Having said all that, Indias economic slowdown does remain an overhang. From an average 8-10% growth, we have come to a low 5% in FY13, which could further see a downside to 4.5% in FY14, and marginally recover in FY15. Growth remains weak, while inflationary pressures have risen, forcing the central bank to raise interest rates. The new RBI governors main focus is on the CPI, even though growth has faced collateral damage. While the primary sector is slowly recovering, the core sector remains weak, and consumption the biggest growth driver in last few yearsis no longer so sticky. We expect the RBIs anti-inflationary stance to continue, with interest rates likely to remain high for now, at least until the first half of FY15.
The current account has seen the worst, and is on its way up, albeit driven by a weak macro. The external situation has improved meaningfully due to stronger export growth, and lower imports led by restriction-based measures on gold imports by the RBI. We expect the current account deficit to come off meaningfully from its record-high 4.8% of GDP in FY13 to 2.6% of GDP or $44 bn in FY14. Despite this positive comeback, the BoP remains a concern as capital flows have substantially fallen amidst huge inflows via FCNR (B) deposits. With increasing odds of a potential, albeit modest US taper, we do not expect the external sector to improve in the near-term, and remain cautious on Indias BoP and the INR, particularly after the RBI shut down the dollar window for OMCs.
History indicates that the INR and markets cant remain divergent for long with the two moving together at-least 2/3rds of the time. In the last few months, the INR has reasonably stabilised, led by declining trade deficit and positive moves (concessional swap window for FCNR (B) deposits/overseas borrowings) taken by the RBI, which has also provided some respite to the markets.
While the EM pack has benefited en masse from positive global cues (deferment of the US taper), India has been in an even better position after a stablised currency, improved CAD and positive state election outcome. We expect the MSCI India valuation premium to MSCI Asia (~30%) to sustain at current levels as the domestic macro has bottomed out and things are set to recover, albeit
very gradually, from here on, even as
a secular recovery looks unlikely at least over next year. As such, we expect India to outperform its EM peers over
the long-term, given its stronger macro-fundamentals.
Currently, valuations are a liquidity-driven rally, and sustainability is the key amidst the weak macro scenario. With the Sensex now trading at 12M forward PE of ~15x, at par with historical average, the current valuations have largely priced in the positive political cues, and any signs of a US taper could potentially result in some de-rating with sustained macro uncertainty. We expect weak corporate earnings to further see some downside, as our top-down analysis looks at an earnings growth of 5-7% for FY14, with a marginal pick-up to 10% in FY15.
State elections revive electoral calculus. The BJPs sweep in the state assembly elections vindicated the markets positive stance on anti-incumbency even as new-fangled AAP emerged as a strong contender in Delhi. While early to say, it does raise hopes of a similar outcome at the Centre, which is sentimentally positive for the market and could provide the much-needed boost to business sentiments. A comparison between the general and state election outcomes over the last two elections, signal that the probability of the winning party to score an equal/higher share of the Lok Sabha seats is significantly high. Four-and-a-half years of slackening growth (9%+ to 4.5%) and essentially dead markets (five-year return ~0%) have contributed to one of the strongest anti-incumbency waves Indias ever seen against the Centre, resulting in a sharp increase in voter turnout in all the four states. Aggregate turnout of the four states put together has increased from 67% in 2008 assembly elections to 72% this time, a trend we expect to continue in 2014. We expect near-term euphoria to gloss over the weak macro (and our cautious portfolio stance) as 2014s scenarios get recalculated. We would buy global stocks such as IT, Pharma and Autos that have export themes (Tata Motors).
Gautam Y. Trivedi
The author is MD & head of equities, Religare Capital Markets