By: Navneet Munot, CFA, CIO, SBIMF and Director IAIP
Just when the dust was settling down on Greece, the Chinese currency devaluation and their subsequent regulatory actions created shivers in the global capital markets. The markets cross asset classes have entered a zone of heightened uncertainty and consequent volatility. Market behavior is making it tougher for the US Federal Reserve to get out of its zero interest rate policy.
Strengthening US dollar, falling commodities and economic slowdown are putting tremendous pressure on emerging market currencies and equities. India outperformed its Emerging market peers in the first leg; but it can’t remain completely insulated as emerging market funds continue to witness further redemptions. So far, domestic Investors have more than offset the FII selling. The rupee has relatively been resilient during this period too. The recent depreciation has actually helped in correcting the overvaluation.
Since the Global Financial crisis in 2008, developed economies have taken an easy option of frequent steroids of monetary easing as against taking the poison-pill of structural reforms. Apart from the developed economies, one of the biggest stimulus program was carried by China. The excessive leverage has not been able to generate the desired economic outcome. We must note, in a world that is obsessed with instant gratification, India has opted for a road less travelled – delayed gratification. The politics and policy both have opted to invest in structural reforms. There is measured fiscal tightening and move towards higher real rates in India when policy makers in rest of the world are focused on propping up asset prices.
India’s macro environment – fiscal and current account deficit, forex reserves and inflation indicate that we are in a much better shape now as against previous such crisis in 2008 and 2013. There exist short term challenges in terms of stress in the real estate sector and strained balance sheets of corporates and banks, but remember, the household balance sheets are strong and keen to participate in financial assets. Similarly, the Government is strengthening its balance sheet with the initiatives on revenue augmentation through tax reforms and better compliances, better expense control and reduction in subsidies. We expect government to provide a fiscal balance to the equation by engulfing parallel economy to mainstream (with its initiatives like JAM Trinity, Direct benefit transfer (DBT) and Tax Information Network), improving tax/GDP ratio and incentivizing financialization of savings. We expect the resultant savings/income to get invested in physical infrastructure in the sectors such as railway, roads, ports, defense and agriculture.
The government’s efforts on economic diplomacy are delivering results as global companies are looking at India favourably. State governments are also competing hard to attract investments through FDI. There has been significant increase in FDI flows with several global companies like Xaomi, Foxconn and Ikea announcing large investment commitments apart from pick up in PE and VC investments into multiple sectors. We believe this is a structural trend that will gather pace over the years as India looks like the “oasis of hope” in a growth starved world.
The decision of RBI to anchor its rate policy to CPI is India’s “Volker moment”. On one hand, it starts an era of concerted fiscal and monetary regime that targets lower inflation and hence lower interest rate; while on the other hand it brings money from non-productive assets into financial assets. Our view has been that CPI could remain structurally low going forward on account of lower wage inflation, lower global commodity prices, and moderate food inflation. Our view is reinforced looking at the presence of excess capacity across sectors, increasing adoption of technology and e-commerce platforms, improvements in logistics and “ease of doing business”. Government policy measures have focussed on augmenting supply side responses, which should kick in gradually over time. Productivity driven growth and structurally lower inflation will make Indian macro look very different from its historical background. This will also have significant impact on flows of savings and investments.
While analyzing corporate earnings, one needs to take in cognizance that almost 25-30% of the broad market earnings are global in nature and have got impacted by the external environment. The nominal GDP growth is in single digit due to fall in GDP deflator (inflation) which is also one of the reasons for subdued topline growth for the corporate sector. The period gone by, has shaped an environment for factor cost efficiency in terms of lower wages, lower rentals, lower input costs and lower borrowing costs. As economic recovery picks up, we feel the earnings cycle should follow as corporates start benefiting both in terms of volumes and margins.
We feel India is emerging from a short-term cyclical bottom to a structural long-term growth story. Fortuitously, the world is uncertain, and struggling for growth when India is getting its act right. In volatile markets, liquidity is a dominant driver. While one expects any further emerging market redemptions to impact India, we feel India would hold an edge of outperformance on the back of sustained domestic flows, higher FDI Flows, better economic positioning and relative ROE premium over its peers in spite of being in trough cycle.
The period of uncertainty provides its own challenges as well as opportunities. There exist strong forces on globalization, digitization and governance which are setting an entirely new landscape for the “Next India”. The challenge is to remain alert to these disruptive forces both in long term and short term. They would disrupt numerous existing businesses and give birth to new set of winners. For example, a low inflation and high real rates environment may be very challenging for several companies with excessive leverage. We have reinforced our processes for further stringency both on bottom up stock picking as well as credit selection in this environment.
In short term, the markets would navigate on global capital and news flows, progression on monsoon and political developments. The resultant volatility and indiscriminate selling offer opportunities to buy good businesses at attractive valuations. We remain alert to tactically grab these opportunities in equities when the price game in the market fits our value equation. Our portfolio construct in fixed income remains biased towards a higher duration given that medium term prospects for bond yields remains very positive.
Looking at the global environment, only certainty is the continued uncertainty and we have to learn to live with heightened volatility in the near term. However, we feel investors should use this period of volatility induced by global events to gradually increase their exposure and remain logged in to a structural opportunity in Indian equities and long- term bonds.
(September 4, 2015, Mutual funds’ investments are subject to market risks, read all scheme related documents carefully.)