Conclusion: India screens flat-out awful on all of our fundamental and quantitative factors. As such, we remain bearish on Indian equities and the Indian rupee over the intermediate-term TREND.
Virtual Portfolio Position: Short Indian equities (INP).
From a quantitative perspective, Indian equities look awful. From a fundamental perspective, India’s economy looks just as dire. While neither point is new news to Hedgeye clients, we have taken advantage of the latest price action in Asia to hedge our long Chinese equities position with one of our least favorite international stories (equities, debt, and FX) for the better part of the past 14 months.
As a refresher, our updated views on India are as follows:
Growth: Indian real GDP growth continues to slow and looks to sink to bombed-out levels in 1Q12, where we’re modeling in a range of +6-6.5% YoY based on all the data and quantitative signals we currently have at our fingertips. Those estimates are subject to further downward revisions pending more 4Q high-frequency data.
Inflation: Inflation remains the largest headwind for the Indian economy and corrosive to the real returns of holders of Indian assets. Just like in late 2010, the Reserve Bank of India is again guiding consensus expectations to an intermediate-term inflation target that we don’t think they’ll achieve (+7% YoY by MAR from +9.1% in NOV). To that tune, while slowing, our models can’t get below +7.8% on YoY WPI over the intermediate term, as Indian inflation continues to be fueled by sticky energy costs, rather than slowing food and primary articles inflation. Further, Brent crude oil remains in a Bullish Formation amid heightened geopolitical risk. Net-net, the RBI will be forced to continue largely sitting on its hands as elevated inflation continues to narrow the scope of using monetary policy to support economic growth.
Policy: Speaking of policy, economic and political leadership in India remains among the worst (w/ Argentina and Russia), if not the worst, of any of the G20 economies. We’ve been all over their ineptitude over the past year (FEB ’11: India – Missing Where It Matters Most and MAY ’11: India’s Nasty Trifecta) and continue to see little in the way of positive momentum.
Subir Gokarn, deputy governor of the Reserve Bank of India, said last week that “the monetary cycle has peaked.” While not at all a surprise, we do think his additional commentary confirms our view that the RBI is in a box as it relates to monetary policy. More specifically, India’s growth/inflation dynamics prevent them from raising or lowering interest rates – a condition that is usually a leading indicator for “creative” central banking and misguided capital account policy changes in emerging markets:
“The RBI is very concerned about the impact of rupee depreciation on inflation… The central bank remains more comfortable using open-market operations to inject liquidity for now, because cutting the cash reserve ratio would send a premature signal that the monetary policy stance has changed.”
-Subir Gokarn, 1/5/12
To that tune, Indian banks are taking advantage of RBI liquidity at an accelerating rate in the face of ever-tighter interbank lending conditions, borrowing an average of $22 billion a day from the central bank in DEC (up from $17.5 billion in NOV). We remain the bears on the Indian rupee, which has fallen nearly -16% vs. the USD from its cycle peak in early AUG. We look for King Dollar’s breakout vs. the INR to keep an elevated floor under the dollar-denominated debt servicing costs of Indian corporations and their ability to refinance – dramatically eroding what little earnings growth is left on the table. Per the latest data, India’s corporate bond issuance dropped to 14-quarter low of 257 billion rupees in 4Q12 (through mid-DEC).
On the fiscal front, India’s widening federal budget deficit and resultant increase in sovereign debt supply continues to provide an overhang on Indian growth and the nation’s currency, as well as a floor under interest rates absent RBI intervention in the secondary market (the RBI has purchased just under 500 billion in sovereign debt since NOV). As Indian banks are forced to underwrite incremental sovereign debt supply amid a -97% miss in the FY11 state asset sales target of 400 billion rupees and a big miss in tax revenue stemming from a pollyannaish +9.25% FY11 growth target, interbank liquidity is eroded (see previous chart).
As a result of India’s Finance Ministry being way off on its economic growth assumptions, the country is all but assured of missing its 4.5% budget deficit target, contributing to a crowding out of private sector credit growth. That may ultimately spark a wave of defaults across the lower end of the country’s credit spectrum.
To that tune, the RBI released a report on 12/22 that forecasted India’s aggregate NPL ratio could climb +300bps to 5.8% by March 2013 in a “stressed macroeconomic scenario”. We’re not sure what they define as “stressed” but their history of underestimating the downside in growth and the upside in inflation suggests to me that their worst-case scenario may ultimately be closer to baseline when it is all said and done. With elevated mortgage rates (16.5%), slowing property sales (-20% YoY in Mumbai in NOV), and eroding earnings growth (-23% YoY in 3Q11), Indian property developers may pose a serious risk to the balance sheets of Indian financial institutions with 1.8 trillion rupees in debt coming due over the next 3yrs.
This dire scenario is being reflected in the 5yr CDS of the State Bank of India, which at 405bps wide, is challenging post-Lehman levels of stress.
Jumping ship to regulatory policy, India has recently hit rock-bottom in this regard. India’s lawmaking body passed just 22 laws in 2011 (the second-lowest since 1952) amid several notable corruption scandals that fueled political gridlock, a well-publicized renege on pro-growth retail market reform, and a monumental failure to pass Prime Minister Singh’s anti-corruption Lokpal bill at year’s-end.
Turning to what’s coming down the pike, India will have five regional elections next year, and reading through from the macroeconomic malaise, Singh’s Congress party stands to lose incremental support in parliament over the intermediate term, which may perpetuate gridlock. India’s inability to get it done on the regulatory front forces us to remain skeptical that they’ll be able successfully reform the country’s convoluted tax code – a key “win” needed to reign in the federal budget deficit. For example, India’s government revenue as a % of GDP is only 18%, which compares to 21%, 36%, and 37% in China, Brazil, and Russia, respectively. Moreover, India’s lawmaking ineptitude and de facto green light for corruption suggests to us that they’ll are likely to fail to capitalize on a planned $1 trillion in infrastructure spending over the next 5yrs. Time will ultimately tell here, but if their past behavior is any indication, India will have limited success in this regard.
All told, India screens flat-out awful on all of our fundamental and quantitative factors. As such, we remain bearish on Indian equities and the Indian rupee over the intermediate-term TREND.