I have been part of many discussions over the last week with prospective investors trying to figure out whether this is a good time to put money to work in India. Everyone is naturally cautious and worried about the drawdowns and mark-to-market pressures. Also, most markets in the world are in bear market territory (down 20 per cent from their recent peak). Thus, someone with capital to invest is spoilt for choice. On paper, India does not look particularly cheap. European and American markets are trading at 12 or 13 times their prospective earnings with bond yields nearly two per cent, while India is trading at 13 or 14 times with bond yields above eight per cent. India is also trading at a 25 to 30 per cent premium to the emerging market averages. So why come to India when the majority of global markets are far cheaper?
If one takes a 12-month view, then the following becomes clear:
(i) Interest rates in India are going to be lower than they are today. The Reserve Bank of India (RBI) has been the most aggressive central bank in the world in normalising rates. Our interest rates are within 50 basis points of where they were before the collapse of Lehman Brothers in September 2008. Given the leads and lags of monetary policy in curbing inflation, the clear economic slowdown we are entering both in India and globally, and the likelihood that commodity prices will stabilise if not go down, it would be very surprising if rates do not come down in the next 12 months. India has the ability to cut rates, and has already gone through an inflation spike. Most countries do not have this flexibility.
(ii) The global economic environment seems to be one in which the West will stumble around at near recession levels of between 1 and 1.5 per cent gross domestic product (GDP) growth. Liquidity will remain very easy and interest rates are going to remain near zero for at least 24 months. With global interest rates at zero, capital will flow into the emerging market asset class in search of growth, returns and to move away from the exposure to the US dollar. I believe enough regulatory action will be taken to prevent this capital driving commodities parabolic.
(iii) India will probably grow at seven per cent, with the RBI itself mentioning 6.8 per cent (growth rate in the financial crisis) as being a disaster scenario and the absolute worst case. Our domestic-oriented, non-correlated growth will be far more attractive and get a lot more attention in a growth-starved world. Indian companies will be able to deliver 15 per cent earnings growth, which will stand out globally. As the capital spending cycle restarts (it will eventually have to unless the country comes to a halt), this will also jump-start earnings growth for the market. With a robust monsoon so far, consumption demand for the coming year is going to be strong, which will also underpin earnings.
(iv) Indian valuations, which are currently about 13 to 14 times March 2012 earnings, will be nearly 11 times March 2013 earnings. These valuation multiples are arrived at after cutting earnings estimates by five to eight per cent for FY 2012 and 10 per cent for FY 2013. While there may be some more earnings downgrades, investors have already built that into their calculations. Rarely does India stay at these levels of multiples for long. In a weak global growth environment, the growth visibility that India has will attract premium valuations. Mid-cap valuations in particular are starting to get very attractive. As these stocks have underperformed the broad market, investors are bailing out and want to have only large cap investments to reduce portfolio risk. There has also been significant sectoral dispersion. If one can take some short-term pain, valuations of companies with economic sensitivity are at very reasonable levels. Indian multiples are at a premium to the region, but arguably, so are the return ratios and growth visibility.
(v) The current policy paralysis and standstill in government decision making cannot go on. Either the government should take the initiative and start governing, or we will have some change. This fire-fighting approach to governance is not sustainable. India is one of the few countries that have the opportunity to undertake fundamental game-changing policy reforms. The goods and services tax Bill is one example. Government policy action can make a huge difference to structural growth and investor sentiment.
One was negative on markets at the beginning of the year, as valuations were high, earnings estimates were too optimistic, and interest rates were rising much higher and faster than the consensus. Over the next 12 months, interest rates will decline, with valuations getting far more interesting, and the global economic difficulties will highlight the value of India’s growth story. There are very few large markets that can deliver double-digit growth and earnings, independent of all but the most extreme global economic conditions. Combine this with the fact that retail participation in the markets is next to zero, all investor surveys show most professional investors underweigh India, and record outflows from emerging market equities. This market is not over-owned, especially not from a longer-term real money perspective.
We are going through a classic bout of risk aversion and investor fright, when risk is taken off the table indiscriminately. This will settle down and the fundamentals will then become relevant again.
So should one buy now? It really depends on the time frame and positioning. If one has a genuine longer-term view and underweight equities (as most Indians are), then we are close to a very interesting entry point. I am convinced that investments made slowly and systematically over the coming three to six months will deliver good capital gains over an 18 to 24 month time frame. If one has the ability to time markets or is very concerned about short-term mark-to-market pressures, then one can wait and be more opportunistic. There is the possibility of one more leg down in markets, as markets need to riot to force western policy makers to act decisively. We could have another five to ten per cent downside. However, to remain bearish from here, you have to believe that either this policy paralysis is the new normal for India or the Indian growth surge of the past decade is unsustainable. You would have to believe that India grew at 7.2 per cent over the last decade owing to global capital flows and a very benign global economic backdrop, both of which will now reverse and thus Indian growth will slip to five per cent.
I do not belong to this bearish camp and genuinely believe that the economy has enough momentum and the polity has the understanding of the consequences that such a downshift in growth will not happen. I also believe all the noise today will eventually lead to structurally better governance. This is a transition that we have to go through.
The author is fund manager and CEO of Amansa Capital
