Domestic muscle sets India apart

27 October 2015

The dust has begun to settle since Chinese policy-makers surprised just about everyone by devaluing their currency. This affords investors a chance to review the carnage suffered by emerging market equities and, in particular, examine how India is holding up.

Based on our analysis, we firmly believe that conditions in India are improving, albeit in a ‘stealth-like’ manner. We believe the country is well placed to handle the current global backdrop.

The first point to note as part of this discussion is that emerging market equities have been under pressure for some time (as is evident in the graph alongside). As Tristan Hanson noted in his recent opinion article (“What happened to the emerging markets dream?” 26 August 2015) this eclectic grouping has been suffering under a cloud of pessimism; a position which is at odds with the widespread optimism of just a few short years ago.


Source: Bloomberg

Clearly China’s devaluation has provided further fire to already skittish investors exposed to emerging markets; despite the fact that the term ‘emerging markets’ encompasses a range of countries with a huge variety of political systems and underlying macroeconomic fundamentals. The accompanying table, for example, highlights various equity and currency performance numbers of key emerging economies, compared with returns generated by the global index (MSCI World index).

Performance divergences among emerging market economies become even more evident if we look slightly longer term. Over the past two years (to 31 August 2015) India’s Nifty has returned 49.97% in INR terms (50.48% in US dollar terms), China’s A-share composite 60.57% in CNY (53.95% in US dollars), South Africa’s JSE Top 40 index 25.01% in ZAR (-3.26% in US dollars), Brazil’s IBOVESPA -6.77% in BRL (-38.92% in US dollars) and Russia’s MICEX 27.00% in RUB (-28.08% in US dollars).





Source: Bloomberg

One of the new government’s key policy objectives is to promote manufacturing in India.

Domestic Chinese equities are still holding up relatively well compared to some other emerging markets, despite the headlines of a Chinese stock market crash over the last few months. That said, Indian equities are the standout emerging market performer over a two-year period. While returns look pretty respectable in comparison to other emerging markets this year, there is no doubt the going has become a little tougher over the last six months or so. The reasons behind this are varied - some are domestic but, to our minds, mostly remain external.

One of the biggest factors behind India’s recent lacklustre performance has actually been attributable to the country’s recent success. The overwhelming 2014 election victory of reform-minded Prime Minister Narendra Modi led to elevated hopes of a rapid positive change in India’s prospects. This, in combination with a well-liked new Governor of the Reserve Bank of India (RBI) and falling domestic inflation, led most emerging market-focused investors to be overweight India. This situation persists today, although with emerging market funds suffering heavy redemption pressure due to China and United States interest rate policy worries, India is seeing its fair share of selling.

Despite this, we believe there are a number of factors which investors in India should consider:

Economic backdrop - India is one of Asia’s most domestically orientated economies, and is not reliant on exports to drive growth. As a net commodity importer, India has benefitted from falling prices of energy and basic materials, which has not only helped drive inflation down, but has improved India’s macro fundamentals. Foreign exchange reserves have risen to 10 months of import cover and the twin deficits (fiscal and current account) have narrowed. Since September 2013, the current account deficit is down from more than US$88 billion to less than US$20 billion now (about 1.3% of GDP). In addition, for those worried about China’s slowing economy, India’s trade with China is very small compared to other emerging markets.

Inflation - We highlight the importance of falling consumer price inflation to levels below the central bank target. Although the RBI is being somewhat conservative with regard to the possible impact of rising interest rates in the United States, India has plenty of scope to cut interest rates over the next year. This is obviously positive for Indian companies, as their cost of capital is on a downward path.

Stealth recovery - India is the only major emerging economy where GDP growth is actually picking up after a sluggish few years. Although the pace of economic recovery on the ground has been patchy, we can find significant pockets of improvement which lead us to expect a broader recovery is not far off. A few data points are worth noting:

Investment spending - We are seeing more signs of a recovery in the capex cycle, albeit in select sectors. Power and roads capex is leading this recovery and is being driven from both central and state government spending.

Real economy indicators beginning to improve - Data on toll road usage indicates growth in traffic and the Q1FY16 diesel consumption growth is the highest over the last 11 quarters.

Credit growth - There are widespread concerns that credit growth has remained anaemic. However, this is largely due to falling inflation, and real bank credit and commercial paper growth have actually accelerated over the past year and are now at historical average levels of 11.6%.

Made in India – One of the new government’s key policy objectives is to promote manufacturing in India. While this has a long way to go, some early successes include the announcement on 13 August that Taiwanese company, Foxcon, will invest US$5 billion building a smartphone manufacturing business in India. This is in addition to announcements from General Motors of a US$1 billion expansion of its car operations and from Siemens of a €1 billion expansion of its manufacturing facilities.

Reforms - While Modi has certainly not had it all his own way in terms of rolling out his reform agenda, the market remains too focused on the short term and has lost sight of the bigger picture. Perhaps the biggest changes are the adoption of an inflation target and the empowerment of India’s states to be in control of their own destiny. While neither of these changes will impact India overnight, we believe they are fundamental in improving India’s long-run growth potential. We also still remain optimistic that a pan-India goods and services tax will be adopted by FY17, which will be a genuine game changer for the country.

In light of these observations, it is our opinion that India remains a compelling investment destination for investors, particularly those able to take a slightly longer-term investment view.