Financial markets in India are going through a challenging time with worries on deficits, economic slowdown, and global issues. The biggest worry currently is the INR weakness and volatility. Both RBI (Reserve Bank of India) and the government are taking a series of measures to arrest the same. Some of these measures while having their desired impact in the medium to long term, may have unintended consequences in the near term. After tightening measures announced by the RBI to rein INR volatility, India bond market, especially longer dated bond, suffered the unintended consequences and the 10-year bond yield surged to 9.4%, the highest since 2001. Though the RBI intervened through open market purchase operation, the yield still remains at around 8.5%. The rupee, due to outflows on both equity and debt markets and sell off in global emerging markets, also weakened and continued to hit record lows. The failure of RBI’s measures to halt the depreciation of the rupee, fear of Fed tapering, increased tension in Syria, and higher than expected July WPI inflation number weighed on the equity market and Nifty lost 12.85% (in USD terms) for the month.
While some part of India’s problem is related to global worries, a large part of the problem is self-inflicted. Recently we have acknowledgement from the policy makers on these issues and are seeing corrective measures being taken. The new RBI Governor, Raghuram Rajan, will assume office on 5th September 2013. We do not expect RBI to reduce policy rates in the current year. The new Governor will have to balance the impossible trinity of managing growth, inflation and the INR. The issuance of a sovereign bond along the lines of the earlier issued India Millennium Deposits (IMD) or Resurgent India Bonds (RIB) is a possibility.
Market Outlook and Valuation
Every crisis brings an opportunity. If one reads the media bytes and headlines in India, one perceives all round gloom in India. However the rural economy is going through good times. We have had one of the best monsoons in recent years and the clear outcome of that will be a strong agricultural growth. Given that the water tables would have been augmented, even Rabi (winter crop which is the more important crop) will be most likely much better. This will definitely cushion the slowdown as two thirds of India still lives in rural areas.
Additionally while the scenario looks like a repeat of Lehman crisis, the global economy is at this juncture on a recovery path. US has seen GDP growth recovering and recent pointers suggest that even Euro zone is stabilizing. This augurs well for exports, particularly software and to a certain extent pharmaceuticals where we as a fund are also overweight. INR depreciation could well be part of the solution by making domestic produce more competitive versus imports and also slowing down excessive / wasteful consumption of imported goods and this could lead to current account correction. Recent trade data points to the same. We have also seen in past that in crisis, tough policy measures are taken by policy makers. We are already seeing ease in the FDI rules in various sectors and oil related subsidies being addressed. Recently, the Cabinet Committee on Investment (CCI) has expedited clearances of 36 infrastructure projects worth about INR1.8trn (USD27.3bn) across various sectors. The concerned ministries have been directed to expedite clearance of these projects.
At the current juncture post the INR and the market correction, as of end of August 2013, the Indian equity markets are trading at 11.1x one year forward earnings (Nifty – Source: Kotak Institutional Equities). On price to book we are at the lower end of the historical average. Post the recent correction, valuations in several good companies are beginning to look reasonable. This should, over time, attract equity flows into India once the INR stabilizes. So, while not ruling out volatility driven by both global and local factors, one should look to add exposure.