Indian equity markets have surprised everyone with their performance in 2012. At the beginning of the year Indian equities were universally disliked, investors were tired and disillusioned after a horrendous 2011, and no one had any faith or confidence in the country. Positioning was also very one-sided, with almost everyone underweight on India. Yet the markets wrong-footed everyone and delivered a return of over 26 per cent (in dollar terms). The mid-cap indices were up over 30 per cent. India delivered the second-best return among the larger, more recognised equity markets, beaten only by Turkey.
The strong rally in the beginning of 2012 faded as the year progressed, until we had the change of guard at the finance ministry. The new finance minister has managed to enthuse markets and rebuild investor confidence. He has convinced participants that governance is back on the agenda and that he understands why growth has slowed and how to revive it.
P Chidambaram is clearly very market savvy and knows exactly what the markets want to hear. He has created enough buzz that investors are willing to be pre-emptive and bet on an economic recovery, looking through the ongoing economic slowdown. The finance minister has delivered just enough reform to keep his promises credible, and investors are willing to give him and India the benefit of the doubt. The rally has obviously been helped by the unprecedented monetary accommodation being undertaken by all central banks globally, with all risk assets doing well. However, there is a clear change in mood towards India; foreign investors are now willing to be pre-emptive. They are prepared to bet on reforms, economic revival, and a market rally, as opposed to the attitude of “show me before I believe” prior to Mr Chidambaram.
The ground reality in India, however, remains dire. Most companies that we speak to are actually talking about a further deterioration in performance. There is no pickup in the investment cycle, nor are any projects coming to banks for sanction — even existing signed projects are being shelved, such as the GMR Kishangarh-Udaipur-Ahmedabad highway. The idea that the environment ministry and the National Highways Authority of India will litigate in the Supreme Court hardly inspires confidence in inter-ministerial co-ordination. Most companies report a stretching of payment cycles and money being stuck in working capital. Despite the rupee’s depreciation and the improved competitiveness it brings corporate India, exporters are seeing no real pickup owing to subdued global trading conditions. Even consumption has started to show cracks. When an institution of the standing of State Bank of India reports that approximately 25 per cent of its SME (small and medium enterprises) loan book is impaired, there can be no further debate on the state of the real economy.
However, at turning points it is always like this. The markets keep going up, ignoring the bad news building in an economic recovery. Non-believers in a recovery will scratch their heads, as PE multiples expand in cyclical, more economically sensitive sectors, and the market prices in earnings upgrades. The markets should consolidate here for a while as the bulls and bears fight it out. Is there a recovery around the corner, as the foreigners seem to be pricing in? Or is the continued selling by locals – the non-believers, so to speak – the correct course of action? By selling $10.5 billion in 2012 (when foreigners bought $25 billion), domestic investors clearly do not believe in any imminent economic pickup or serious reform. Their selling has only accelerated in the first two weeks of 2013.
The finance minister has managed to get investors to look beyond the current valley in corporate and broad economy performance and, instead, focus on the future and the unlimited potential of India. He has delivered just enough reform to be credible, but needs to deliver much more if this growth gamble has to pay off. He is, clearly, making a bet on market reflexivity, hoping that strong financial markets and access to capital will by themselves improve the fundamentals enough to kick-start the economy. This may work, since improving markets and access to equity will improve confidence, allow companies with impaired balance sheets to recapitalise, and make many stuck projects and groups bankable. Once entrepreneurs are able to de-leverage, they may regain their animal spirits and confidence. Strong capital markets may kick-start a virtuous circle of growth for the economy. Though it is true that, given the current mess (in infrastructure especially), rising markets will genuinely improve the fundamentals of many companies, it is a risky gamble. Without more fundamental reform, entrepreneurs may still baulk at investing, given the pain they have been through in the recent past. And unless the investment cycle resumes, a sustained economic upswing is unlikely.
So what choice does the finance minister have? It is unlikely that he can deliver the type of basic branch-and-root reform that is required. The difficulty of doing business lies at the heart of the investment slowdown. Can he wean the Congress off populism? Can he deliver a working goods and services tax? Can he make India a place where projects can actually be implemented, and declog access to factors of production ? I am not even getting into the areas of rule of law, administrative reform, civil society and so on.
The finance minister has pushed through some quick fixes; he has done some tinkering with subsidies and foreign direct investment; and, hopefully, he will be reasonable when it comes to some of the tax-related controversies. The fact that someone credible is in charge and is taking decisions has rebuilt investor confidence – at least globally – and given the economy some time. He must be hoping his talking up the markets will allow the economy to regain some momentum and give him space till the 2014 elections. It is only after the elections that the more serious and structural reform can be attempted.
India may do well again in 2013. Global risk appetite is high, interest rates in India will trend down, corporate earnings will accelerate, valuations are at long-term averages, and investors tend to chase price momentum. In a zero-interest rate world, investors are hungry for any growth asset. Economic growth will accelerate in 2013, at least up to six to 6.5 per cent, given the steps taken and the improvement in financial conditions.
So while Indian markets may do well, this is at best a cyclical rally. Until we address some of the issues raised above, there will be no secular bull market. These issues – and whether they will be addressed or not – will have to wait for the 2014 elections.
India has enough low-hanging policy fruit, productivity catch-up and stock diversity to be one of the best-performing markets over the coming years. If we don’t seize the moment, the rising aspirations of the middle class will turn into frustration. Just as an aside, the government’s own statistics seem to indicate very limited organised sector job growth over the last five years — in dollar terms, the starting salary of an entry-level software engineer in Infosys remains unchanged since 2007. Statistics like these highlight the growing anger and disenchantment among the young and educated.
The writer is fund manager and CEO of Amansa Capital
