GREED & fear still likes the Indian equity story. Indeed it remains GREED & fear’s favourite equity story globally so long as the hyper energetic and hyper focused Narendra Modi remains at the helm. Still the Indian equity market got another boost last week with the Indian currency’s appreciation following the first rate cut by the Reverse Bank of India since May 2013. The rupee has appreciated by 1% since the RBI cut its policy repo rate by 25bp to 7.75% on 15 January. There will be many more interest rate cuts to come since reported inflation has collapsed while inflation expectations are also now finally starting to come down with a lag. CPI inflation has slowed from 11.2%YoY in November 2013 to 4.4%YoY in November 2014 and 5%YoY in December (see Figure 16). While the December survey of household inflation expectations released by the RBI last week shows that inflation expectations one-year ahead have declined to 9%, the lowest level since 3Q09. In terms of the extent of the monetary easing that can be expected, GREED & fear believes it is a minimum of a total of 200bp this year and next. But that may well be an underestimate given the deflationary market action globally. In this respect India remains a wonderful market for global investors, and not just emerging market investors, to diversify their portfolios given it has nothing to do with quanto easing and nothing to do with China. It also remains the case that the economy is in the process of bottoming out after a drawn out deleveraging cycle while Indian corporate RoE has nearly halved from the FY07 peak of 26% to an estimated 15% in FY15, up from a low of 14% reached in FY13 (see Figure 18). If there is a risk for the Indian equity story this year, after the significant rally least year celebrating Modi’s landslide electoral victory in May 2014, it is that investors may become impatient waiting for evidence of a cyclical recovery, most particularly a private sector-led investment cycle. This is because many corporates, particularly in the infrastructure space, are still in deleveraging mode.. If this is a legitimate risk, GREED & fear for one is prepared to be patient, most particularly as the substantial overweight in India in the recommended Asian portfolios worked last year. Thus, the MSCI India rose by 21.9% in US dollar terms last year, compared with a 0.2% decline in the MSCI AC Asia Pacific ex-Japan. The MSCI India has also risen by 7.9% so far in 2015, compared with a 1.7% gain in the regional benchmark (see Figure 19). The reason to be patient is that the stock market will be acutely sensitive to the operating leverage in Indian earnings on any hint of a cyclical pick up. Meanwhile, as argued by CLSA’s Indian strategist Mahesh Nandurkar in a recent recommended thematic report (The next orbit – India’s hopes can become reality in 2015, 5 January 2015), there is already evidence that profit margins have begun to bottom out. Thus, CLSA’s Indian office projects a 2ppt Ebitda-margin increase for the universe of 112 stocks under coverage over FY15-17 to 17.8%, up from a low of 14.5% reached in FY13. Returning to the trend in aggregate profits from a more macro perspective, the same report shows profits of a universe of 20,000 listed and unlisted companies declining to only 4.3% of GDP in FY15 compared with a recent peak of 7.1% in FY08 (see Figure 21). Mahesh notes that an increase to 6% of GDP over the next three years would imply 25% compound annual growth rates in the next three years. This is why the CLSA India equity universe, now trading at 15.9x 12-month forward earnings, is not at ludicrous valuations if it is assumed that a private sectorled investment cycle will resume in the next two years. Meanwhile, the fact that such an investment cycle is not necessarily imminent may induce the Modi government to allow more fiscal stimulus in the forthcoming budget than previously anticipated, in terms of the currently proposed FY16 fiscal deficit of 3.6% of GDP (down from an estimated 4.1% in FY15). Still if there is more stimulus it will be investment driven not subsidy driven; though hopefully the Modi government will remain relatively conservative on the fiscal front given the excesses of the previous government, which ran an average deficit of 5.3% of GDP in its last five years in government. The need to see proof of fiscal responsibility, along with lingering concerns about base effects and stubbornly high inflation expectations, were among the reasons cited by RBI governor Raghuram Rajan of late to explain why he has not proceeded more proactively with rate cuts. There has also, naturally, been the concern about easing aggressively ahead of consensusassumed Fed rate hikes. Still these considerations have looked less and less compelling as the collapse in inflationary pressures has become more and more evident, most particularly as the much cited “base effect” was meant to kick in in November. Thus, CPI inflation peaked at 11.2%YoY in November 2013 and fell to 4.4%YoY in November 2014 before rising to 5.0%YoY in December (see Figure 16). The other positive point, which will have pleased the RBI governor, is that deposit growth has begun to exceed credit growth for the first time in five years as real interest rates have risen. Thus, total deposits rose by 11.9%YoY in the fortnight ended 9 January, while bank credit rose by 10.7%YoY (see Figure 23). As a consequence, the real one-year deposit rate has risen from -1.2% at the end of 2013 to 3.3% at the end of 2014 (see Figure 24). Meanwhile for those like GREED & fear long the equity market, the good news is that monetary easing buys time while waiting for evidence of an investment cycle.. If all these factors are positives, GREED & fear still encounters a lot of scepticism from investors about whether Modi will introduce real reform, most particularly as the BJP does not control the Upper House of Parliament, known as the Rajya Sabha. In fact the BJP-led ruling NDA coalition has only 24% of the seats (see Figure 25) compared with the 63% of seats the coalition controls in the Lok Sabha or Lower House. If this is a problem which will only be solved by the due passage of time since Upper House members are elected for six-year terms by state legislators, GREED & fear continues to believe that the most important task facing Modi is to make the existing machinery of government work in India. But it is also true that certain legislative initiatives would represent significant progress if enacted. Examples are the long-awaited introduction of a goods and services tax and reforming the existing land acquisition legislation. In this respect Modi has signalled intent by issuing ordinances on the following legislative initiatives. Thus, an ordinance was issued in late December to dilute the Land acquisition law to make it easier for industrial projects to acquire land. The changes proposed will waive the toughest and most consuming parts of the land acquisition act, such as consent seeking for affected parties and conducting “social impact” assessment studies. The government has also raised the FDI limit in insurance from 26% to 49% and revived the coal mines bill through the same ordinance route (see CLSA research India strategy - The Legislative Imbroglio, 21 January 2015). Issuing an ordinance does not mean it becomes definite legislation since an ordinance lasts for only six weeks. To be exact, an ordinance is a temporary law that does not require Parliamentary approval. But it has to be ratified and converted into legislation within six weeks of the commencement of the subsequent Parliament session. This means the existing ordinances will expire by mid-April. Still the good news is that the ordinances can be re-promulgated indefinitely while waiting for both houses of parliament to pass the relevant legislation (though the Supreme Court might intervene at some point). How quickly this happens will depend on how quickly the current government can find new allies in the Upper House. Meanwhile, the willingness of Modi to issue ordinances is the clearest of signals that he wants to get things done, while the rupee’s appreciation on a rate cut at a time of US dollar strength is a signal that an acceleration of growth is coming. Another encouraging sign is that since the launch of Modi’s Financial Inclusion program in August 2014, 117m new bank accounts have already been opened, compared with the initial target of 75m by 26 January. If India remains the best of the Asia and emerging market stories, US dollar strength and related Fed tightening concerns have definitely caused investors to think about renewed Asia and emerging market debt crises judging from meetings over the past two and more weeks. Still to GREED & fear it is more an issuer specific and country specific issue than an asset class crisis, with the likes of Ukraine and Venezuela obvious potential disaster areas.
Posted on: Tue, 27 Jan 2015 03:53:12 +0000
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