India: Pictet’s Kothari sees changes ahead
Pictet Asset Management’s senior investment manager Prashant Kothari shares his findings from a two-week trip to India, where he visited factories, met senior company executives and spoke to policymakers and business leaders.
India is one of the best performing equity markets this year, thanks to expectations that the new government led by Prime Minister Narendra Modi would implement reforms and tackle inflation. But how sustainable is the rally, given looming risks from higher oil prices and slowing economic growth?
Politics: Perform or perish
I got a sense that real changes are happening on the ground in India, just a month or so after Modi came into power in a landslide victory. He’s making his politicians and bureaucrats work a lot harder – gone is a cushy 9am-5pm working day — and pushing for corporate-style working culture where you have to deliver results to stay in the job.
The government seems to have started working on multiple fronts at once with priorities on cutting red tape and fiscal deficits. For instance, ministries are being asked to simplify government application forms to make it easier for citizens and corporates to access state services and a special team has been appointed to study ways to curtail black money in the system.
Many of the executives from around 50 companies I visited have already met government officials who are keen to hear their thoughts on how to tackle problems they are facing. The government is also simplifying the tax regime with the planned roll-out of the Goods and Services Tax as part of their flagship business-friendly policies. At the same time, it is keen to move fast on cutting fiscal deficits: it is likely to cut fuel and food subsidies and we expect some announcement in the July budget.
Last week’s 14 per cent increase in politically-sensitive rail passenger fares also highlights steps the government is taking to plug a budget gap and restore the economic health. To sum up, expectations for Modi are running high, but from the soundings I took, I believe they are well-founded.
Economy: Worst is over
Economic indicators paint a near-term picture that is far from rosy, with corporate margins at a record low and investment flagging. But Asia’s third largest economy may be bottoming out – which is evident in better industrial production and retail inflation data.
Among the companies I visited, cement firms were planning to build new factories as they expect fresh projects for houses, roads and airports to kick off, doubling demand growth in the next few years. A capital goods company was expecting more orders for its industrial boilers for power, sugar and textile factory clients.
The IMF expects India’s economy to grow by 6.4 per cent in 2015 from 5.4 per cent in 2014, putting it closer to its trend growth rate. Rising foreign reserves – which hit a 2-1/2 year high of USD314 billion in May – are also positive as they help minimise future volatility from the US Federal Reserve’s move to withdraw monetary stimulus.
However, a recent spike in oil prices and a possibly lower harvest due to El Nino effects pose a near-term threat as the economy grapples with high inflation. India is the world’s fourth-largest oil consumer and oil takes up more than a third of its total import bill. It is key for Modi’s government to liberalise fuel prices and push forward food subsidy reforms to control prices – which company executives were very hopeful would happen — and reduce government deficits.
Markets: Structurally positive
The 20 per cent rally in stocks and an almost 3 per cent gain in the rupee make India one of the best performing markets so far this year. Equity markets are beginning to look a little expensive as valuations of 16 times one-year forward earnings are just above their long-term average. But with reform promising to raise the country’s long-term growth potential, Indian stocks remain attractive.
Corporate margins are likely to bottom out from the current historic lows. We expect a structural bull market in India for the next 5 years, which is likely to deliver double-digit gains in equities. There is a relative value story here too – Indian corporates have historically generated better returns on capital than the rest of EM and the economy is likely to grow faster than its developing counterparts.
In the near term, financial firms will benefit first because they are most sensitive to a turnaround in economic and investment cycles. Some banks expect that projects which they have financed, but were in limbo, would finally go ahead as a result of Modi’s reforms. Steel and power companies told me they expect faster approvals for their projects which were on hold on environmental grounds. Some iron ore mining and road projects have already received a go-ahead in the last few weeks. Industrial and consumer discretionary sectors will also be the beneficiaries. On the contrary, energy companies are unattractive because of high valuations and telecom firms will struggle to outperform because of intensifying competition.