We have remained constructive on the broader Indian market, given the steady year-on-year increase in index EPS, a below-average market P/E and a stable if not a marginally appreciating currency. Now, however, given the political and economic challenges in other EMs, India suddenly looks relatively more attractive.
While we continue to expect downward revisions to index EPS in India, the pace of these revisions is far slower than in other EMs, particularly as many EMs have been forced to raise interest rates sharply to avert a currency crisis, and some others like China are only starting to unwind some speculative excesses. Further, forward-looking estimates suggest a much stronger earnings growth trajectory.
Consumer price inflation is out of the double-digit territory, and the high base of vegetable inflation in CY13 suggests that even potential weather disruptions in CY14 rule out spikes. WPI inflation is near four-year lows. While we do not expect inflation to come down anytime soon to levels at which the central bank can start cutting rates, a lower inflation trajectory keeps markets optimistic. Further, at a time when investors are worried about the effect of tapering on EM currencies, the Indian rupee has been remarkably stable and range-bound. Indias current account deficit (CAD) for the last six months has shrunk to $10 bn, ~1% of GDP, annualising to $20 bn/year. The reduction in CAD has been the most dramatic among EMs.
The necessity of and the dependence on foreign capital is, thus, significantly lower than it used to be in the past. This has happened mostly due to weaker domestic demand.
The relative attractiveness among EMs implies continued capital inflows, though external capital requirements have come down with the fall in CAD.
Hopes are high among investors that elections can re-start the investment cycle. Such misplaced optimism ignores the realities of the business cycle and overestimates the powers of the central government. Only a fourth of investment projects under implementation are stuck with the central government; the rest are constrained by overcapacity, balance sheets, or with state governments.
Of the Rs83 trillion of projects under implementation, 437 projects adding to an investment of Rs21 tn (~25% of total) reached the Cabinet Committee on Investment (CCI): it is reasonable to assume that projects that were stuck due to central government clearance would all have appeared in the list of CCI projects.
Not surprisingly, the proportion of projects stuck with the Centre is the highest for sectors like metals, mining, and oil & gas. In terms of investment amounts, power, steel and coal together account for over 80% of the outstanding amount.
In the last 15 months since it was set up, the CCI has cleared Rs5 trillion of projects, leaving Rs16.4 trillion still with it. More than three-fourths of the clearances have been in the power sector. We believe most of these projects may not progress much for now.
Not surprisingly, a third of all capital to be spent on investment in India goes into power projects. This is true not just of the recent period, but also historically, even when the government undertook most of the spending.
The slowdown in new project announcements too has a similar pattern. The slight upturn seen recently in new project announcements cannot be the start of a new investment cycle.
New announcements are currently an insignificant part of the investment ecosystem, given the large number of projects under implementation currently. Till these get completed or shelved, with losses apportioned (to banks or to the corporates), the room for new projects cannot be created. In the previous cycle as well, a substantial pick-up in new orders took several years.
So, can a new government help revive investment in the power generation sector We believe not, for two reasons: (i) overcapacity and lack of power distribution reform; and (ii) slow growth in coal production.
While road transport is the second largest segment of projects under implementation, most of it is under state governments jurisdiction. Only National Highways are managed by the central government. Road projects are only 3% by the value of the projects pending with the CCI.
Rail is one of the two sectors in India where the government holds a monopoly (nuclear energy is the other). As working expenses have again started to take up 90% of gross receipts, Indian Railways has struggled to accelerate rail capacity. For the first time since 1998, its capex dropped y-o-y in FY14. While the dedicated freight corridor (DFC) is an important project for debottlenecking the freight movement, at $19 bn, it is roughly equivalent to just two years of Railway capex.
The second largest segment of projects outstanding where the Centre can play a role is steel. With capacity expected to be 30% higher than demand in a years time, and all major steelmakers at dangerously high debt levels (more than 5x debt/Ebitda), even timely clearances are not going to trigger fresh investments in steelmaking capacity. While cement demand growth is slightly better than in steel, industry capacity is likely to be 30% higher than demand in FY15: a pick-up in capex is unlikely anytime soon.
Now that gas output at Reliance seems to have bottomed out, the negative incremental updates to Indias gas output are likely behind us. Indias gas output is likely to pick up by nearly 46% in the next four years. This should ideally relieve pressure on projects stuck due to lack of gas.
Of the 21GW of commissioned gas-based capacity, only 53% is currently operational. Further, half of the operational capacity is also running at less than 40% PLF
While the reported (or cash) budget deficit for the central government has shrunk quite sharply in the last two years, it is far from levels at which the government can think of a fiscal stimulus.
Further, the apparent reduction seen in the last three years has been achieved mostly by pushing expenditure into subsequent years: while earlier March used to see 16% of the full-year expenditure, in the last three years, it has come down to 11-12%, with the spend in June picking up.
In our view, fiscal stresses for the government continue, given that "profit-based taxes" like income and corporate taxes are now a larger part of government revenues than they were earlier, causing volatility in receipts. Expenditure on the other hand is mostly non-discretionary, and the government cannot control more than the timing of the expenditure. This limits the room for a fiscal stimulus.