The Indian markets now seem to have cracked, delivering the worst performance in Asia (year to date). The markets are now hovering around 4,500 (Nifty) and are in danger of breaking the January lows. In dollar terms, the markets are down nearly 35 per cent, and that too all in a matter of six months. As is to be expected, the prophets of doom and gloom are out in full force, with the bears talking of sub-4,000 levels on the Nifty. One has also seen a series of articles questioning the long-term India economic story itself. Foreigners seem to be selling in droves.
But first, how did we get here?
There was clearly some hysteria and overconfidence in the markets and among companies in January 2008. We could clearly see signs of excess in terms of valuations, IPO pricing and fund flows. But what should have been a normal 10-15% correction has turned into a full-scale rout as the macro for India has worsened by far more than anyone could have imagined. Nobody predicted oil surging past $125, and at these levels the damage to India's current account (breaking 3-3.5%) and fiscal (consolidated deficit beyond 9%) is considerable. Inflation has also raised its ugly head, leaving no wiggle room on interest rates for the authorities to fight a growth slowdown.
The macro worries have been compounded by an election-oriented government, which does not have the political space to implement reforms or cut subsidies. Thus, we have seen a Rs 70,000 crore loan waiver and the Sixth Pay Commission recommendations being implemented at the same time as food, fertiliser and oil subsidies have risen to unprecedented levels. We are seeing the build-up of a potential fiscal time-bomb, despite having gone through five years of unprecedented tax buoyancy. All the hard fought fiscal gains seem to be at risk of being frittered away, and interest rates may blow out.
India has gone from having one of the best macro stories, to one of the worst. As is typical, investors have suddenly woken up to the fact that we are one of the few large markets to run large twin deficits (fiscal and current account), and need financial flows to sustain. The reversal in the rupee, where in October 2007, the RBI stopped P-notes to stem capital inflows till today, where the currency has dropped by over 10% in a couple of months, has only heightened investor anxiety on the macro. We are one of the worst impacted by high oil prices, and most now believe in oil having entered a new price zone.
The government's willingness to sacrifice growth to stem inflation, and its penchant to interfere in micro industry level pricing and profitability decisions have also dented investor perception towards the country and the willingness to pay for seemingly unpredictable earnings.
Even on the micro company level, we have seen signs of margin pressure and difficulties in meeting growth expectations and scaling up challenges.
However, is everything as bad as it looks today?
The fact is that even in a year like 2008, the economy should still be able to grow at 7-7.5 per cent, and corporate earnings are likely to see 10-15 per cent growth, in a relative sense still outstanding performance. Most of the world will have zero growth and negative earnings.
All the secular drivers of growth, viz. demographics, rising savings/investment rates and the entrepreneurship of corporate India remain in place. These are long-term secular forces which do not reverse on a dime. Even the fiscal hole being created will ultimately hit a crisis point and force fundamental policy action, in a typical Indian way. Serious investments are taking place in the economy, be it in infrastructure, education or industrial capacity and the fruits of this still lie ahead. Indian companies continue gaining global share and relevance. A growth slowdown for a year will also give breathing space to the economy and corporates to put their house in order after five years of helter skelter growth.
Also at these market levels, the valuations no longer look outlandish. We are probably trading at about 15 times March 2009 earnings, not absurd for 20% RoEs and a 15-20% long term earnings trajectory. At 8-9% long bond yields these multiples could drop to 12.5-13.5 times, but are unlikely to go sustainably lower. Which means either 6-9 months of sideways movement as the market grows into its earnings and looks towards March 2010, or another 10 per cent down from here.
The big move down in India has already happened, this is not the time to now question (as investors inevitably will) whether India can grow at 7.5-8 per cent on a trend basis or whether Indian companies can grow earnings at 15-20 per cent. I think the answer is a resounding yes on both counts.
Current government inaction does not mean that we will permanently have a political construct wherein no hard economic decisions are taken.
To sell now (independent of a short-term trade), one has to believe that the macro will truly fall apart and we will fall into a negative spiral of rising rates, falling rupee and negative earnings. Given the reserves at our disposal, continued flows on the invisibles account and the strong underlying growth dynamic, the odds of this happening remain low.
India remains an exciting growth story; it was probably never as good as the bulls made it out to be in January 2008, but neither is the story over. The last five years are not some cyclical aberration (8.5 per cent GDP growth); we have made a break from the growth rates of the past. The country is now a trillion dollar economy and is firmly on the global map for investors and corporates alike, and will not fade away. It is highly unlikely that we can just disappear off the radar of investors as we did in the decade of 1994-2003.
The economy has serious macro headwind, but the odds remain in favour of us being able to grow through these issues, independent of commodity prices themselves normalising. We now have to live through 6-9 months of pain, partly brought on by an ineffective political construct, partly by unprecedented surges in commodities and finally by investor exuberance. This is a good time to build a portfolio, as the market will throw up many opportunities. Use the time wisely and patiently, as you will get rewarded disproportionately when things turn, as they inevitably will.
