Prospects for India are 'excellent' – but don't jump in just yet
Nov 20, 2009
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Indian shares have lagged behind Brazil, Russia and China in the last couple of months. That looks set to continue, says Kevin Grice of Capital Economics. Why? The economic outlook is good – GDP should grow at around 8% in 2010. Corporate earnings are also likely to recover. Revenues are bouncing back after three flat quarters, up 4.3% year-on-year, says Aditya Narain of Citigroup. And profits in the next few months will look good compared to the weak results from this time last year. However, "stretched valuations suggest all the good news is priced in", says Grice.
The main headwind is likely to be monetary policy. The Reserve Bank of India (RBI), the country's central bank, took "the market by surprise" when it raised the statutory liquidity ratio (the amount that banks must keep in easy-to-sell government bonds), at the end of October, say analysts at investment bank DBS Group.
This, and the hawkish tone of its latest statement, suggests interest rates will soon be going up in response to signs of a pick-up in inflation. "Our expectation remains for rate hikes to start in January... [and] the risk is growing for considerably more rate hikes in 2010 than are currently being priced in."
What's more, "the RBI statement betrayed considerable concern on asset price inflation". This may result in attempts to control inflows of foreign capital, which have played a significant part in boosting the Indian markets this year. "Foreign institutional investors, who greatly influence the direction and movement on Indian bourses... have purchased a net $14.5bn in equities this year, more than reversing their outflow of $12bn in 2008," says Deepak Lalwani of stockbrokers Astaire & Partners.
Still, if the near-term outlook argues for caution, the long-term prospects are excellent, says Philip Wyatt of UBS. "India's economy is likely to hit a growth sweet spot, driven by high savings rates, attractive demographics and rising industrialisation." GDP should grow at 8%-9% a year for an extended period. The need for significant improvements in power and transport infrastructure mean plenty of investment opportunities.
As GDP per head rises steadily towards $10,000 (in purchasing power parity terms, which adjusts for differences in the prices of goods and services between countries) from around $3,000 just now, "discretionary consumption spending should also take off". So Sensex earnings could grow at an average of 12% a year for the next 15-20 years. On a long-term p/e multiple of 15 times, the index could hit 100,000 by 2025, from 17,000 now.
The risks include bureaucracy, poor infrastructure and gaps in education. But these issues are gradually being dealt with.
"The larger potential risk is the state of India's balance sheet." The country has high public debt and a large budget deficit by emerging market standards, while the economy has seen rapid loan growth in recent years. "If there is one area where India could stumble, this is probably it."
Investors willing to take that risk could look at a tracker, such as the DB x-trackers S&P CNX Nifty (LSE: XNIF), or a fund such as Aberdeen's New India Investment Trust (LSE: NII).
But we wouldn't rush: the popular JP Morgan India Investment Trust (LSE: JII) now trades at a slight premium to its net asset value, suggesting that investors may be getting carried away in the short term. Hold off for a correction.
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