Please Note: This is a general commentary based on the analysis and opinions of the fund management team of the Kotak Group and is not intended as a recommendation or for the purpose of soliciting any action in relation to any investments, or to be otherwise relied upon for any purpose.
Investments in India are subject to the normal risks associated with emerging markets, including but not limited to risk of losing some or all of the capital invested, high volatility, variable liquidity, geopolitical risks (including political instability), exchange rate fluctuations and restrictions on foreign investors. Investments in India should, therefore, be considered only as part of a well diversified portfolio.
India: The new Asian Tiger
“It was the best of times; it was the worst of times,
It was the age of wisdom; it was the age of foolishness,
It was the epoch of belief; it was the epoch of incredulity,
It was the season of Light; it was the season of Darkness,
It was the spring of hope; it was the winter of despair,
We had everything before us, we had nothing before us”
- Charles Dickens in “A Tale of Two Cities”
The above captures the sentiment best, for both 2008 and 2009 as asset prices gravitated from one extreme to another. While in 2008, Indian markets fell by 61.49% in USD terms, they have risen by 89.39% in 2009. This has possibly been the shortest bust-boom cycle and in this environment; the Indian economy has managed to grow at a commendable 6.7% in FY2009 and is likely to grow at 6.5% in FY2010. (Source: Kotak Institutional Equities).
Looking back at the year gone by, we believe it can be characterized by the following:
1. Strong Wave of Liquidity: As all major economies pursued a policy of strong monetary easing and fiscal stimuli, liquidity was very benign and this resulted in strong flow of capital to markets like India, which remained one of the key growth destinations. Corporate India undertook a massive recapitalization exercise and has raised equity capital in excess of US$14bn (Source: Kotak Institutional Equities)(via a combination of qualified institutional placement, primary issues and promoter stake sales). Year Till Date, Foreign Institutional Investors have invested a net of USD$ 17.46bn (Source: Securities Exchange Board of India) into Indian markets – a significant portion of which has been channeled to restructure corporate balance sheets.
2. Elections: Indian voters delivered a surprising verdict returning the incumbent government with a larger majority. For international investors, this removes one of the key risk factors and this provides a 5 year opportunity for the government to focus on various policy reform initiatives and on bolstering Indian infrastructure.
3. Failure of Monsoons: In a year with so many positives, nature seemed to play spoil sport and India was on receiving end of very poor monsoon – the worst monsoon for over the last three decades. While government schemes like National Rural Employment Guarantee Scheme and higher support prices for crops may offset to some extent any fallout in rural consumption and demand, fall in yield will have an impact on -inflation.
4. Return to Growth: The last few quarters have seen the Indian economic indicators returning to growth. For example, the last two data releases on Industrial Production saw growth in double digits. The Reserve Bank of India has also increased GDP growth statistics for FY2010 to 6.0% with an upward bias. All this is translating to strong corporate earnings with a lag. So, while for FY2010, street estimates point to an earnings growth of 3.9%, in FY2011, their estimate for earnings growth are at 21.9%.
5. Re-rating in Indian Markets: A combined effect of strong political stability, abundant liquidity providing companies with growth capital and the return to growth by corporate India, has lead to a sharp re-rating in Indian markets. As shown in graph below, while in the near-term the earnings forecast have improved, most of the rise in Indian markets has been led by expansion in the PE multiple.
|Sensex performance drivers since market trough (Index points)|
|Source: HSBC, Thomson Financial, IBES|
With a return of 89.39% (In USD terms), 2009 happened to be the best year for Indian equities since 1991. Rather unlike the volatile 2009, we expect 2010 to be a year of consolidation. In 2009, the Indian economy faced possibly the worst combination of the credit crisis in the initial part of the year and a very poor monsoon, yet has come out very well from this crisis.
GDP Growth to be strong
It is likely that the GDP growth for year ending March 2010 would be between 6.5%-7.0%, and if we were to factor in the effect of the poor monsoon which in our estimate has shaved of between 1-1.5% of GDP, Indian GDP growth would perhaps be in the range of 7.5 – 8.0%. We expect GDP growth to revert to this level in 2010, with possible upside from a base effect in agriculture which could add another 50 bps – 100 bps. The GDP growth is expected to be driven by the likely strong revival in the industrial sector and continued buoyancy in the services sector.
