If you find yourself inadvertently sat next to a stranger in India, there are three topics of conversation that will usually be met with a receptive ear. Whilst discussions of the latest Bollywood blockbuster and the fortunes of the Indian cricket team may quickly find consensus, it is Indian politics that can stimulate some of the most engrossingly diverse perspectives. Indeed the long march has now begun towards May 2019, when the world’s largest democratic exercise in history will crescendo in the form of India’s 17th General Election.
But for those in need of a more immediate political fix, you need not look further than 11th December. Important state elections are underway in 5 states with a combined population greater than Brazil. Of those, the ruling BJP party oversee three states – Madhya Pradesh, Rajasthan and Chhattisgarh – and their success or failure may be viewed as a barometer of their wider popularity. Opinion polls paint a mixed picture. Whilst it’s clear from history that electorates vote differently in state and general elections, a dramatic loss in vote share for the BJP will re-shape the thrust of their public policy for the remaining six months. The bond and currency markets await nervously for how destructively populist this might be.
For us at Mobius Capital Partners, the market volatility driven by sensationalist political newsflow is something to take advantage of. Certainly, the general election in 2014 was significantly more important that the election next year. This is because the India of 2014 was a different animal – bloated by twin deficits, hamstrung by low foreign exchange reserves and self-doubting after years of policy paralysis.
Today, India’s productive capacity has been transformed by policy steps and measures that have now been institutionalised by the current government. A sturdier Bankruptcy Law, a well-functioning Goods and Services Tax, a flexible inflation targeting regime and success in financially including more than 300 million Indians through the country’s unique biometric identification system are just a few examples. GDP growth has accelerated from 4.9% in the second quarter of 2012 to 8.2% in the equivalent quarter this year.
In the longer term, this will reduce India’s equity risk premium and cost of capital whilst pushing up valuations to higher justified multiples. At the same time, income inequality will narrow through more efficient welfare transfers whilst inflation will trend lower and with less volatility. Huge disruption will take place in the financials sector as the traditional barriers to entry of underwriting, distribution and collection capability are beginning to crumble through the powers of digital disruption. Meanwhile in the shorter term, external vulnerabilities have diminished whilst corporates have emerged from a painful period of balance sheet repair, now limbering up to kick start India’s next investment cycle.
It would be trite to argue that everything has been rosy though. Indian equity markets struggled through the third quarter of 2018 due to the unhappy combination of higher US rates, a stronger US dollar, resurgent crude oil prices and a domestic liquidity scare that threatened to snowball into a solvency issue. Meanwhile the local press was whipped up into a frenzy as rumours of a rift between the government and the central bank emerged. Foreign investors pared back exposure and India’s historical valuation premium to global markets began to recede below its long-term average of 20%.
Whilst the bears continue to dominate the narrative, an attractive entry point has emerged for the long-term investor. Credit growth has accelerated to a five-year high whilst inflation continues to remain benign below 4%. The policy response to the liquidity crunch has been speedy and coordinated whilst domestic equity flows (which increasingly matters more than foreign flow) have been resilient. Price to book multiples are now below their long-term averages of 2.5x and foreign ownership has shrunk sharply to healthier levels. Despite this, earnings growth estimates are amongst the fastest across the emerging world with more than 20% and 18% expected for 2018 / 2019 respectively.
This is being driven by India’s position on its own capital cycle – where the combination of excess capacity, improving demand and continued balance sheet restraint lay the foundation for operating leverage and rising return on invested capital. Indeed it is India’s bottom up, micro story, that will now be the engine for strong equity market performance.
As we approach the end of the year and we go through the annual process of making bold predictions for 2019, how about this for size? The BJP underperform in the election, scrabble together a minority government but Indian equity markets outperform for the year. Micro trumps macro.
Wishful thinking perhaps, but it’ll sure keep the stranger by your side entertained.