Issue date: 2019-10-01
2018 first half has been a slog for Indian equities. The market is barely staying afloat after a strong run last year. Despite an economy that remains among the fastest growing in the world, a slew of external and domestic worries have kept market bulls at bay. Crude prices that have risen from $45 to above $70 a barrel in just a year could inflict pain on an economy that imports most of the oil it consumes, along with fiscal and current account risks. Already, this is pressuring the rupee, which has sunk to five-year lows against the U.S. dollar.
If the U.S. Federal Reserve (Fed) raises rates faster than expected, this could further impinge on inflation and already hawkish monetary policy. Add to the mix geopolitical risk, with US-China trade tensions escalating despite US-EU tensions eased as both parties agreed to suspend new tariffs. In July, China and the US imposed tariffs on US$34 billion of each other’s exports.
Domestically, the re-introduction of a long-term capital gains tax, which has raised the hurdle rate for returns, and fraud at the country’s second largest bank have weighed on the market recently. Meanwhile, Prime Minister Narendra Modi has been following his reform agenda to the letter. First demonetization, then Goods and Services Tax (GST), followed by digitization, the bankruptcy act and the land bill. They are being set in place one after another. While some reforms have induced acute short-term pain, they set the scene well for economic prospects over the long run. Take GST, for instance. It widens the tax base, simplifies businesses and cuts red tape across state and federal lines, even though implementation has been far from smooth.
Such commitment to reform has come at a cost to Modi, who is less popular today compared to the rapt attention he received when he first came to power in 2014. Already, he is facing key local and state polls ahead of the 2019 general elections, including Karnataka. In this election, Modi is personally leading the Bharatiya Janata Party’s (BJP) campaign to wrest control from the main Congress opposition. His main rally cry has been “sarkar badlisi , BJP gellisi” or “change the government and bring BJP to power.” At the end, Modi’s ruling party Bharatiya Janata Party (BJP) has won the most votes in Karnataka but failed to form a majority in the assembly, and Congress Party has retained control of the state by unifying with other opposition parties.
With three more state elections to come this year, pundits are divided over whether Modi would be able to keep his majority in next year’s general election or be forced into cobbling together a coalition.
Amid political uncertainty and economic pressures, we believe India offers a more reassuring picture on the ground. While GST-related disruptions hampered earnings last year, we are seeing signs of a nascent demand recovery, as orders pick up across various sectors.
The information technology (IT) industry is at an inflection point. The sector appears on the cusp of a cyclical upswing after prolonged weakness caused by a structural shift towards digital as well as U.S.-related pricing and wage pressures. Our visits to our core holdings reflected the improving outlook for IT spending. Some companies are benefiting from U.S. tax reform, while others can expect robust revenue growth from consumers.
In the consumer sector, demand is on the recovery track. In fact, we’re finally seeing demand and trade channels normalize post-GST. Volumes are recovering, although there are concerns over cost inflation. There is also evidence of strong progress among companies across other sectors, including materials, industrials and financials.
Amid the disparity between the macro and political uncertainty and what we're witnessing from companies on the ground, we continue to view India as among our favored Asian markets. There is a plethora of quality businesses to choose from, coupled with structural positives of a young population and expanding middle class. The recent market weakness has brought valuations down to levels that are more in line with Asian peers. And if stocks were to fall further, investors could potentially purchase more of the stocks they like. Over the long term, India still has much to offer.
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