&M as a key play on the rural economy through its market-leading farm equipment business, an area that will gain increasing traction in the period ahead as government focuses on boosting the rural economy ahead of the general election. Its auto business has just started a new launch cycle into a competitive space and the company is well placed for the shift to electronic vehicles. High capex and worries over margins, primarily raw material price rises which have recently begun to abate, have pushed the stock down to favourable valuation levels, from where we see an attractive risk/reward.

Outlook

Many of the headwinds that buffeted India over parts of 2018 have now begun to ease or should do so in the period ahead. External factors such as the rapid rise and recent fall in crude oil prices are difficult to predict over 2019, but falling crude has certainly aided both sentiment as well as the Indian rupee and given the government some breathing room. In fact, the recent weakening of commodity prices in general will help an importer like India as well as ease input costs for many Indian companies. A weaker US dollar and falling global bond yields have also helped, with Indian bond yields falling significantly over the last few months.

Domestic bond yields however, have been heavily influenced not only by global factors but also over India’s election calendar (with worries over government borrowing) as well as the well-publicised spat between the government and the RBI. The market took the surprise resignation of the RBI’s governor remarkably well, and further rallied when Shaktikanta Das was announced as Dr Urjit Patel’s replacement. The new governor comes from the finance ministry and has previously held various key positions including representing India at the G20, but importantly, he has a good relationship with both the Prime Minister and Finance Minister. India has a long history of senior bureaucrats running the RBI and we believe the appointment of Shaktikanta Das will not only ensure a better relationship with government, but also preserve the independence of the institution and improve communication with investors.

An RBI that market participants can better understand is a key positive. We do, however, expect volatility to remain elevated due to earnings, the general election and global cues. But we remain convinced that India’s growth story continues to gain traction, and as we move through the year the capex cycle will improve as the private sector starts to spend. We also anticipate the housing market will post a sustained recovery by the second half of the year following a torrid number of years. The recovery in capex and housing will help maintain an economic upturn that, in a globally challenging environment, will stand India in good stead over 2019.