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With key political developments out of the way, market participants are now eyeing the Union Budget for the government to spell out its economic reform agenda. Richard Gibbs, global head of economics, Macquarie Research, tells Puneet Wadhwa that India is now being viewed as a potential investment opportunity. From a corporate valuation perspective, the Indian market has the potential with a well-implemented reform agenda to provide companies the means to bolster top line revenue growth, he says. Edited excerpts:
Do you see investors raising allocation to the developed markets towards the end of the calendar year?
Economic data for the US indicates that the economy is shaking off the effects of the severe winter weather conditions that detrimentally affected economic activity in the first quarter of 2014. In the euro zone, the gradual recovery in activity continues, but there are justifiable concerns about persistently low inflation and the still high value of the euro.
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Global investors are already heavily weighted towards developed markets and in the past month or so, the strength of the Euro has reflected a further shift in asset allocation in favour of European assets – both equities and fixed income. Therefore, scope is limited for a further sizeable build up of developed markets assets.
What is the road ahead for emerging markets?
It is likely we will see a more differentiated risk profile across emerging markets, as investors seek to better quantify the sovereign and policy risks for specific economies. For example, we would expect to see economies that are slow to address structural issues penalised by investors in terms of risk premiums.
Are you raising your allocation to India now that we have a stable government at the Centre that is seen as pro-reform and wants to create a business-friendly environment?
We have adopted a very positive approach to the emergence of a stable and pro-reformist Indian government, following the recent general election. As such, we view the election of a new government as being a welcome opportunity to strengthen investment positions in India, in anticipation of stronger sustainable growth which is underpinned by an overdue recovery in business investment and the progress in addressing supply-side deficiencies throughout the Indian economy.
Do you think India could garner higher allocation now from foreign institutional investors (FIIs)?
FIIs continue to view emerging markets with a degree of caution, which is a function of two underlying concerns. First, the ongoing risk of increased volatility in global capital flows due to potential shifts in the stance of US monetary policy – it is the lingering risk of policy spill-over effects. Second, structural reform pressures in many of the key emerging economies have cast doubt on the capacity of the region to sustain previously high rates of gross domestic product (GDP) growth.
After the elections, India is being viewed as a potential opportunity by investors, with the economy having the capacity, due to the decisive election outcome, to gain a ‘first-mover’ advantage in terms of structural reforms. This is important as if the new government can deliver on its election manifesto, global investors will likely form the view that India can achieve higher sustainable rates of GDP (gross domestic product) growth over the next decade.
A number of market participants/analysts suggest Indian markets are now at the start of a multi-year bull run. Do you agree? If so, what are the likely triggers?
The capacity of the Indian market to support a multi-year bull run will critically depend on the new government’s delivery of much-needed structural reforms and de-regulation and liberalisation initiatives. Absent of progress in terms of microeconomic reform, and then it is questionable whether India’s economy will achieve the sustained growth rates needed to support stronger top-line revenue growth.
From a corporate valuation perspective, the Indian market has the potential with a well-implemented reform agenda to provide companies with the means to bolster top-line revenue growth, while at the same time reducing operational costs. The scope for cost reductions will be greatly enhanced by government measures to overcome supply-side deficiencies.
What’s your advice to someone who wants to enter the market now? Is it the right time?
For well-informed investors with a good understanding of the key drivers of India’s economic development, the present circumstances provide a very good opportunity to enter the market. In this context, investors should be looking for sectors that are establishing robust and stable cash-flows by expanding their reach in the domestic market.
A well-informed investor should not be looking to trade speculative waves, but rather engage with the structural growth opportunities present in the Indian economy.
The to-do list for the new government in terms of implementing key reforms is long. Which ones do you think will take top priority and why?
The new government will need to assert its policy credibility from an early stage and there will need to be a clear focus on steps to address chronic supply-side issues and on improving corporate governance and transparency. In this context, the thrust of the government should be decision, delivery and decentralisation.
Specifically, key policy initiatives should include: focus on governance – implementation and delivery; ensure greater autonomy for states; measures to bring down inflation; move towards fiscal consolidation with a focus on quality; encouraging foreign direct investment in all sectors except multi-brand retail; as well as measures to address manufacturing, land acquisition and infrastructure bottlenecks.
How did you position your portfolio allocation to India ahead of the elections? What’s the strategy now? Which sectors and stocks are you underweight and overweight in the Indian context?
Prior to the elections, the Indian portfolio allocation was dominated by defensive sectors and stocks in line with lower GDP growth and the potential for further declines in interest rates. After the elections, our asset allocation has shifted to anticipate improved growth prospects for the economy with overweight positions in finance, industrials, materials, telecom and utilities. Overall, we believe that valuations have headroom to expand from current 14x to 16-17x, implying a target range of 8,300 – 8,800 on our 12-month forward Nifty target.
We are mindful, however, that the run up to the general election had a huge sentiment impact on the market that scaled new highs as opinion polls revealed an emerging trend of a clear mandate – the Nifty in dollar terms is up over 17 per cent year-to-date and 23 per cent from its lows in February.
While economic fundamentals are yet to show any improvement, the outlook for the market and the economy has improved considerably.
In the near term, we will be watching the Budget session after elections, which will provide an opportunity for the new government to lay out its medium–term strategy.
