Issue date: 2019-09-26
Aberdeen Standard Investments
Markets are now facing a lots of uncertainties. US-China trade brinkmanship has reared its ugly head, continuing to cloud the outlook for emerging markets. Global liquidity is draining much faster than anticipated, as we appear to be transitioning from an era of monetary easing to a phase of monetary tightening. Thrust into the mix were volatile crude prices, exacting their toll on countries which import most of their oil needs, including India which faced immense pressure on its currency and current account deficit earlier in 2018.
For India, the big domestic concern has been the liquidity squeeze in the non-banking financial companies (NBFC) sector. This has its genesis in the default of IL&FS, a major infrastructure financing and construction company which twisted and buckled under its US$12.6 billion debt. As discussed with several of the local companies, the risk lies in asset liability mismatching. Some of the NBFCs have borrowed short-term when their revenue streams are longer-term, throwing their debt refinancing ability into serious doubt.
This problem has been exacerbated to some extent by a draconian Reserve Bank of India (RBI) that has arguably been overly rigid. The important point here is that solvency doesn’t seem to be an issue, although the crisis has reinforced the criticism levied at the RBI for failing to regulate the sector appropriately and being too tough on the public sector (PSU) banks, thereby trapping liquidity in the system.
We’ve seen periodic skirmishes of varying magnitudes between the RBI and the Modi government, which finally blew up into an open and unbridled acrimony between RBI governor Urjit Patel and the finance ministry in late October 2018 because of the NBFC crisis. This has led to the RBI loosening its stance towards limiting the PSU banks, and the expectation is that Patel is unlikely to see his term renewed in September 2019.
Given the above, we would expect tamer credit growth in the NBFC sector, and flowing from there, a slowdown in real estate development and unsecured retail lending. We also see a flight to quality. This will be positive for our private-sector banks, which are well capitalised and have solid deposit bases. They should gain market share and benefit from reduced competition amid NBFC consolidation.
Outside of the financial sector, we’ve had positive updates from the consumer and IT sectors. The outlook appeared more mixed among materials names. In the fast-moving consumer goods (FMCG) segment, a major retailer is seeing strong momentum in its results and remains leveraged to a recovery in rural consumption. IT sector also struck a positive tone with structural change playing out in its favour. Clients are in increasing need of digital transformation with more of their work core to their business models, for instance in retail and manufacturing, which will benefit IT companies with scale.
India remains a safe haven amid the uncertain global backdrop. Real GDP growth is still robust at around 7%. Inflationary pressures are benign, particularly as Brent crude, the international oil benchmark, has fallen from a year’s peak of US$86 to US$60 in just two months. Expectations are also rising of a revival in the capex cycle, following the disruptions caused by GST and demonetisation.
That said, going into 2019, our optimism is tinged with some caution. Certain sectors are trading at significantly higher multiples than their historical averages, notably consumer staples. This has been fuelled by strong domestic inflows into mutual funds and a re-rating of growth stocks globally. Meanwhile, the third-quarter results season saw consensus cuts to Nifty earnings by 3%. Competitive intensity remains high with operating margins contracting over the past few years, excluding financials and commodities. Moreover, at 74% aggregate industrial capacity utilisation remains below the level seen in the last recovery cycle (of above 80%), so some analysts have indicated that it could take another few years of healthy growth before the private sector really starts to ramp up new capacity.
Over the longer term, we continue to view India as among our favoured Asian markets. India boasts some of the best-quality businesses in the region, offering a good mix of well-managed local companies and multinationals. Growth prospects remain compelling, underpinned by structural positives of a young population and expanding middle class, while the country is less export dependent than many of its peers. In the current environment, companies with pricing power and robust balance sheets will benefit. We still favor companies that will continue to gain from India’s long-term consumption trends, as well as those that play into the strength of what it has to offer in IT services for instance. We believe that India still has much more to offer.
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