Excerpt from Greed and Fear (sorry, couldn't include the charts):
Originally scheduling a trip to India after the country’s general election seemed like a good idea to GREED & fear. But clearly in a certain respect the action has already happened. The Sensex is up 23% since the result of the poll was announced on 17 May while the benchmark index is now “only” 29% below its all-time high of 21,206 and 7% above the level reached prior to the Lehman collapse.
If this is the case, GREED & fear is fortunate in the sense that a reasonable overweight position in India was maintained in the relative-return portfolio prior to the election’s result while a 30% of the Asia long-only portfolio was also invested in India, which was subsequently raised to 34% after the result (see GREED & fear – flash, 18 May 2009). It is also the case that GREED & fear has seen nothing in India this week to cause a severe questioning of the long-held view here that a structural bullish position towards the market should be maintained by specialist emerging market investors and indeed by global investors in general.
Indeed, if there is a risk to the market it is probably in the short term. The Sensex has moved a long way in a hurry as sidelined foreign investors reacted to the surprisingly decisive election result. As a result, there is talk of US$15bn of equity issuance in the pipeline while hopes of positive reform initiatives are also high for the budget announcement due in early July. There is also the risk that, with crude at US$67/bbl, the oil does not have to move too much higher before it starts to influence sentiment negatively towards India.
Still this is short-term noise. GREED & fear is not going to change current country allocation towards India even if the Sensex treads water for a time while S&P500 heads towards GREED & fear’s 1,000-1,050 bear market rally target. This is because the fundamental reason to stay structurally overweight India in an Asian portfolio remains that it is the only Asian economy primarily driven by domestic demand. While attention has for most of this year focused, for understandable reason, on China’s ability to engineer command-economy traction in terms of its stimulus programmes, it is also the case that India has surprised the sceptics with its first quarter 2009 GDP data. And, clearly, in the case of India, there is no ability in the part of the government to implement command-economy traction. Thus, Indian real GDP rose by 5.8% YoY in 1Q09, while the 4Q08 growth has been revised up from 5.3% YoY to 5.8% YoY. This means the Indian economy grew by 6.7% YoY in FY08/09 ended 31 March. Real private consumption rose by 2.7% YoY in 1Q09, up from 2.3% YoY growth in 4Q08. While real fixed capital formation grew by 6.4% YoY in the first quarter, up from 5.1% YoY in 4Q08.
The above performance is why economists are now upgrading the real GDP growth forecast for this fiscal year from below 5% towards 6% and even higher. CLSA’s economics team, for example, now expects FY09/10 real GDP growth of 5.8%, up from a previous forecast of 4.6% (see CLSA research The Infofax: India 1Q09 GDP – Quality growth, 2 June 2009). Such a performance at a time when the US economy is not growing at all is clear evidence of “incremental decoupling” even if it is also true that India’s capital market remains heavily influenced by foreign flows; which is why the Sensex’s surge in recent weeks has been driven by renewed FII buying. Thus, the Sensex has risen by 84% since bottoming on 9 March, while foreign investors have bought a net US$6.6bn worth of Indian stocks over the same period (see Figure 5). In aggregate, foreigners have now bought a net US$4.4bn worth of Indian shares this year having sold a net US$13bn last year, after buying a net US$51bn between the beginning of 2003 and the end of 2007 when global fund managers fell in love with India.
Still not all aspects of Indian officialdom are unimpressive. GREED & fear has written before that the Reserve Bank of India has a clear claim to be viewed as the most effective central bank in the world during the past decade. GREED & fear refers not only to their practical decision to control securitisation and similar gimmicky financial techniques before they could threaten the credit cycle, but also the macro decision to monitor asset prices and credit growth in the conduct of monetary policy. The successful legacy of that policy is now clear from the remarkable lack of a pick up in NPLs given the huge credit growth that occurred in India this decade, albeit from a low base. Total bank credit has grown by an average annualised rate of 22% over the past ten years, while the bank credit to GDP ratio has surged from 22% to 56% over the same period (see Figure 7).
It is this huge credit growth which has convinced many sceptical investors that Indian banks are a disaster in the making. GREED & fear has never agreed with this view and still does not. The view now seems to be that NPLs will peak at worst at 5% of total system loans in this cycle, with the problem loans confined primarily to unsecured consumer loans and problem sectors such as textiles and real estate. Note that the current system NPL ratio is 2.4% (see Figure 8). If this is a realistic outcome, and in GREED & fear’s view it is, then it would constitute an impressive achievement given the scale of the credit boom in recent years; most particularly given that system NPLs peaked as high as 19% in the last downturn in 1995. GREED & fear attributes the achievement primarily to the RBI’s pre-emptive monitoring of credit standards; though it is also probably the case that Indians’ traditionally conservative attitude to credit has also played a part.
The resilience of the banking system has been the prime reason why GREED & fear has remained overweight the market in the recent past. This is because it means that the aggressive monetary easing implemented by the RBI since October 2008 is likely to get traction precisely because the Indian banking system does not have the structural problems that many dysfunctional Western banking systems still do. The other critical positive point of the past several months was that aggressive monetary easing did not undermine the rupee, as it could have done.
