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. 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. 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.
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 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.
It’s the case of pain before gain and structural factors such as favourable demographics and an asset allocation shift within households should drive economic growth in the long term. Among major emerging economies, India is the only country where the working population is expected to keep growing right up until 2040.
Equity holdings
Indian households, which have financial assets of $6 trillion, are expected to move money away from non-productive assets such as gold and land as economic growth returns, and lift their equity holdings from the current record low of 2 per cent.
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 $314 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 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.
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 five 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 emerging markets 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 reforms. Steel and power companies 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.
— The writer is senior investment manager for Indian equities at Pictet Asset Management.
