Upgrade Indian Equities to an Overweight as Pace of Reforms Quickens

Soaring investor confidence in the quality, direction and speed of the economic, political and regulatory reforms promulgated so far by India’s ruling Bharatiya Janata Party (BJP) under the leadership of Prime Minister Modi should remain evident in a consolidation of the nation’s stock market and currency performance in the months ahead as New Delhi gradually adopts additional measures for liberalizing the Indian economy.  Having rewarded both domestic and overseas investors substantially (28.9 percent) year-to-date, the S&P BSE Sensex index ranks fourth behind Argentina, Dubai and Qatar among top equity market performers in 2014.

The Indian rupee, meanwhile, is distinguished by the fact that it has been just one among five currencies to have appreciated vis-a-vis the US dollar, albeit only fractionally (0.7 percent), thus far this year.  In light of the improving climate for business in the world’s second most populated country, we expect the regime to bring forward more reforms in the near future – encouraging Global Markets Intelligence (GMI) to restore Indian equities to an overweight.

Although the progression of India’s liberalization agenda has by no means been as swift or fulfilling as that of Mexico’s, the policy changes, which have already been announced, are remarkable nonetheless.  An executive order to hasten project approvals that were backlogged in New Delhi’s bureaucracy facilitated the issuance of licenses that brought 175 stalled infrastructure projects on stream, surmounting a major restraint on business fixed investment.  In addition to accelerating licensing procedures, Modi’s regime has eased some restrictions on foreign direct investment by increasing the quota that outside firms may invest in the nation’s industry.

Most recently, in the aftermath of the BJP’s two state election victories in Maharashtra and Haryana, the government ended subsidies and effectively decontrolled prices of diesel fuel, a clever and timely decision in view of the steep slide in petroleum costs.  Subsequently, New Delhi announced it may end the public sector’s monopoly of coal production and its intention to launch a scheme for injecting flexibility into the labor market by streamlining complex labor regulations.

The macroeconomic prognosis too bodes well for India.  A strengthening of real GDP growth during the second quarter of the year spells an improvement from the prior quarter owing chiefly to a much-needed seven percent turnaround in fixed capital formation.  Going forward, we foresee some further modest acceleration in inflation-adjusted economic activity this year before an anticipated advancement of liberalization and deregulation in the coming year bears more fruit for the economy, possibly elevating growth to as high as 6.5 or 7.0 percent by year-end conditional on the efficacy and timing of the reforms.  Fiscal policy, considering the regime’s budget-deficit targets for this year and next, will likely remain a hindrance rather than an impetus to the recovery in the national economy.  Meantime, the decelerating tendency in wholesale price inflation, aided by a relatively firm rupee, is starting to appear at the consumer level, which – along with expanding employment as a result of rising capital spending – will boost the real incomes of households and promote increased private consumption of goods and services as the Reserve Bank of India (RBI) ponders when to ease credit once price pressures approach the six percent objective.

From an absolute valuation perspective, the BSE stock exchange’s positive-adjusted, one-year forward price-earnings multiple (p/e) of 17.0x in Indian rupee terms is comparatively expensive when measured against that of China (9.4x), Hong Kong (11.0x), Taiwan (13.9x), Singapore (14.2x), Thailand (15.1x) and Indonesia (16.1x), but inexpensive vis-à-vis Philippine’s 19.9x forward multiple and on par versus Japan and Malaysia (16.9x apiece).  Moreover, while it understates its record high of (38.4x), it is firmly above its all-time low (7.5x) and surpasses its historical average (16.7x).  Lastly, compared with its overall bellwether – the MSCI Emerging Asia index, the S&P BSE Sensex seems 0.30 point overvalued on a relative basis, which generally would not favor a multiple expansion were it not for an encouraging economic outlook and well-aligned policy objectives of the Indian government and the RBI.

So, in GMI’s opinion, the case for upgrading Indian equities compositely to an overweight is unequivocal.  With the government tending to favor an intensification of its reform drive over time, the primary beneficiaries will be the country’s economy, businesses and households.  Rising investment in infrastructure projects will create jobs and lift nominal wages, the real component of which should also trend upward because of ebbing inflation.  Stronger income and capital growth, in spite of fiscal and monetary tightness, could generate an expansion in the overall economy of as much as seven percent in 2015.

Needless to say, risk-fervent investors should be prepared to diversify their exposures across a number of sectors in the Sensex, including industrials, materials, energy, utilities, telecommunications and health care – all of which would appear to offer the most unexploited opportunities as potential long-term investment exposures provided, of course, that the reform process remains on course without interruption and its evolution continues to record steady progress.

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