It looks like investors’ love affair with India has hit a rough patch. Since early last year, the big Asian country bet on everyone’s lips has been the sub-continent.
There were good reasons for the exuberance: a new government led by Narendra Modi, who has a track record of implementing economic reforms as chief minister of the state of Gujarat, and a central bank led by an economist with international credibility, Raghuram Rajan. But just over a year into the new regime, high spirits have been replaced by more sober expectations.
One reason for that is the new government has been slow to implement reforms. Meanwhile, old headaches, namely difficult weather and inflation, are resurfacing.
India’s meteorological department has predicted a second year of weak rainfall, which is bad news for a country where more than half the population depends on agriculture.
Poor farm output usually has a domino effect on the rest of the economy; one of the most visible signs is spiking food prices, a major driver of consumer inflation in the recent past.
Fears of a weak monsoon come at a particularly bad moment, just as concerns grow about the timing of a US Federal Reserve rate hike.
To add to the glum news, the economy hasn’t significantly picked up from its multi-year growth slump, and the most recent earnings season has disappointed.
These combined factors have two major implications: one is that the central bank may be heading for a pause in its rate-cutting cycle. Governor Rajan has cut the benchmark repo rate three times this year, and it seems unlikely he can continue with the threat of inflation rising in the background.
Adrian Lim, senior investment manager on the Asian equities team at Aberdeen Asset Management, says: ‘With conflicting data suggesting an economic recovery that is less than robust, governor Rajan is “front loading” rate cuts in case developments later this year make further reductions more difficult.’
In the absence of rate cuts, the burden of boosting the economy will fall primarily on the government. As Lim says: ‘Companies are still waiting for concrete evidence of Modi delivering on reform pledges and corporates are holding back on investments, especially in key areas such as infrastructure development.’
Of course, some experts say expectations for what India’s new government could achieve in a year were overestimated.
Meanwhile, a new tax demand from the government – the minimum alternative tax (MAT) – has also upset foreign investors. According to reports, the tax department has sent claims to more than 50 international funds demanding close to $100 million (€88 million) for profits generated in the past. That has shocked many investors, who were expecting a more business and investor-friendly regime under Modi.
The noisy discontent that followed has forced the government to go slow on MAT, but it continues to cast a shadow on the stock and bond markets’ prospects in the near term.
Concerns about the monsoon and the MAT come after fund selectors at Citywire’s investor forum held in Singapore earlier this year voted India the country they were most positive about in Asia this year. This was while China’s slowdown was expected to pose the biggest headwind for growth in the region.
Citywire A-rated Vanessa Donegan, Threadneedle’s head of Asian equity, echoed this sentiment in a recent comment: ‘All the stars are aligned for a significant improvement in Indian economic growth, which we believe will exceed China’s between 2016 and 2017.’
Stock markets have certainly bought into this story, and have galloped far ahead of reality. However, investors are starting to wonder if their investments still remain attractive, especially as earnings growth hasn’t picked up the pace yet.
In fact, Krishna Kumar, director of Eastspring Investments, says there is scope for further downgrades to 2016 (April-March) earnings estimates. ‘We expect economic activity to revive in a meaningful way only in calendar year 2016 and earnings may witness a revival then.’
Lim says, even with the recent sell-off, Indian stocks are trading at levels that are hard to justify unless prices are supported by improvements in corporate earnings. ‘That said, we still see value in this market and we have been trimming existing holdings, taking advantage of recent price gains, to build up stakes in other companies.’
Goldman Sachs Asset Management’s CIO of EM equity, Prashant Khemka, however, is one of the more optimistic investors. He estimates Indian equities are trading at a P/E ratio of 16.3 – not far off the historical average of 15.5.
‘Valuations may ultimately prove quite attractive if this is indeed the early stage of a multi-year earnings growth cycle,’ the Citywire AAA-rated manager says.
For now, that remains the big question. India is clearly a long-term story, but do investors have the patience to wait? Only time will tell if this love affair holds a happy ending for investors.
This article originally appeared on the July/August issue of the Global magazine