This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Becket, CIO of PSigma Investment Management, considers the future of India.
So is now the time to invest in India? In truth, this is far from a clear cut short term decision. Before one even begins to evaluate the domestic drivers of future returns, you need to factor in the potential impact of the (probably soon) 'Tapering' of QE.
Despite recent improvements encouraged by the excellent new Reserve Bank of India governor, Raghuram Rajan, India still has a structural current account deficit and budget deficit, which leaves it heavily exposed to the vagaries of global financial flows, as we saw in those painful early summer months. These financial dependencies ensure that there are large exogenous risks for India, although admittedly recent currency weakness has aided exports. It is undoubtedly a major positive how well received the excellent Dr Rajan has been; early signs suggest he is a class operator and could provide a steadying hand to the Indian economy after twenty-five years of economic mismanagement.
I learnt while in Mumbai recently that there is generally still plenty of deep scepticism about the future within India, which has been reflected in western commentary on the opportunity there. While pessimism is rife, there are also potentially a number of positive catalysts to blast Indian equities from their listless performance since the end of 2010.
First of all there is a chance that the political paralysis that has been created by the ruling Congress party might finally be over next year (it appears that useless politicians are sadly a global epidemic). There are signals that the business friendly Bharatiya Janata Party (BJP), led by market darling Mr Modi, might win enough seats in next year's general election to form a coalition. Each swing of the pendulum in opinion polls in the BJP's favour has been welcomed by investors who have driven the Sensex Index back up to the highs seen in late 2007 and 2010. Many Indian investors see a possible Modi win as an 'Abe moment' for India. While such a result could be transformational, it is far from a certainty and investors would do well to curb their enthusiasm until the outcome is clearer.
What is certain is that fractious Indian politicians need to get a grip on themselves and their country. Regardless of the immediate questionable outlook, the long term future for India should be extremely bright. India is a nation of immense potential, aided by favourable demographics and a competitive labour force.
But this future economic super-power is being held back by political incompetence, poor infrastructure and an impaired vision for the future. Many businesses do not want to commit capital in India due to the pervasive uncertainty. Just to use one example of how utterly useless things are in the political sphere, there has been a new international airport being developed outside of Mumbai for fifteen years, but work has ground to a halt as the politically-connected have bought land around the airport to try to make a quick buck. Work has now ground to a halt.
India's current economic performance is poor, with GDP stuck in the 4-5% range, way below the growth rates of the last decade and firmly below potential output. The present level of growth feels like a recession and is too insipid to create sufficient new jobs to meet the 15 million new entrants to the workforce each year. When you combine the lack of employment opportunities with ravaging food price inflation (circa 10% per annum) then you have a toxic cocktail for social unrest. Whilst there has been a 'great deceleration' across the whole of the industrialising world, India's economic growth delta has been amongst the poorest. The only real cure will be structural reform and a significant reduction in bureaucracy, hopefully starting with reformation of the oil / energy markets and a reduction in unnecessary subsidies. There have been tentative efforts over the last few months, but much more work is required, whoever wins the election. Everyone mocks the Chinese political situation, but when one compares democracy with communism, it is easy to see which gets the job done more efficiently.
Turning to valuations, assuming that Indian companies can achieve earnings growth of 10% next year (analysts expect more, but it pays to be sceptical) then the Indian market is trading on circa 14xs forward P/E, towards the bottom end of its historical trading range. On a price to book basis, Indian equities are similarly valued against historical comparisons. When juxtaposed with other emerging markets, India is not cheap, but then it never has been. On balance I would argue that Indian equities are sensibly priced and offer value, if the politics and, by implication, the economic growth rate improves. There should be good operational leverage to any recovery from companies, meaning that earnings growth could surprise to the upside on a three to five year view, probably ensuring very good returns to patient investors.
The biggest opportunity for nimble investors comes from the extreme divergence between expensive defensive sectors and cheap cyclicals. This global valuation phenomenon is particularly easy to spot in Indian equities, with some 'safe' and 'quality' companies such as Nestle India trading on 38xs P/E, whilst cyclical companies are often below 10xs. Indeed, the state banks trade on P/Bs of 0.4-0.6xs. There are also plenty of superb long term opportunities in the mid-cap area of the market, which is cheap and offers investors efficient access to the themes where you surely can't fail to make money in the next 10 years in India; education, healthcare, agriculture, genomics, financial services and business process outsourcing. These are the sectors where the real opportunities are in a nation of over 1 billion people.
So to answer my earlier question on whether one should invest in India or not, it is hard not to be impressed by the long term potential within the Indian equity market. However, you want to be selective, don't just buy the index and employ a manager with on the ground capabilities. You also want to have a long term horizon, as there will be extreme volatility. We won't be rushing in after the spurt higher from the 'Modi rally', as in the short term the markets have moved too far ahead of fundamentals, but I can easily see us allocating money to this potentially very rewarding opportunity in the coming months.
I normally caveat all of my research trip conclusions with a warning that it is impossible to get a fair reflection of a country from a few days in its financial capital. I won't this time, as I believe that Mumbai is an efficient reflection on India; badly structured, poorly planned, in need of real help and with a gaping chasm between the “haves” and the “have nots”. However, it is also a place of hope, pent-up demand and plenty of potential. If you use your imagination, there are reasons to believe that the Tiger economy can roar once again in the coming years and go on to achieve its deserved place in the world. Investors will ultimately be well rewarded by the emergence of India.
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