Beyond Bulls & Bears

A View From India

Global investors have taken notice of India, an emerging market characterized by its large and youthful population, rich culture and resources and, perhaps most important, its history of high economic growth rates. India was a global growth engine even while developed countries faced recessions in the wake of the 2008-2009 financial crisis. While a growth slowdown is among the challenges India faces today, K.N. Sivasubramanian, CIO of Franklin Equity India based in Chennai, thinks there are still plenty of reasons to be optimistic about the country’s future. We’ve invited him to share his view of the Indian markets and the economy.  In his words:

KN Sivasubramanian

The global economy and the financial markets are at a crossroads right now. Notwithstanding the de-leveraging taking place since the 2008 crisis and the rising government deficits, there have been some positive developments. Europe is working through sovereign debt issues through a combination of quantitative easing, long-term liquidity and austerity measures. The U.S. economy is relatively better placed; although growth is weaker than in emerging markets generally, it appears to have improved. Many emerging markets, including India, have seen a moderation in growth this year. However, overall I think certain key emerging market economies are better positioned relative to their developed market counterparts, mainly because of the lower debt levels and stronger banking sector.

Looking specifically at the Indian economy, GDP growth has slowed to about 7% from the high single-digit growth we’ve seen in recent years, mainly due to the central bank’s past monetary tightening to tame inflationary pressures, and some policy issues. The IMF expects the Indian economy to grow at 7.3% in 2013 compared with the 9.9% growth witnessed in 2010.1  However, India is expected to remain one of the faster-growing economies in the world. Average GDP growth in advanced economies and emerging economies in 2013 is estimated at 1.9% and 5.9%, respectively.1 Consumption and investment have been fueling GDP growth in India; the contribution of net exports to GDP has been negative.2 India is not overly dependent on exports; it is a domestic-driven economy. Hence, India is relatively more insulated, and in my view, a slowdown in the global economies should not impact India as much as more export-oriented countries.

While India’s central bank announced a 50 bps rate cut in April to support growth, the policy statement indicates there is limited room for further cuts over the near to medium term, given upside risks to inflation and fiscal deficit.3 Notwithstanding the long-term attractiveness, the macroeconomic and policy concerns can impact flows over the near term.

India’s demographics should support robust growth rates going forward. As more young people enter the workforce, that should lead to increased income levels and consumption. India’s population has a median age of 25, one of the youngest among large economies.4 (For example, the U.S. median age is 36.9.)5 In addition, the government has projected increased investments in building the infrastructure. So, consumption and investments together should support India’s long-term growth outlook.

That said, Indian companies are not completely immune to any weakening of global growth. Certain sectors— textiles, IT, and, to some extent, engineering and auto component companies—are more dependent on exports. The slowdown in Europe and the U.S. has had an impact on these industries, and earnings have slowed, too. In addition, while many other countries have seen inflation ebb a bit, many Indian companies are still absorbing the impact of higher input costs.

Inflation is always something we have to be vigilant about, particularly related to oil as India depends on imports for most of its energy requirements. Hence, the recent rise in crude oil prices is a concern. If the geopolitical issues in the Middle East are sorted out, I think energy prices could drop a bit, given the still-weak characteristics of the global economy. This should help India in reducing the pressures from imported inflation.

If you look at how India’s corporations have managed the challenges of the past year, we think the top line has been quite solid, even as margins were impacted by higher input and borrowing costs. This year, it appears to us that corporate earnings per share are likely to slow from last year, but stay above 10%. Despite a fairly significant economic slowdown in the last year or so, we think corporate growth has still been relatively strong. The current environment and disparate growth characteristics warrant a disciplined stock-picking approach, focused on quality.

From a valuation perspective, Indian markets are currently below the 10-year averages, and given the long-term growth potential we see, I think any correction could be viewed as a buying opportunity. The government needs to address the perception of an uncertain policy environment with some clear reforms, and also provide clarity on the recent changes to taxation of offshore vehicles. At this stage, it appears that long-term equity investors might not be impacted (there is no long-term capital gains tax in India) too much, but debt flows might be affected, depending on the final clarifications.

Only time will tell what the future holds. Of course, there are always risks and unexpected challenges. I’m optimistic about the long-term fundamentals of the Indian economy and feel it’s an opportune time to take a look at Indian equities.

What are the Risks?

All investments involve risks, including possible loss of principal. Generally, investments offering potential for higher returns are accompanied by a higher degree of risk. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

1 Source: International Monetary Fund World Economic Outlook, January 2012.

2 Source: India Ministry of External Affairs.

3 Source: Reserve Bank of India.

4 Source: U.S. Department of State, 2011.

5 Source: CIA World Fact Book, 2012.

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