In this backdrop, measures announced recently to help address investor concerns on taxation and liquidity seem to make sense, as these do not require much direct cash expenditure. Even as we argue there is limited scope for a fiscal response to the slowdown, a monetary easing cycle is already underway. The Reserve Bank of India (RBI) is injecting liquidity and has cut rates. This will reflect on the economy through improvements in aggregate demand. Base effects are also likely to turn favourable in a few quarters. We expect India’s headline GDP growth to improve.
Do you blame the slowdown on a tailwind impact of demonetisation and hurried implementation of goods and services tax (GST)?
It is futile, and possibly incorrect, to look for a single driver of the macro slowdown in a country as large and diverse as India. Our analysis of data across multiple consumer sectors suggests the recent weakness is very bottom-up and idiosyncratic. It cannot be said that either rural or urban demand is uniformly weak. Similarly, data does not suggest that mass-market or premium-market product sales are consistently slowing. Observations of deceleration of growth are patchy, which we argue is a sign that these are not driven by one or two broad macro variables.
That said, tight liquidity last year could have driven some of the current issues. This has already reversed and should show up in the economy over the next few months. We also argue that portions of the auto slowdown are purely cyclical. Two-wheeler sales, in particular, seem to be below trend now as they were well above trend in 2018. In many consumer businesses, base effects explain some of the weakness.
While year-over-year (YoY) growth rates appear lower when compared to last year, two-year or three-year compound annual growth rates (CAGR) rates for several consumer businesses do not display any deterioration. As Indian GDP growth has weakened, the MSCI India’s forward price-to-earnings (P/E) multiples have come down in absolute terms, and relative to MSCI Emerging Markets.
How does India now look within the emerging market (EM) space?
India is unlikely to underperform EMs and presents a significant long-term opportunity, especially in comparison with other EMs. We don’t think modest tax changes are sufficient to attract or deter foreign flows. Fundamental opportunities to make money are more important. Valuations are back to historical average premiums. Growth is slowing locally but it is also weak in most peer countries. Our fair value for the Nifty for December 2019 is 11,300.
Your overweight and underweight sectors?
Our current recommended position is based on the hopes of an economic recovery; we do not recommend adding relatively expensive consumer names given near-term risks. We like financials, which have recently underperformed the market and whose valuations have also fallen from peaks. Increasing liquidity should drive top-line growth in a few months. Larger banks should also be able to manage pressure on net interest margins (NIMs) for some time. We are also overweight on the information technology (IT) sector given currency concerns and also like industrials and cement due to their recent correction in valuations.
What about public sector banks (PSBs)?
Bigger PSBs will have a better bandwidth to fund long-term big-ticket corporate loans, as well as invest more to achieve retail financial inclusion goals more efficiently. In theory, the better scale should drive better efficiencies, but we surprisingly found a low correlation among PSBs. The new PSBs might have to take a much sharper approach to cost cuts, which may not be easy.
The last five-10 years have been a honeymoon of sorts for private banks – they have been significantly punching above their weight in the context of a capital-constrained PSB sector. During FY14-19, private banks grew at a CAGR of 17 per cent, compared to 5 per cent for PSBs, allowing them to grow their market share by 10 percentage points to over 30 per cent, with an incremental market share of system-level loans at 50 per cent (versus 14 per cent for PSBs). With a better-capitalised PSB sector, these growth rates could normalise.