Cross-currents affecting India
In the current emerging markets turmoil, India is seen as a safe haven
Global EM (emerging markets) are now officially in the bear market territory. The MSCI EM index is down 20 per cent from its January 25 peak. The EM currency index is down 16 per cent from its peak versus US dollar in mid-February and the Emerging Market Bond Index (EMBI) spread has widened 101 basis points since early February. EM assets remain in a tough spot. A strong dollar, weakening and less synchronised global trade/growth and rising yields all spell trouble. Chinese data also continue to soften, and the renminbi remains vulnerable. While we have started to see a greater easing in China, it remains very unlikely that we will see any substantial (2008-like) stimulus programme which could bail out commodity markets and other emerging market countries.
Valuations have corrected along with prices and EM equities now trade approximately at a 10 per cent discount compared to their normal relative level to developed markets. They also offer about 25 basis points of higher dividend yield.
However, despite the weakness in the asset class, we have not seen capitulation yet. Flows into EM have been largely stable. In all regions except Europe, the Middle East and Africa (EMEA), year to date flows are still positive. Emerging Asia, in particular, has seen very limited selling. Even on a 12-month trailing basis, flows into EM are still strongly positive. Given prior periods of EM stress and the type of outflows associated with those periods, what we have seen till date is quite benign, despite 20 per cent sell-off in prices.
Within EM, India is the best performing large market and the only one still in the positive territory in dollar terms. This is a very counterintuitive outcome, as there was absolutely no one who had predicted that India would be one of the best-performing markets in EM in 2018.
Of course, it is true that the indices in India are being propped up by a handful of stocks, and below the surface, if you look at the midcaps, the indices are down almost 20 per cent in dollar terms. However, the stocks propping up the indices are also the ones which have large foreign ownership, and the maximum impact on FII portfolios. So from a global investor perspective, the gains are real.
Why has India surprised most capital allocators, and held up far better than other large emerging markets?
One obvious reason is that India is less exposed to global growth and trade than most of its peers. The trade wars, tariffs and a moving away from the most synchronised and robust global growth environment of the last few decades have hurt India far less. India has not been as much a beneficiary of globalisation as north Asia and any sign of a slowing or reversal of globalisation affects it less.
India is largely a domestic demand story. In 2017, north Asia and other more globalised economies outperformed as they took full benefit of strong and synchronised global growth. India had almost no incremental growth delta from the strong global economy. These same characteristics of limited global exposure have now moved from being a handicap to a strength as the global economy has started to slow and trade wars take centre stage. India is, in fact, the only large EM economy in which economic growth is actually accelerating in the calendar year 2018.
India is also not a play on robust global commodity prices, unlike many other EM countries. As emerging markets have weakened, so have commodity prices. Copper, for example, is down nearly 20 per cent. The weakness in commodity prices will hopefully extend to oil prices as well, which is an unambiguous positive for India.
Earnings in India have started to inflect. Q1 FY19 has seen earnings slightly ahead of expectations, ex of the banks and oil companies, it was 15 per cent EPS growth and 20 per cent sales growth. Hopefully, this is the beginning of a regression to the mean for corporate profitability.
The economy is clearly strengthening, with a strong pickup in rural demand, government spending on track and the initial signs of a private sector capital expenditure revival.
The macro in India also now seems stable, with the adjustments largely completed, the rupee has corrected, rates have already risen and inflation is stable. Given the volatility in other EM regions, India’s macro seems very benign.
In the current EM turmoil, India is seen as a safe haven. Many global investors have tempered their negativity on the country, and outflows have reduced.
The concerns around India rest first on valuations. Markets are not cheap, especially not the quality companies. One is having to pay up for the growth visibility. In almost every sector, India has companies trading at valuations which are the highest in the world.
The second concern has to rest on politics. As we get towards the end of the year, political uncertainty will ratchet up. Foreigners seem less concerned on politics than local investors. They do not see an alternative to the current regime. Domestic investors seem to have a more nuanced view, with a greater awareness that political risks are not trivial. There are concerns about domestic financial flows as well. These have reduced, but are still strong in absolute terms. Any reversal will pressure markets. Investors have been very mature to date, but increased volatility can spook retail flows. These monthly inflows have cushioned the markets to the downside.
India will to my mind continue to outperform the rest of EM, till such time as EM remains in a sell-offand-risk-averse mode. However, in terms of strong absolute performance, this seems unlikely. We all will have to accept lower returns for this year. India is not a bad place to be in 2018, just don’t be too greedy.