If this was the macro backdrop for India going into the election, the result has further enhanced the investment story. For Congress’ surprisingly large margin of victory has not only raised hopes of more effective policies. It has also served as a reminder that rural India has been doing much better in recent years. This not only reflects rising food prices. It also reflects specific Congress pro-rural policies, such as debt relief for farmers and the National Rural Employment Guarantee Scheme; where rural workers are guaranteed 100 days of employment a year at a minimum compensation rate of Rs60 a day. The idea of this scheme is to address rural underemployment where harvest schedules mean that people are only gainfully employed for about four months a year.
While debt relief and make-work schemes are hardly the ideal policy responses for an “Austrian”, and are open to all sorts of abuse, there is no doubt that such policies help explain Congress’ victory. It is also certainly the case that India’s 827m rural population was not bothered in the slightest by last year’s dramatic decline in the Sensex. This is also why Hindustan Unilever reports a much more stellar level of consumer confidence in rural India than in the cities in recent months while Maruti Suzuki reports a much better car sales trend in the rural areas than in the largest cities. A total of 9% of car sales now come from rural markets even though India’s most successful carmaker only started focusing on this market two and a half years ago.
If this is the context which leaves the Congress with the biggest majority in government since 1991, the question remains what the party will do with the mandate. In this respect history suggests a considerable dose of scepticism is required; most particularly those looking for more pro-market solutions. For the Congress has an interventionist history and the party has after all been elected because of its policy of supporting subsidies.
There is then certainly not going to be any free-market crusade. Still, that does not mean there will be no progress. First, Prime Minister Manmohan Singh has probably only about two or three years in power before he hands over to 38-year-old Rahul Gandhi as Indian politics returns to its post-Independence dynastic routes. As a pro-reform technocratic economist, it is reasonable to assume that Singh would want to achieve some lasting reforms now that he no longer has the disruptive presence of Communist coalition parties. One such possibility is the abolition of the petrol and diesel transport subsidies which last year cost India Rs742bn (US$16bn) as a result of oil’s surge. Hopes for such a reform have seen the oil refining stocks surge in recent weeks. GREED & fear would caution that with oil now nearly at US$70/bbl it will be harder to implement such a reform. Still the view here is that some cuts in these subsidies will occur if not the more politically sensitive subsidies relating to fertiliser and kerosene.
Two areas where progress seems probable as a result of the election are infrastructure and the fiscal deficit. On the latter, the new government is likely to sell down stakes in government owned enterprises not for ideological reasons but because it needs to raise revenue to pay for social programmes. The consolidated fiscal deficit was 10% of GDP last year. But these sales will not take the state into a minority ownership position.
On infrastructure, the government will be anxious to make up for the slowdown in activity that occurred in its previous term, most particularly in the critical area of roads. On this point, a new minister in charge of roads has been appointed who is reputedly a man of action, while the National Highways Authority has just put out 48 projects for bidding on a BOT basis. The banks also show every sign of being willing to finance such public-private partnerships on infrastructure provided the BOT-like projects are put together on a rational base.
It is also the case that infrastructure investment has not slowed as much as many feared when the global economy “hit the wall”. Thus, Larsen & Toubro surprised the market in April when it gave guidance for a 25-35% increase in its order inflow this fiscal year when some in the market were still expecting negative growth. In terms of the composition of the order book just over 40% comes from infrastructure and 22% from power.
The huge infrastructure growth potential remains obvious in India to any causal visitor even if it is also true that traffic in Mumbai is a little less gridlocked than it used to be given the construction of a few flyovers to provide temporary relief from “Slumdog” streets. But the real potential in this respect is apparent from India’s cement consumption per capita of only 150kg compared with China’s 800kg per capita. Cement demand has traditionally grown in India at 1.1-1.2x GDP growth reflecting traditional household demand. But if a real infrastructure boom ever got under way that could easily rise to 1.5x GDP growth.
This long-term story is why GREED & fear has always maintained a weighting in Indian cement stocks in the Asia long-only portfolio despite perennial concerns about new supply. Investors should do likewise even though it is the case that total cement capacity will rise from 210mt to 270mt or by an estimated 27% this year and next. Another point to note is that two major groups now have a nearly 40% market share in an industry which used to be extremely fragmented.
All the above is why GREED & fear continues to believe India remains in a secular bull market like the rest of Asia. But in the case of India it already enjoys a position which other Asian economies will increasingly be desperate to achieve. That is for their economies to become more domestic demand driven as policy markers in Asia realise, as they will in the due course of time, that the US and other excess consumption-driven Western economies face long-term structural problems. Meanwhile, in the case of India, it is reasonable to project forward a trend growth rate of at least 7-7.5% per annum even in a world where Indian export growth remains only single digit. This growth rate assumes consumption grows at a steady 6% and investment, which remains the key component, grows at 10-12%. On that point, India’s gross fixed capital formation as a percentage of nominal GDP has risen from 22.7% in FY00/01 to 34.8% in FY08/09 (see Figure 11). But it can move higher before running up against over-investment issues.
This is why India remains an important complementary part of any Asian equity portfolio. As for valuations, the market is certainly no longer cheap on a prospective multiple basis, though in GREED & fear’s view it merits its premium rating in an Asian context. CLSA’s universe of 109 Indian companies now trades at 18.2x this year’s forecast earnings and 15.5x next year’s earnings, compared with 17.8x and 15x for the Asia ex-Japan universe. Meanwhile, investors worried about valuations should look at the following chart of the Sensex’s price to book ratio which looks more comforting (see Figure 12). |
