What’s on the Horizon for India’s Markets?
India’s second COVID wave subsided in June and continues to remain at the lower level and Indian equities were a bright spot for the region, significantly outperforming Asia and broader emerging markets in August. Portfolio Manager Peeyush Mittal, CFA, reviews the current state of COVID restrictions, the prospects for India’s markets and shares his views on which sectors may offer opportunity as the country emerges from the pandemic.
COVID-related pressure kept much of India under lock-down in May and part of June, pressuring end demand. What is the current state of COVID-19 restrictions in India?
It’s still a very fluid situation in India. The crisis of the second wave which started at the end of March began to ease somewhat after many state governments imposed localized lockdowns in the most affected cities and towns. While localized lockdowns in some parts of the country have continued, there are certain cities where vaccinations have increased, and as a consequence, people are feeling more comfortable stepping out and activity, mobility has normalized rapidly in the months of July and August. However, it’s still a volatile environment given the fear of a third wave.
Indian equity markets have been fairly resilient despite a vicious second COVID wave, punchy equity valuations and higher-than-normal inflation outlook. What were the drivers to performance?
Indian equities have provided positive returns through August despite many adverse economic events. In part, this is because many Indians are diverting their financial savings from fixed deposits to equity markets given the low interest rates prevailing in the economy despite high inflation. As a result, the number of individual brokerage accounts have doubled in the last 12 months.
In part, it is also the favorable monetary policy environment that has existed in the country over last 18 months. The central bank has remained dovish with their monetary policy stand and as a consequence the cost of capital in the country is currently at the lowest in the past 10-12 years. This clearly has had a favorable impact on asset valuations, equity markets included.
Additionally, a pro-growth budget presented by India’s central government, with an emphasis on higher infrastructure spending in the coming years, helped boost consumer confidence.
What’s on the horizon for India’s markets?
In the near term, discretionary consumption may be reduced as household savings of many have been negatively impacted due to higher health care spending in recent months. However, as vaccination efforts in India continue to gather pace, we believe COVID’s impact on human health and India’s economy will continue to recede in the coming months.
Despite near-term COVID challenges, we remain optimistic about India’s cyclical recovery, aided by increased infrastructure spending and a likely pick up in private sector capital spending. I think there is a bit of worry in some corners of the public markets given the valuations, but on the whole, we remain positive. In my view, India is still in recovery mode from a cyclical slowdown that started three and a half years back and we still may be in the second inning or the third inning of that recovery, so there's a ways to go on that. The recovery is being helped by what the government is doing and also the interest rates. After a lull of five to six years, India is seeing negative real rates in the market, or very low interest rates, and that's beginning to create some bit of excitement.
Is the cyclical turnaround being aided by China Plus One?
‘China Plus One’ is a business strategy to diversify operations by adding another location outside of China. There's a lot of manufacturing activity which is shifting to India. It started with chemicals and it’s expanding to some of the pharmaceutical supply chain, especially the starting materials, which are called APIs (active pharmaceutical ingredients). We are beginning to see some signs of that in industrial products, some Indian companies—especially the multi-national companies—are beginning to talk about considering India as a bigger export hub than it was in the past. I think this will expand into additional sectors, and that gives me more confidence that when COVID subsides, India is likely going to surprise on the upside in terms of GDP growth. The government is doing a lot from their end in terms of putting in structures and incentives or, in some places, import duties to provide the necessary regulatory landscape for manufacturing in the country to grow. So I think that's the other silver lining in terms of the India growth story going forward.
To the extent there is a shift in global supply chain dynamics, is India poised to benefit?
We are already seeing notable progress on several fronts that should result in increased foreign investment. When companies consider locating their supply chains in India, they frequently face two major hurdles: land and labor. Land acquisition can be a cumbersome and time-consuming process in India—but the government is taking steps to change that. Modi's administration is working to help corporations procure land. The central government is also partnering with states to create programs to support transparent, speedy land acquisition. More action on this front would represent a big step forward in India's ability to attract foreign investment. In terms of labor, changes in laws at the state level are driving momentum toward a more unified national labor code, creating another catalyst for drawing global companies to India.
What sectors and themes do you favor in India?
Given our hypothesis that India is in the early stages of a cyclical recovery, we think some of the cyclical sectors like financials, industrials, and consumer discretionary will be beneficiaries.
With respect to financials, credit growth has been muted and credit quality concerns have dominated the investors discourse over the last one to two years. In our view, the worst is already behind and performance of the financial sector should improve meaningfully in coming quarters.
The automotive industry has been in doldrums not just through the pandemic but even prior to that. Cost of ownership and cost of operating a vehicle both have gone up dramatically in the last three years. And more recently, despite a favorable interest rate regime, auto sales have been impacted due to supply chain issues related to chip manufacturing. In our view, barring a third COVID wave, the worst of times for the automotive industry is also behind and demand normalization should materialize over the course of the next 12-24 months. We also think that automotive suppliers in India are beginning to see better export opportunities as western world OEMs (original equipment manufacturers) look to outsource more in their bid to save cost and invest more towards electric vehicles. Both these factors make us more constructive about the automotive sector.