India (EPI) Is Up +31% YTD vs. Only +8.7% For the SPY… For the Right Reasons
As you are probably well aware, we LOVE Indian equities. Per our July 7th note titled, #WINNING: INDIA’S STRUCTURAL GIP IMPROVEMENT CONTINUES:
“In five years of writing research notes on India’s budget, this is the first one that has a takeaway that isn’t extremely negative; in fact, it’s overwhelmingly positive. India’s new “management team” is flat-out killing it. We’ve said this before and we’ll say it again: if we could LBO entire countries, India would be our primary acquisition target!”
It should be noted that we turned bullish on India a full five months before we turned broadly positive on emerging markets (after having authored the bearish thesis in early 2013) because we were fortunate enough to anticipate India would begin to showcase the two things that’d make us bullish on any economy:
- Implement sustainable monetary and fiscal policy, which, on balance, tends to be pro-growth and anti-inflation;
- Introduce investor-friendly regulations, at the margins, effectively promoting free(r) markets in the process.
In the prose below, we highlight the key initiatives Indian policymakers have introduced recently that are in support of the aforementioned catalysts.
Secular Tailwind: Sustainable Monetary & Fiscal Policy
The seed for our bullish bias on Indian equities was planted back in September of last year when new RBI Governor Raghuram Rajan hiked interest rates. Since then, the RBI has hiked its benchmark repo and reverse repo rates a cumulative +50bps, which has aided a +10.8% recovery in the Indian rupee off its all-time low of 68.82 per USD.
In addition to hiking rates, “Dr. Raj” has introduced a number of supportive measures on the guidance and regulatory front that have been profoundly helpful in assuring international investors of the safety and sustainability of Indian financial assets:
- Prioritizing Inflation Over Growth: Throughout his tenure as central bank governor, Dr. Rajan has resisted calls from investors and economists to help support Indian growth via dovish monetary policy, instead opting to aid growth the old-fashioned way – i.e. through quashing inflation. In his latest guidance, Dr. Rajan remarked, “Inflation is coming down and this is consistent with our forecast and I am glad. Macro indicators are improving but still have some way to go before we can declare we are out of the woods and claim victory on inflation, and that is only a matter time… The RBI in no way will hold rates high any longer than necessary... Growth will be most benefited if we disinflate the economy and we don’t have to fight this fight again. Let’s fight the anti-inflation fight once and let’s win. That will create the best conditions for sustainable growth.”
- Growing FX Reserves; Tightening the Current Account Deficit: Since bottoming in August of 2013, India’s FX reserves have increased +15.5% to $317B as of the week ended September 5th; as a ratio to imports, India’s reserve coverage has ticked up nearly two full points since then to 7.7x . Moreover, India’s current account deficit has tightened from -5.4% of GDP in 2Q13 to -1.9% as of the latest reading (1Q14) on the heels of the RBI’s gold import restrictions. Both are incredibly positive for India in the since that it significantly de-risks the Indian rupee in the eyes of an international investment community that is [inappropriately] focused on the timing of a rate-hike cycle in the US.
- Cleaning Up Bad Debt: With nonperforming loans officially running at 4% of total assets (versus ~1% for China and ~0.9% for South Korea), the RBI is appropriately incentivizing Indian lenders to clean up their balance sheets in order to make headway for additional loan growth to support an economic recovery in the coming quarters. Per CARE Ratings Ltd., a sample of 39 financial institutions including State Bank of India and ICICI Bank have sold 100B INR ($1.6B) of non-performing assets in the fiscal year ending March 2014.
Not surprisingly, consensus expectations for Indian inflation have been steadily falling over the past few months amid such policies:
Secular Tailwind: Investor-Friendly Regulations
Not to be outdone, recently elected Prime Minister Narendra Modi has been busy working deals and cutting red tape in an effort to make good on his plan to hit $1T in investment by 2017. Such efforts have helped perpetuate a record $18.7B inflow into Indian bonds this year, after an unprecedented $8B outflow in 2013.
The latest news on this front comes in the form of $53B in loans and investment pledges from China and Japan this month. Specifically, Chinese Premier Xi Jinping has just pledged $20B in investment over the next five years to help India narrow its largest trade deficit with any single country ($34.4B on imports of Chinese heavy machinery, telecom equipment and durable goods alone as of 2013). Japanese prime minister Shinzo Abe also promised $33B in loans and investment earlier this month – investments that are sure to be part of the GPIF asset allocation overhaul, which is coming down the pike in Japan.
