For many years India was one of the most promising emerging
markets. Real gross domestic product growth averaged more than
8 percent per year from 2003 through 2010, but by fiscal 2013
(which ran through March) the nations economic expansion
had slowed to an annual rate of 5 percent the lowest
level in more than a decade.
It continues to falter. Just last month both the
International Monetary Fund and the World Bank slashed their
GDP forecasts for the current fiscal year, from 5.6 percent to
3.8 percent and from 6.1 percent to 4.7 percent, respectively.
Those reductions didnt sit well with the current
government, especially with national elections only months
away. Chakravarthi Rangarajan, chairman of Prime Minister
Manmohan Singhs economic advisory council, dismissed the
institutions as unduly pessimistic and insisted
that growth would meet or beat 5 percent this year.
However, with myriad problems besetting Indias
economy, few market observers believe that much will change by
the time polling begins in May. Inflation remains high
Indias wholesale price index rose 6.46 percent
year-over-year in September, up from 6.1 percent in August and
the fastest rate since February as does the
current-account deficit, which neared $88 billion, or a
record 4.8 percent of GDP, in fiscal 2013. That was up from $78
billion, or 4.2 percent of GDP, in the previous fiscal
Growth has been one concern that we think will
continue into early 2014, asserts Jyoti Jaipuria, head of
India research at Bank of America Merrill Lynch in Mumbai.
The fiscal deficit will also be a concern. Over the next
six months, however, the primary focus of investors will likely
be the elections and what the nature and shape of the new
Chetan Ahya, Morgan Stanleys economist for the
Asia-Pacific region, points to other issues. As
policymakers focus on improving the macro indicators
such as inflation, the current-account deficit and the gap
between loan growth and deposit growth over the next six
to 12 months, a meaningful recovery in private capital
expenditures, government spending or private consumption will
be difficult to achieve, he says.
Thats not to suggest that investors necessarily should
steer clear. Although the benchmark S&P BSE Sensex Index
climbed only 5.8 percent year to date through mid-October, far
below the 19.1 percent gain of the S&P 500, it nonetheless
trumped the MSCI Emerging-Markets Index by some 7.4 percentage
points. Opportunities abound for investors that know where to
Money managers often rely on the sell side for direction,
and this year they say Bank of America Merrill Lynch provides
the best guidance. The firm rockets from fourth place to first
on the All-India Research Team, Institutional
Investors annual ranking of the countrys best
sell-side analysts, after picking up three spots, bringing its
total to 11. Thats enough to push CLSA, which had been
No. 1 for the past two years, down one notch to second place,
even though it claims the same number of positions as last
year, ten. Credit Suisse and Kotak Securities, which tied for
sixth in 2012, jump in tandem to the third tier after picking
up one spot each, bringing their totals to eight. Rounding out
the top five is previously unranked Barclays, which captures
six team positions. These results reflect the opinions of
roughly 330 investment professionals at more than 200 buy-side
institutions that collectively manage an estimated $100 billion
in Indian equity assets.
Global investors began to flee emerging markets in May,
after the U.S. Federal Reserve Board signaled that it might
start to scale back its program of quantitative easing in
September. India was among the hardest hit, owing to its high
inflation and heavy reliance on foreign investment. By late
August the rupee had plunged to a new low against the dollar,
68.85. The Feds decision to postpone action until it sees
more signs of sustainable economic growth in the U.S. was
welcome news to the worlds largest democracy.
Receding concerns over QE tapering have helped to
revive capital inflows into India, reports Morgan
Stanleys Ahya, the highest-ranked economist for a
third year running. These developments have helped to
stabilize the currency and allowed the Reserve Bank of India to
remove the monetary-tightening measures in a calibrated
manner to support growth, which remains weak. However, these
reduced pressures on the currency may mean the
governments efforts to implement policy reforms may
For example, early last month the central bank lowered the
marginal standing facility rate it had raised in mid-July to
slow the plummeting rupee, but the reversal in monetary
measures by the RBI has meant that short-term real rates are
back in negative territory, delaying the adjustment required to
address the domestic liquidity imbalance, he explains.