Gains from Global Recovery
Apart from the strength in the domestic economy, India will also benefit from the global recovery. While the risk of a double dip remains, the likelihood of that is receding. The key risk from a sharp global recovery for India is oil prices and if oil moves towards the US$100/bbl mark, it could be a risk to the India story. Some of the headwinds that the Indian equity market face are inflation, and thus monetary tightening, fiscal deficit, fresh equity issuances, valuations and oil prices (if they move towards the three figure mark). Tailwinds would be revival in industrial growth, a strong rural sector growth, ongoing reforms, infrastructure spending, earnings growth and liquidity.
Liquidity has always been a very important driver of equity markets and this hangs in balance. While we expect strong flows from both domestic investors (mainly insurance flows) and also continued allocations from the foreign investors, a large part of this will be absorbed by fresh equity issuances driven by the government’s divestment program. A successful disinvestment program could well be a trigger for a longer-term fiscal deficit management.
Government of India shall play a pivotal role
Government of India along with the central bank will play a very important role in shaping 2010. An accelerated exit policy from the central bank could play spoilsport to asset reflation and is a key thing to watch out for. While we believe that the central bank will take certain tightening steps in the face of likely high inflation, we expect a calibrated exit and don’t expect the central bank to raise rates in a hurry. The tug of war between rising growth expectations and fears of withdrawal of monetary easing is likely to cause some volatility. The likely reform process on disinvestment, infrastructure, insurance and banking reforms, and tax reforms (implementation of GST) augurs well for the medium to longer term health of the economy, and a faster implementation of these may lead to further re-rating of the markets.
After the sharp depreciation of the rupee in 2008 and in the early part of 2009, bolstered by strong capital flows and remittances, the rupee looks to be in a phase of appreciation. From the lows, while the Korean Won has appreciated by 25.38%, Indonesian Rupiah by 20.97%, Brazilian Real by 28.40%, Russian Ruble by 16.33%, South African Rand by 30.43%, the Indian Rupee has just appreciated by 10.47%.
Global Outsourcing to benefit India
A lot of debate is ongoing on the effects of fall of global trade on the Asian economies which have had an export led model. With consumption accounting for more than 65% of the GDP (Source: Bloomberg), India stands out, being a more domestic focused economy. While a lot of noise has been made on outsourcing, we see India’s strength on global IT outsourcing being maintained and further gain from the stability of the global financial sector which is the largest clientele for the sector. Additionally, with the increased focus on cutting healthcare cost, we expect India to be an important player in the global generic pharmaceuticals markets.
Indian markets are trading at a premium to its long term multiples. Markets are trading at around 15.5 times year ending March 2011 earnings and around 17 times one year forward limiting near-term upsides. However, GDP growth and especially Industrial growth has continued to surprise economists and analysts on the upside, implying room for further earnings upgrades. We expect the markets to largely track the earnings growth which is expected to be around 20%+. After a broad rally in 2009, 2010 could well be a year of stock pickers and as such midcaps may tend to outperform. Under-ownership, revival of growth and easy liquidity all augurs well for the midcap space. Sector wise, we are overweight infrastructure and financials, and are scouting for long term bets in consumption as discretionary spends increase.
We believe 2010 would a year of consolidation and will lay the foundation for a faster economic growth in years to come. A large part of the infrastructure spend is expected to start paying dividends over CY2011-2013 and benefits of large domestic oil & gas finds is likely to fully accrue. With the likely reduction of fiscal deficit as the government exits the stimulus package, successful disinvestment and strong GDP growth, revenues by themselves are likely to pick up, credit availability and cost are likely to remain benign.
A bulk of global growth in coming years will come from Asia, and India is expected to be a large contributor to this growth. In that context, investors should consider increasing their exposure to Indian equities and benefit from the transformation of the Elephant into the new Asian Tiger.
|Key events to watch||Key data points to watch|
|Budget 2010 (Feb)||Fiscal deficit & Divestment schedule|
|RBI’s quarterly credit policy meetings||Inflation, credit growth and key policy rates|
|Monsoon progress (June – August)||Agri inflation and rural spend|
|Policy reforms||GST Implementation, Banking & Insurance reforms|
|Global variables||Oil price, US Dollar|