Indian consumer continues to be a pillar of support, says Manpreet Gill
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Standard Chartered Plc expects India to continue to be among the most preferred equity markets in Asia, says Manpreet Gill, its Singapore-based head of fixed income, currency and commodities investment strategy.
“Domestic factors remain positive... Economic growth has clearly held up well, inflation and interest rates are lower than where they were a year ago and a significant reform measure—the goods and services tax bill—is now well on its way to implementation. The Indian consumer continues to be a pillar of support,” he said in an interview.
What is the outlook for the Indian market during this financial year? Do you get a sense that this recent outperformance that we have seen is going to continue?
Our outlook for Indian equities is positive, and it remains one of our most preferred equity markets in the Asia ex-Japan region. We expect gains to continue through a combination of both domestic and global factors, though, as always, we keep a tight eye on any clouds that may be developing on the horizon. Domestic factors remain positive, in our view. Economic growth has clearly held up well, inflation and interest rates are lower than where they were a year ago and a significant reform measure—the goods and service tax bill—is now well on its way to implementation. The Indian consumer continues to be a pillar of support.
Global factors have also been a key tailwind. The fact that the US dollar has remained capped has meant capital flows into emerging market equity and bond markets has rebounded; Indian equities and bonds have been key beneficiaries as a part of this process and we expect this tailwind to stay in place as reflation—improving growth and reduced deflationary forces—continue to broaden globally.
All of these factors argue recent Indian equity market outperformance is set to continue, especially if new catalysts continue to be forthcoming.
Any concerns on what can derail the current markets rally? Can it be another set of bad results from the March quarter? Did the markets overestimate the strength of the recovery from the cash ban?
We believe earnings delivery is increasingly key. As we’ve often seen elsewhere in equity bull markets, positive expectations for the future have meant that market gains thus far have been led by rising valuations as investors have been willing to pay higher prices in anticipation of higher earnings in the future. However, at some point, markets will begin to demand to see evidence of the expected higher earnings. A disappointment here is a risk, potentially causing markets to take a pause to re assess.
Global factors are also a second key risk. The lack of further US dollar strength and strengthening flows into emerging markets have also been an important factor behind recent equity market gains. However, this has partly occurred as the initial phase of the ‘Trump trade’ takes a pause amid the new US administration’s challenges in passing key legislative measures.
A rebound in inflation expectations in the US, a more aggressive Fed or imposition of a border tax, all of which could trigger another bout of US dollar strength, are risks because that could cause market-supportive foreign investment inflows to pause, or reverse.
We are less worried about the impact of the cash ban. Recent consumer spending data—eg. auto sales—suggest the impact was transitory and may now be behind us.
Okay, let me then frame the question differently. From valuation point of view, the market is still at the levels seen in the bubble years of 1992 and 2000, or even what we had in 2007. Does this imply that it is still a good time to enter India, especially for global investors?
Valuations are undoubtedly elevated, but we would refrain from automatically using this factor alone to scale back our positive view. Instead, we would use the following three factors to guide how we should factor valuations into our decision-making process.
First, it helps to understand the context that valuations are a great indicator of long term—multi-year—returns, but are rarely any good at predicting short-term—the next few months’—returns.
Second, market valuations rarely hold at about average. In bull markets, valuations tend to be high and rising while the opposite holds in bear markets. We would only begin to worry if valuations were to stretch to extremes—a standard deviation above average, for example, could be one approach. Today, Indian equity market valuations are on the higher side, but not at extremes that would be a cause for imminent worry, in our view.
Third, valuations cannot be narrowed down to one measure alone; instead, we prefer to look across a range of measures such as price to earnings—the P/E measure—or looking at book value relative to the return on equity. Today, a wider approach to valuations tells us that while traditional measures like P/E are elevated relative to the market’s own history, other measures such as those that account for Indian markets’ higher return-on-equity relative to other Asian markets suggest valuations are less elevated.
The conclusion for us is that while we need to keep a tight eye on valuation measures, today, they are not providing enough of a signal on their own to either hold or take profit. We believe the potential positive and negative catalysts we discussed in earlier questions may be more useful at this time.
