Winds of Change

India Infoline News Service | Mumbai |

Developing economies show signs of strong domestic demand, which has allowed them to recover from market turmoil more quickly than developed markets

India’s macroeconomic scenario has deteriorated in the last few months. A sharp depreciation in the rupee, rise in crude oil prices and high fiscal and current account deficit has led to a fall in equities and rise in government bond yields, raising the spectre of rising inflationary risks with lower growth. To add to the economy’s woes, fragile demand in several sectors has put pressure on corporate profitability and earnings have slumped to single digit growth. Worries that the US Federal Reserve could end its massive stimulus programme next year have roiled emerging markets such as India for months, inducing foreign investors to sell currencies, stocks and bonds that have supported the dollar against other currencies.

However, despite the volatility in the markets, developing economies show signs of strong domestic demand, which has allowed them to recover from market turmoil more quickly than developed markets and grow at a much faster rate. The current correction in the markets has also made these emerging economies like India attractive. This represents an attractive entry point to all investors as there is great potential for higher returns from these markets in the medium to long term.

The Virtue of Potential / Positive cues
India is among the five largest economies on the basis of purchasing power parity. However, it can no longer be insulated from the risk developments in the global market. Economic growth hit a record low of 5% in the financial year ended March 31, 2013 and slowed to 4.4% in the first quarter. Still, India has the highest growth rate after China among all economies with a GDP of around $2 trillion or more.

One of the positives that need mention is the good monsoon this year with most of India receiving adequate rainfall, which will ensure that the rural economy does well and controls headline inflationary risks. On the reforms front, the government seems to be taking resolute measures to revive the economy by introducing fast-track clearances in investment projects and through increasing FDI limits in various sectors in an effort to bring in incremental FDI flows. We have also seen succeeding diesel prices hikes to shore up the revenues of the oil and gas sector. These reforms and policy proposals are crucial to restrain the fiscal and current account deficits while providing better elasticity on the policy front.

In the last few days, we also saw Parliament give its assent to the National Food Security Bill, 2013 (also Right to Food Bill) and the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2012 (also Land Acquisition Bill), which will replace the existing Land Acquisition Act, 1894.
Market sentiment improved after the newly appointed Reserve Bank of India Governor Raghuram Rajan unveiled a slew of proposals to support the rupee and open up markets much to the relief of investors hit by the country's worst economic crisis in two decades. India's trade deficit for the month of August narrowed to $10.9 billion, as compared to $12.26 billion in July. The deficit narrowed on the back of improving exports and declining imports and was down 11% month-on-month. The Government has set a target of exports rising to $325 billion in the current financial year against $300 billion in 2012-13.

On the whole, economic data points (jobless claims, retail sales, etc) from the US signify that the US economy is improving. Moreover, Eurozone’s GDP saw a growth of 0.3% quarter-on-quarter in Q2 2013, marking its first expansion since Q3 2011. Indeed, there seems to an uptick in economic activity signifying that the recession may be waning in the Eurozone.

Outlook
India has a tendency to have higher valuations given its growth potential. Strong earnings growth, high return on equity and low leverage should lead to increased confidence in Indian companies. The new earnings season will reveal the impact of the ongoing tempering of economic growth, rising input prices and higher borrowing costs. However, while consumer demand is still reasonably strong and we might see the recent trend of strong top-line growth with lower margins continue to persist, interest rate sensitive sectors will be prone to larger downshift. Volatility in the market could persist for some time on the account of uncertainty over the timing and extent of the unwinding of quantitative easing by central banks.

The Indian economy will be able to withstand currency risks and maintain growth over the next few quarters. In this scenario, we on our part should help effectively implement the Government’s measures to halt the fall of the rupee and get the country’s fiscal calculations right and economy back on track. Our economic record is the best among the emerging economies and I genuinely hope our macroeconomic pointers will remain fundamentally strong in the long run.

They key task ahead would be for the Government to quickly address the current account deficit and subsidy burden in view of the positive US data points that might lead to the early reversal of the Fed’s easy monetary policy stance. I
n general, the ambiguity surrounding the economic scenario will have its bearings in the short term. Over the long term, fundamental analysis will play a major role. To get back on track, India needs to tackle its various imbalances: supply chain bottlenecks, execution of infrastructure projects and higher inflationary pressures resulting from rising food prices and dependence on fuel imports. The rate of reforms needs to be fast and sustained as impediments in approvals weaken business confidence.

As the economy recovers, I believe reinforced demand and improved profitability could drive much faster earnings growth than current investor expectations. With valuation on their side, investors can make very healthy returns over the next 3-4 months.

The writer is Chief Investment Officer, Max Life Insurance. The views expressed by the author are his own and do not in any way reflect the views of the company.






 

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