We believe persistent negative real rates on [consumer
price index] inflation since the credit crisis have been one of
the key factors increasing macro stability risks in
Ahya is more upbeat than the IMF, forecasting real GDP
growth of 4.1 percent in the current fiscal year and 5 percent
in fiscal 2015. We expect export-related sectors to
do well, but growth in domestic demand-related sectors
will remain constrained for a while longer, he predicts.
The outcome of the general elections could be a big
positive trigger for business as well as consumer
In the meantime, the economic and political
environment in India is still uncertain, observes
Aashish Agarwal, who directs India research at CLSA in
Mumbai and also leads the lineup in Financials for a third
year. We recommend that investors stick with quality
stocks and be prepared for volatility.
The Feds decision was especially beneficial to
Indias bankers. As the market recalibrated to
delayed withdrawal of QE, Indian banks have outperformed,
reflecting that concerns of tighter monetary policy to defend
the currency have eased, Agarwal explains.
For the first time in a decade, the sector is poised to
expand as a result of regulatory changes. The RBI is set to
grant banking licenses to companies that meet the stringent
criteria it outlined earlier this year. Seemingly unlikely
contenders include outfits whose operations are far afield from
banking, including Aditya Birla Group, a conglomerate with
interests in agribusiness, chemicals, and metals and mining;
Larsen & Toubro, the nations largest construction and
engineering concern; and Tata Group, whose subsidiaries include
automakers, consumer goods manufacturers, information
technology providers and retailers.
More than 20 groups have applied, and we understand
that about five new licenses may be awarded, says
Agarwal. Entry of new banks can lead to price-based
competition for deposits, loans and talent. Smaller banks may
face higher pressure, so it can also increase the possibility
of acquisitions of the smaller private banks.
Not all firms are created equal, he adds, and investors
should be mindful of the differences between private operations
and public sector undertakings. Private banks in India
are more profitable, less leveraged and have less exposure to
riskier sectors than the PSU incumbents, he says.
Therefore we expect private banks to provide better
longer-term returns to shareholders.
Amish Shah, consistently No. 1 in the Power sector, holds
an inverse view with regard to his companies. We advise
avoiding most private sector power developers, owing to their
mispriced power purchase agreements and high leverage, he
says. Government-owned utilities such as NTPC should do
well, as we expect fuel supplies for its projects to improve.
This should lead to a rebound in its earnings growth and return
ratios, and therefore its stock performance.
Even so, the Mumbai-based analyst has a negative view on the
sector, which he says is in dire need of overhaul. India has
one of the worlds fastest-growing energy markets,
with demand far outpacing supply and forcing the country to
rely heavily on coal and oil imports rather than developing its
The domestic fuel deficit is the key issue impacting
the power companies, Shah maintains. Resolving the
problem would alleviate such related issues as financially weak
state electricity boards and incorrectly valued power purchase
agreements, but this would require structural reforms and
is thus unlikely to get resolved in the near term, he
says. The governments response is very poor so
Nor are recent liquidity gains providing a lift. The
power sector has been among the least beneficiaries of
curtailment in tapering and increasing [foreign institutional
investor (FII)] equity flows to India, Shah observes.
The sector, in general, has underperformed the market
since September; however, some stocks with highly geared
balance sheets have witnessed a 14 to 25 percent rally in hopes
of their ability to raise funds through asset sales. Muted
performance, despite easing liquidity, reinforces our view that
the sector will not rally unless the issues are
Capital goods companies have also been underperforming.
There is a very sharp decline in industrial and
infrastructure investments in India, driven by clearance
hurdles, policy issues, weak demand outlook and high cost of
capital, explains Kotaks
Lokesh Garg, now in his third year as sector champ.
The government is trying to take steps to alleviate the
situation, but we do not find them adequate and believe that
significant pickup in the investment cycle particularly
private sector investment will take time.