If everything is positive, than what can derail India’s status as the fastest growing major economy? Could it be under-investment in infrastructure, reforms by the Narendra Modi government not taking off, oil prices going up?
We are positive on Indian economic growth and would prefer to focus on up and downside risks to this growth number rather than fixate excessively on how this ranks relative to other major economies.
From a domestic point of view, a few risks to growth come to mind. A rebound in oil prices is undoubtedly a key risk. We believe US shale oil production is likely to cap price gains at $60-65/barrel, which is not far from where we are today. However, oil continues to be a fairly large constituent of total imports; so a larger-than-expected move higher in oil prices would pose a key risk, both in terms of domestic growth—via higher input prices—but also for the rupee, as a higher import bill could tilt the balance of payments in the wrong direction.
A lack of a rebound in private sector investment is also a key risk. Higher capital investment, together with continued investment in infrastructure, remain key to sustaining growth in the long term. While higher government spending has helped fill the gap in the interim, any lack of a sustained rebound here would pose a key risk to long-term sustainability of growth. Today’s growth numbers are being held up well through robust consumer spending, but this can be at risk from external factors such as a poor monsoon.
Finally, the global context remains important. Part of the reason for India’s elevation to the fastest growing major economy was because growth elsewhere, especially in China, has slowed structurally. Some of this has been for a good reason—a modest slowing in headline Chinese growth has been well flagged by authorities as the economy seeks to rebalance, for example.
For investors, the link between GDP growth and equity market performance is not as tight as one would expect.
We believe a focus on market fundamentals remains much more important than headline GDP growth alone.
Two positives that are often talked about when it comes to India in the long-term are that GDP growth will benefit from the country’s favourable working-age population growth and output-per-worker growth, and also that ongoing reforms will s trengthen the productivity part of growth. How big are these two factors in boosting growth? Is the country on track to harness these two factors effectively?
Both are significant positives for India’s economy and, at a very basic level, are behind structurally positive long-term views on the economy’s growth potential. Reforms that raise productive potential are essential to achieving higher economic growth over time without simply raising inflation. Positive demographics—a growing working-age population—means high economic growth can continue, or accelerate, as labour inputs are less of a constraint.
Having said that, the key with demographics, especially, is that positive demographics are a potentially positive factor, but far from a guarantee of higher economic growth. What is key is the economy’s ability to employ the large working-age population and demographics to productive use. Without this, a young population can end up being a liability rather than a support.
This is why going back to growth basics—ensuring sufficient employment opportunities—is very important.
What do you think is the most important next step the government needs to undertake in terms of reforms? Is it sorting out the banking system stress?
Reforms targeting the banking sector would be a significant positive. One can make a strong case that slow investment activity has at least partially been driven by constraints on lending ability as banks seek to address non-performing assets and free up room to resume lending at a more rapid pace. Addressing this constraint could significantly accelerate the pace of credit growth and, hence, economic growth.
However, addressing stress in the public banking sector is not easy or quick to address. Historical experiences in other countries suggest there are many ways this could be addressed—capital injections, raising capital in the market, mergers or creation of a ‘bad bank’. There appears to have been an initial effort at using public capital injections. However, the reality is that fiscal constraints mean this can only be limited in nature and must be combined with one of the alternative, market-oriented approaches.
According to recent reports, in 4Q-2016 India’s total external debt moderated to $456 billion, the smallest in over two years. Long-term debt eased but short-term debt was up marginally. Should reserves accumulation be a priority for India to build a buffer against external volatility?
By most measures, Indian foreign exchange reserves are more than adequate, especially following the surge in reserves over the past few years. This applies both when thinking of reserves in terms of months of imports covered, but also more complex measures such as relative to short-term capital in the country. The Reserve Bank of India has clearly not been averse to building reserves when appropriate.
We should expect foreign exchange reserves, and the Indian rupee, to move in a direction consistent with the broader emerging market currency universe. This undoubtedly means we will see at least temporary periods of rupee weakness and reserve drawdowns, but we do not for