Securing pledges for investment is one thing; actually putting the money to work has been and continues to be a decidedly different activity in India given the country’s well-documented issues with bloated bureaucracy and corruption.
For example, former Prime Minister Monmohan Singh actually had to form a committee in June of last year to help unclog 463 blocked investments totaling some 22T INR ($362B). Since then, the committee – officially dubbed the Project Monitoring Group – has approved up 176 investments worth 6.5T INR, but only 60 of those have actually begun construction, effectively highlighting India’s ongoing struggle with bureaucracy.
Corruption is not exactly a non-issue either. Per the World Economic Forum’s 2013-14 Global Competitiveness Report, “inefficient government bureaucracy” and “corruption” are the #2 and #3 most frequently cited responses in response to the “most problematic factors for doing business” prompt at 17.5% and 17.3%, respectively:
Not surprisingly, India ranks rather poorly in key fixed investment-related categories such as (rank of 148 economies):
- Diversion of public funds (98th)
- Public trust in politicians (115th)
- Irregular payments and bribes (110th)
- Burden of government regulations (104th)
- Quality of overall infrastructure (85th)
- Quality of electricity supply (111th)
- Total tax rate, % of profits (128th)
- Number of procedures to start of business (129th)
In light of this, we are extremely encouraged to see Prime Minster Modi aggressively seek to cut red tape and promote foreign investment. Under his stewardship, the Project Monitoring Group has accelerated its efforts to unclog India’s investment pipeline. Per PMG head Anil Swarup:
“The pace at which things are happening is faster than what we saw in the past. In the previous government, our job was just to see that the clearances would happen and we would assume that it was translating to work on the ground. The present government has asked us to do the leg-work and make sure that it is.”
While just a start, efforts like this are in line with his decision to raise foreign investment caps on defense and railways and we’re excited to see that Modi is living up to his reputation as a pro-business, pro-growth leader during the early days of his administration. Moreover, we anticipate that such deregulatory efforts are likely to continue.
Not surprisingly, consensus expectations for Indian growth have been steadily trending higher over the past few months amid such policies:
India Has Cyclical Tailwinds As Well
Generally speaking in emerging market investing, “reform” is a buzzword that perpetuates capital inflows, which is exactly what we’ve seen in India over the past year or so. Specifically, outstanding foreign investment in Indian equities has increased +9.7% in the YTD to $160B, while outstanding foreign investment in Indian debt capital markets has increased +10% in the YTD to $44.4B.
With the tailwind of “reform” remaining at our backs, we are excited to notify you that the Indian economy is likely headed into Quad #1 on our GIP model in the coming quarter. Easy growth compares, difficult CPI compares and annualized currency strength all contribute to this forecast.
This would be a inflection from the 3rd quarter slowdown we called for back in May when we booked what effectively equates to a sizeable gain (we don’t run money) in the WisdomTree India Earnings Fund (EPI) ETF: +21.6% vs. a +4.6% gain for the MSCI All-Country World Index. Since then, Indian growth has taken a hit:
- Both Industrial Production and Manufacturing Production are slowing sequentially and negatively diverging from their respective trailing 3M, 6M and 12M trends.
- Commercial Credit growth is slowing sequentially and negatively diverging from its trailing 3M trend.
- FDI is negatively diverging from its trailing 3M trend.
- India’s Composite PMI is slowing sequentially and negatively diverging from its trailing 3M trend.
- Both Exports and Imports are slowing sequentially and negatively diverging from their respective trailing 3M trends.
Investment Conclusion: Remain Overweight Indian Equities
Please note that we rotated back into India on June 3rd, post the election consternation (or lack thereof); the EPI has appreciated +2.6% since then, besting the MSCI All-Country World Index’s +1.1% advance by 150bps.
All told, Indian officials continue to enact policies that are structurally positive for the country’s GIP fundamentals. In the context of these secular tailwinds and cyclical ones as well, we think India (EPI) will continue to deliver investors a positive absolute return over the intermediate-to-long term.
Indeed, the EPI poised to finally break out of the $22-$23.50 trading range it has traversed since June amid the aforementioned slowdown in economic growth.
India remains our favorite way to play the long side of EM equity exposure – an asset class that both our Tactical Asset Class Rotation Model (TACRM) and global GIP fundamental analysis is signaling as having legs to the upside.
Have yourself a fantastic weekend and Go Seahawks!
Associate: Macro Team