India emerges as a defensive play
"In the land of the blind, the one-eyed man is king," so the proverb goes – not the most positive turn of phrase to pick when describing the country you help run.
For former Indian central bank chief Raghuram Rajan in 2016, it was nonetheless apt as he described the way investors viewed India as a “bright spot” in an otherwise tepid global economy.
Fast-forward three years and, despite some teething problems on the ground, foreign investors continue to bet on the country of 1.34 billion people.
Between January to March this year, foreign investors poured in $17.7 billion into India, an increase of about 26% over the same period a year earlier, according to the latest data on such investments compiled by the Reserve Bank of India.
The investments were built up on expectations of a significant majority for the current prime minister, Narendra Modi, whose Hindu nationalist party trounced the opposition in May to win more seats than needed for a majority in the lower house of parliament.
That stoked expectations that Modi would be able to push through much-awaited economic reforms and remove some of the bottlenecks holding India back. In his first term, Modi had pushed through a historic tax reform in July 2017 in the form of a common nationwide tax regime that superseded the myriad taxes levied by individual states.
“The recent re-election of the incumbent government will lead to policy stability,” Colin Ng, head of Asia ex-Japan equities at UOB Asset Management in Singapore, said. That coupled with the goods and services tax will help to attract more foreign direct investment and encourage private sector investment, he said.
“The heart is in the right place, they want to make it more market-friendly,” said Sabita Prakash, a managing director at ADM Capital in Hong Kong, referring to the current administration’s attempt to cut red tape and reduce corruption.
On Tuesday, the Indian government fired 15 senior tax officials that were being investigated for allegations of corruption, a rare move for the country. That came after it had sacked another dozen income tax officials who were facing similar allegations.
Such moves might yet help lift investor perceptions further after India’s ranking on a global corruption index compiled by Transparency International improved by three points in 2018.
Despite the recent bearish turn in global market sentiment, including emerging markets, the Nifty 50, a benchmark of leading Indian stocks, registered a record close on June 3 and is up almost 50% on the past 30 months.
Longer-term, India also has a favourable tailwind behind it: a young population relative to other emerging markets.
The country is expected to surpass China as the world’s most populous by 2027 and its population is expected to reach 1.7 billion in 2059, according to the Pew Research Center. And all this at a time when China’s population is expected to peak in 2031 and the populations of Japan and South Korea are expected to decline after 2020, it estimates.
“India is beautifully set for huge population growth,” Felix Lam, a portfolio manager and senior investment analyst at BNP Paribas Asset Management, said.
A mostly working-age population will “support the natural growth coming from the country,” he said, citing the low penetration levels of India's automobile and insurance sectors to further illustrate the untapped growth potential.
BUMPS IN THE ROAD
To be sure, there are bumps in the road ahead that could yet trip up India – even with its good eye – and catch investors out who are banking on India as a defensive play.
The fat premium on Indian assets, for example, is one reason to be cautious, despite the IMF’s expectations of 7.3% economic growth in 2019.
“Valuations are now less attractive and there is increased likelihood of a downward correction,” said UOB’s Ng. Indian stocks trade at more than 18 times their earnings on average, one standard deviation above its five-year mean valuation, he said.
There are also economic risks, which “are not to be underestimated,” according to a report by CEIC Data, which highlights the Indian government's failure to meet its fiscal 2018-2019 fiscal deficit target of 3.3%.
And then there are the nagging debt worries.
A record amount of debt at India’s shadow lenders is due to mature with INR1.1 trillion ($15.8 billion) of local-currency bonds due next quarter, according to data compiled by Bloomberg. The collapse of the infrastructure and real-estate lender IL&FS Group last year along with troubles at other well-known names have weighed on the net asset value of funds in India.
“The funding situation has been difficult in the last year or so,” ADM Capital’s Prakash said. “It’s not until the traditional funding channels begin functioning smoothly again that the liquidity crunch will be fully resolved,” she said.
The number of deadbeat borrowers has been rising despite India’s adoption of a stringent insolvency law, a key reform feted by foreign investors.
Another drawback has been the relatively higher cost of hedging the Indian rupee versus the US dollar, compared with other Asian countries, says ADM Capital’s Prakash. “For us (debt investor) every cent counts.”