India has been well marketed as an investment destination by Prime Minister Narendra Modi over the past year, especially with the "Make in India" campaign. But for all the euphoria gripping the Indian market in the months just after the new government came to power, the reality at present is more sobering.
Nevertheless, all is not lost and if we look beyond parliamentary affairs and the reforms hoopla, there are signs of improvement. Any rise is not linear and short-term concerns usually dwarf the big picture, especially the slow changes that often go unnoticed. Let us try to take a stock of the situation and examine the road ahead.
Equity markets overheated?
Currently, the CNX Nifty is trading at a PE of 21.57 compared to the historical average of around 18-19x. Generally, a PE of 22x and above may signal that the market is overvalued -- it was at 28.29 in March 2000 and 27.62 in January 2008. Looking at market cap-to-GDP ratio, it stands at around 76 now vs. 146.9 in 2007. The usual caveats like interest rates (high rates scenario witness lower Mcap to GDP), number of listed companies especially after recent IPOs etc. do apply while looking at such ratios.
"A recent JP Morgan survey showed that 70% of North American investors see India as the most attractive market to invest in, among BRIC nations."
In our opinion, the current earnings season has been weak and high valuations may warrant a correction. We believe India is yet to reach the overheated stage as earnings will improve albeit slower than expected. Our belief is backed by the improving inflation, and potential for lower rates and record low commodity prices. Evidently, the Indian market continues to fair better than its EM and Asian peers.
The Macro Picture
CNY devaluation led to a sell-off in the markets as fears of competitive Chinese exports increased. Movements in Yuan do have an impact (see our recent article) on the global markets.
The People's Bank of China (PBOC) said in a press conference recently that there's no basis for depreciation to persist and policy makers will step in to control large fluctuations. Moreover, India may not be as vulnerable to FX movements as it was a few quarters ago. The latest RBI data shows that the ratio of hedged positions for Indian corporates has gone up sharply, from 15% of all foreign exchange liabilities a few quarters ago to around 41% in the 1QFY16.
We see other signs of improvement as well. July WPI inflation fell at a faster-than-expected (Reuters poll estimates at -2.8%) annual rate of 4.05%, its ninth straight decline and the lowest in at least a decade. Softening inflation and better hedging may protect to some extent against the impact of a weak Yuan. Soft inflation figures may prompt the RBI to go for a much awaited rate cut sooner than later.
India's Nikkei Purchasing Managers' Index (PMI) for the manufacturing sector for August came in at 52.3, the best in Asia (among China, Japan, Malaysia, Taiwan, Indonesia, South Korea). A PMI above 50 signals expansion. Only India and Vietnam witnessed August PMI above 50.
GDP growth at market prices for the 2Q CY15 saw growth at 7%, lower than the 7.5% during the previous quarter. But looking at GVA instead, on the grounds that the GDP at market prices is distorted by indirect taxes and subsidies, then economic growth has increased from 6.1% in 1Q CY15 to 7.1% in 2Q CY15. Moreover, this is very healthy among EMs given the global growth concerns.
Make In India - The States Are Taking It Ahead
Maharashtra recently secured a five-year deal worth USD 5 billion from iPhone maker Foxconn. General Motors also announced its plan to invest USD 1 billion in India. Chinese phone maker Xiaomi, in partnership with Foxconn, launched a new plant in Andhra Pradesh. Ten states accounting for almost half of India's economy, and most of them led by Mr Modi's party, have said they want to enact their own laws to ease land deals that boost infrastructure development.
" We feel that though broad-based reforms are needed to catapult India into higher growth trajectory, the current atmosphere of pessimism is based on unrealistic hopes for quick reforms."
Increased attractiveness for North American Investors?
A recent JP Morgan survey showed that 70% of North American investors see India as the most attractive market to invest in, among BRIC nations. The remaining 30% ranked India second to China. Since then the macroeconomic scene has changed globally. Fear of a slowdown in China has led to a sell off characterised by high volatility. India too saw heavy selling by FIIs but interestingly domestic institutions have bought heavily, taking advantage of the correction which is more sentimental than fundamental. Moreover, the government said on Tuesday that it would spare foreign portfolio investors (FPIs) from minimum alternate tax (MAT) for the years prior to 1 April 2015, moving to defuse a row with overseas funds concerned about back-dated tax demands. Therefore, we believe that FII selling is overdone and risk them missing good entry points in a promising market.
We conclude that the current Indian situation appears to some as a disappointment due to unrealistic expectations. The point worth noting here is that despite the logjam in Parliament, there is considerable investment heading to India.
We feel that though broad-based reforms are needed to catapult India into higher growth trajectory, the current atmosphere of pessimism is based on unrealistic hopes for quick reforms. In fact, we see the ongoing correction as an entry opportunity for investors. For us, the glass is most definitely half-full!