Aug 23, 2013

Column: Time to be cautiously optimistic

On India in the Financial Express

Column: Time to be cautiously optimistic

Indian assets have been under a lot of pressure in the last few days. The combination of a rapidly depreciating rupee, monetary tightening by RBI and decelerating growth have triggered a very sharp fall in Indian equities. The Nifty 50 index has declined about 11% in the month since RBI’s monetary policy tightening late July.

The recent fall in Nifty masks much deeper cuts in the broader markets. It has been nothing short of a bloodbath in most of the sectoral indices—banking, real estate, infrastructure were all down over 20% with individual names falling by as much as 40-50%.

To add insult to injury, several international and domestic brokerages have started downgrading Indian bonds and equities. Earning per share (EPS) estimates are being cut, the GDP baseline growth rates have been revised to between 4% and 5%. One hears of targets on the rupee coming in the range of 70 to a dollar; wild estimates of downsides on the Nifty abound daily on the markets. It is a bear market!

While there is serious pessimism surrounding the economy, it is important to keep in mind that markets usually price-in most publicly available information. To the extent expectations have moved lower, prices move lower as well and there is less room for negative surprises. Looking at the major issues weighing on the minds of institutional investors and assessing their reflection in prices is useful in determining whether or not to buy equities.

Pessimism on growth & rupee
The biggest disappointment in India has been with growth. India has long been viewed as a growth story with low correlation with global growth owing to strong domestic consumption and favourable demographics. GDP growth, and especially investment as a percentage of GDP has been falling. Various scams and political agitation in 2012 caused policy paralysis which led to a sharp slowdown in investments as clearances stalled, projects were delayed, and the government machinery literally came to a standstill. Subbarao’s war on inflation continued to brutalise growth prospects. The death blow to residual growth expectations in India came after RBI announced liquidity tightening measures in July. Most analysts have downgraded their base case GDP growth expectations to about 4.8-5%. The bear case scenario comes in between 4% and 4.5%.

The rupee also poses a rather serious problem. Foreign investors have a strong distaste for countries with depreciating currencies. Rupee depreciation elicited monetary tightening by the central bank. Higher interest rates exert further downward pressure on growth and on the banking system—it is a vicious cycle. As argued in my previous article (FE, August 6,, RBI’s measures were misguided. They failed to have a meaningful impact on the rupee while wreaking havoc in the money markets.

There is hope
RBI seems to have realised this. It has announced infusions of fresh liquidity to the tune of Rs 8,000 crore in the banking system and adjusted prudential limits to permit more liberal marking of banks' bond portfolios as the losses “could be expected to be largely recouped going forward”. Further, the central bank reduced its damaging communication with the markets on its purported policy stance on the rupee while stepping up on its interventions in the currency markets.

A month ago, extreme price targets for the rupee ranged from 61 to 63. Some offshore NDF desks expected the range for the rupee to shift upwards to the 60 to 65 zone. This, too, has materialised. Many foreign investors find value in the rupee at spot levels above 60, but are fearful of investing in India till they see signs of growth or investments picking up.

Further, indications of reversal in liquidity will certainly be helpful in this respect. RBI governor-designate, Raghuram Rajan, offers much hope to investors in India; he is seen as strongly pro-growth. Expectations of pro-growth rhetoric and action from him in September are increasing.

Investors do not expect overnight miracles from India. The fiscal and current account deficits are here to stay. They understand the dynamics of the Indian election cycle—most private sector investments and projects are usually put on hold till after the elections. Scams being scrutinised by the Supreme Court will delay policy measures in those areas. Recent analyses indicating a hung Parliament in 2014 weigh on investors. While tail risks remain, the fear of imminent sovereign downgrades has been mitigated as Moody’s and S&P affirmed their ratings on India in August.

What investors want is for India’s growth not to fall below 4% levels. The government seems to have understood that piecemeal measures will not work, and that growth is crucial. Constrained on the fiscal side, and knowing that the private sector will stay away till after elections, public sector enterprises with cash-rich balance sheets are being instructed to take the lead in stimulating the economy. According to the economic affairs secretary, Arvind Mayaram, the finance ministry is monitoring investments by PSU firms on a monthly basis. The government is working overtime to grant clearance to stalled projects and redress the problems plaguing many ongoing private sector projects. In desperate attempts at attracting FDI, the government has increased limits and liberalised FDI across sectors and reduced red-tapism by moving several sectors to the automatic route.
What we have at present is a stalled economy, weak currency, a large array of economic reforms, a government desperately issuing clearances and approvals, and a pro-growth governor taking the helm at RBI. The largest problem facing the Indian economy is a lack of confidence—from both, domestic and international investors and corporates. The present prices largely reflect these negative sentiments and the data surrounding the Indian economy.

Come FY15, we will see investor confidence return as a new government takes charge at the Centre and policymaking becomes more decisive, and unconstrained by electoral objectives. The government will take office with a liberal FDI regime, a lot of project backlog cleared, investments being stimulated by PSU, and reduced pressure to divert revenues to social schemes. While it is not a clear case for either the Congress or the BJP, it is clear that we will not have a third-front forming the government.

The formation of a stable government will be the trigger to the beginning of a new bull run in Indian equities. Equities will remain volatile in over the next two quarters reflecting the fluctuating sentiments of market participants due to global and domestic factors. Indeed, we may see a further from these levels in the Nifty index. However, this period of pessimism should be used as an opportunity to accumulate good quality Indian stocks selling at distress valuations. To quote Warren Buffet, “be fearful when others are greedy, and greedy when others are fearful.” India is in the process of bottoming out.

The author is managing director, Bullero Capital, a Sebi-registered portfolio manager


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