2014 was a year of recovery for Indian equities. Boosted by improving fundamentals, decisive general election results and reaccelerating growth, the MSCI India 10/40 NR index advanced by 24.76% in USD terms, making it one of the best performing emerging markets. In 2015, Indian equities are expected to maintain their uptrend, due to lower commodity prices, progress with reforms, a loosening of monetary policy, and ultimately accelerating growth. There may however be some short term corrections on the way as investors may be expecting too much too soon from the government. These corrections could provide investors with an opportunity to enter the market or to reinforce their exposure.
India’s fundamentals have greatly improved in 2014, thanks to effective policy introduced by the Reserve Bank of India (RBI) governor Dr Rajan. Inflation has fallen significantly, moving from 11.2% in November 2013 to 5.0% in December 2014. Meanwhile, wholesale price inflation fell from 7.5% to close to 0%. As a result real rates have moved back into positive territory.
Inflation is on its way to meet the RBI’s target
India also benefits from an improved current account deficit at 2.1% for third quarter 2014, a lower fiscal deficit target at 4.1% of GDP and all time high foreign exchange reserves above USD 300 billion. Consequently, the Indian rupee (INR) has been one of the world’s most stable emerging currencies in 2014, depreciating by only 2.18% against the US dollar and appreciating 11.22% against the euro.
Even growth is now slowly picking up and has been above 5% for two consecutive quarters.
Lower commodity prices – especially oil – a tailwind for India
For a net commodity importer like India, lower commodity prices in general, and oil prices in particular, are a big positive. They should contribute to lower inflation, an improvement in fiscal and current account balances and higher growth. India imports more than 70% of its oil consumption, worth 5.5% of GDP, and it is reckoned that a USD 10/bbl. fall in crude oil helps to reduce CPI inflation by 50bp. The below table quantifies the impact of a sustained USD10/barrel fall in crude oil prices on the Indian economy.
Potential impact of a sustained USD 10/bbl. fall in crude oil
Source: Nomura Global Economics estimates, October 2014
Policy reforms – expectations reset
Since the government took over office following the May 2014 general election, there has been an acknowledgement that economic steps will be incremental and tactical rather than tectonic.
The government has already undertaken some reforms like the diesel price deregulation, the increase in Foreign Direct Investment (FDI) limit in defence and railways, and the online clearance process for the environment and forests. Besides, fiscal reforms are underway with the government focusing on the implementation of the Goods and Service Tax (GST) and direct cash transfer schemes, which are expected to improve the efficiency of the subsidy system.
Economic reforms such as labour, land and power reforms may take longer and may first be implemented by progressive states if the central government is unable to do so because of its minority position in the Upper House of the Parliament. However, the government seems determined to implement economic reforms and has decided to issue ordinances to implement certain legislations that could not be implemented through acts of parliament.
The investment upturn should be the slowest piece to fall into place in India’s growth puzzle. The pace of project clearances has improved and there is increased activity in road infrastructure projects. However, high corporate indebtedness and a work-in-progress approach for improved policy consistency and clarity are expected to be important decelerators. The increased focus on local production for railways and defence will eventually be an important boost for domestic manufacturing industries.
All eyes on the budget for the fiscal year through March 2016
The main question in the budget for the fiscal year ending in March 2016 (FY16) is whether the government will stick to the fiscal deficit target even if that requires spending cuts, or if it prefers to avoid aggressive spending cuts given the weak growth impulses. Credit rating agencies are unlikely to be too concerned about a slight overshoot on the fiscal deficit for the current fiscal year. Hence increased spend on asset creation may be a welcomed move.
Almost everyone expects all good things to be announced on budget day, while in our opinion this intense focus should be de-emphasised. The FY16 budget should be constructive for growth led by a focus on higher spending for infrastructure and improving the ease of doing business while sticking to fiscal discipline.
Shifting towards a more accommodative monetary policy
Monetary policy could provide some much needed support to reaccelerate growth in India. After taking office in September 2013, RBI governor Dr Rajan had set a clear CPI inflation target of 8% by January 2015 and 6% by January 2016, therefore giving a clear plan to follow before a potential easing of the RBI’s tight monetary stance. On 15 January the RBI cut the key policy rate repo rate by 25bp to 7.75%, reflecting the fact that the RBI is becoming comfortable with the idea that inflation is now under control and on its way to meet the target of a 6% inflation rate by January 2016.
Most importantly, this move marks a real shift in the monetary policy stance. The RBI statement clearly states that “once the monetary policy stance shifts, subsequent policy actions will be consistent with this stance”. Therefore, we can expect further monetary policy easing in 2015, provided future data confirm “continuing disinflationary pressures, (…) sustained high quality fiscal consolidation as well as steps to overcome supply constraints”.
This policy shift represents a real positive for the Indian economy, as the recovery has so far taken place under tight monetary conditions with a key policy rate at 8%. Both this rate cut and the visibility it provides in terms of potential future monetary easing provide much needed support for the Indian economic recovery, helping to improve corporate balance sheets and to kick start the investment cycle.
Equity markets – slow but sure
As of January 2015, the MSCI India index valuation stands at 14.61, slightly above its historical average, but still far from its previous peaks. We believe that while valuations are off their lows, they are not yet pricing in the potential acceleration in growth. The outlook for Indian equities remains positive for 2015 and the next two to three years, due to lower commodity prices, progress in reforms, a loosening of monetary policy, and ultimately accelerating growth.
However, investors may be expecting too much too soon from the government. And while the government’s reform agenda goes in right direction, the pace of delivery in reforms and reacceleration of growth may cause some disappointments, leading to short term corrections. We believe that, as long as fundamentals are improving, such corrections may provide investors with an opportunity to enter the market or to reinforce their exposure.[starbox id=paul.milon][starbox id=anand.shah]