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Takeaway: As recently signaled by our quantitative factoring, the fundamental outlook for Indian equities just became far more convoluted.

SUMMARY CONCLUSIONS:

  • We think the RBI’s outlook for “limited headroom” to ease monetary policy from here will be proven incorrect over the intermediate term. Our call for further strength in the USD should continue to perpetuate broad-based commodity deflation, which should continue to lead India’s benchmark WPI inflation statistics lower and help reduce both the current account deficit (about 80% of which is attributable to gold imports, per the latest RBI estimates) and the fiscal deficit (subsidies account for 13.9% of the FY14 budget, which itself relies on a ~200bps acceleration in real GDP growth to fund a projected +21.2% increase in tax and fee receipts).
  • Additionally, we think the country’s 2Q13-3Q13 GIP outlook should insulate further downside in Indian equities (i.e. the SENSEX should hold TAIL support, which is -1.8% lower from last price), as the correction we have been calling for since JAN may now be largely in the rear-view mirror. Moreover, we think expectations on the reform front are pretty subdued ahead of the 2014 general elections, fostering risk of an upside surprise(s).  
  • As such, we now feel comfortable with holding a bullish fundamental bias on Indian equities w/ respect to the intermediate-term TREND duration. A TAIL line breakdown would obviously negate that bias, however, and put our Indian tail risk scenario (BOP crisis) squarely in play. For a deeper discussion of these risks, please refer to our 2/28 note titled, “IS INDIAN TAIL RISK OFFICIALLY “ON”?”.

Today, the RBI cut its Benchmark Policy Rates -25bps, as predicted by 30 of 35 analysts in a Bloomberg survey (Repo now at 7.5% from 7.75% prior; Reverse Repo now at 6.5% from 6.75% prior; and the Cash Reserve Ratio was left at 4%). In the accompanying statement, the board professed that “even as the policy stance emphasizes addressing the growth risks, the headroom for further monetary easing remains quite limited”.

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The lack of headroom Subbarao & Co. are referring to stems from the country’s twin deficits on the current account and fiscal balance fronts, which are both in the area code of ~5% of Indian GDP. Both contribute to a gross savings-investment imbalance that leaves behind a hole(s) that ultimately needs to be filled with int’l capital – capital that may not always be there at the margins (particularly if the USD is in the early innings of a mid-to-late 90s style rip higher).

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The latest estimate from Finance Minster Chidambaram is that India may need more than $75 billion of incremental foreign capital this year and next to fund the current account deficit. As such, Chidambaram continues to push for structural reforms that are specifically designed to perpetuate foreign inflows; in a MAR 15 interview he said that India is reviewing foreign-direct investment caps and may scrap or relax many of the existing capital controls. That would be in addition to liberalizing foreign investment in the country’s pension and insurance industries to promote further inflows of capital.

As an aside, we think the RBI’s outlook for “limited headroom” to ease monetary policy from here will be proven incorrect over the intermediate term.

Our call for further strength in the USD should continue to perpetuate broad-based commodity deflation, which should continue to lead India’s benchmark WPI inflation statistics lower and help reduce both the current account deficit (about 80% of which is attributable to gold imports, per the latest RBI estimates) and the fiscal deficit (subsidies account for 13.9% of the FY14 budget, which itself relies on a ~200bps acceleration in real GDP growth to fund a projected +21.2% increase in tax and fee receipts).

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Moreover, slowing core inflation (at a ~3Y low) should also keep the RBI’s policy bias squarely in dovish territory – especially with the threat of higher real interest rates posing risks to India’s cyclical growth outlook.

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Jumping ship, Chidambaram will continue to have his work cut out for him on the reform front, as his Congress Party’s largest partner in the ruling coalition defected today. The Dravida Munnetra Kazhagam Party (DMK), with 18 seats in the 545-member Lower House, was previously one of the nine partners in the ruling alliance; the party withdrew its backing after a dispute over the government’s approach to alleged war crimes in Sri Lanka, while also signaling a patch-up is possible if its demands are met.

With emerging Asia’s arguably largest amount of political consternation over the TTM, it’s tough to make a call on where Indian politics are headed from here. Recall that the Congress Party-led administration infamously lost its majority in parliament last year when its then-largest ally, the Trinamool Party, formally defected over the government’s decision to allow FDI in supermarkets and multi-brand retail.

All that being said, however, we think the country’s 2Q13-3Q13 GIP outlook should insulate further downside in Indian equities (i.e. the SENSEX should hold TAIL support, which is -1.8% lower from last price), as the correction we have been calling for since JAN may now be largely in the rear-view mirror. Moreover, we think expectations on the reform front are pretty subdued ahead of the 2014 general elections, fostering risk of an upside surprise(s).  

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As such, we now feel comfortable with holding a bullish fundamental bias on Indian equities w/ respect to the intermediate-term TREND duration. A TAIL line breakdown would obviously negate that bias, however, and put our Indian tail risk scenario (BOP crisis) squarely in play. For a deeper discussion of these risks, please refer to our 2/28 note titled, “IS INDIAN TAIL RISK OFFICIALLY “ON”?”.

Darius Dale

Senior Analyst