Time to shed India's brittle image? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Time to shed India's brittle image? 

A  A  A
In this issue:
» Are Indian banks overvalued when compared to peers?
» Based on this ratio Indian stocks don't seem to be overvalued
» Coal block de-allocation: The real culprits go scot free!
» Indian stocks end day on a weak note
» and more....

The term 'Fragile Five' came into the spotlight a little over a year ago. It represented emerging market economies that were relying on unreliable foreign investment to finance their growth. India was one of the counties that formed part of this list; others were Turkey, Brazil, South Africa and Indonesia.

However, a lot seems to have changed since then...

In relative terms, India's health has improved the most. Not only has the Rupee appreciated by about 12.1% since last year, but the country's key pain point at the time - the burgeoning current account deficit (CAD) - has reduced substantially; from 4.1% in September 2013 to 1% in June 2014 (on a trailing twelve month basis). While other nations have also seen an improvement in their CAD figures, they are nowhere comparable to that of India's. Also barring Brazil, the respective currencies of other three nations depreciated against the American Dollar.

So, what is likely to be the situation going forward? Well, analysts at Morgan Stanley released a report recently wherein they tried to gauge the possibility of CAD figures throwing up negative surprises anytime in the future.

As you would be aware, it was the gold and merchandise imports that were playing havoc with our current account deficit numbers. Therefore in order to deal with gold, Government made it difficult to import the yellow metal by raising duties. Consequently , it is expected that once duties are reversed, the demand will bounce back and once again hurt our current account deficit.

This is where the Morgan Stanley guys have dug a bit deeper and come to the conclusion that gold demand may not be as strong as in the past because its allure as an investment asset has gone down. It should be noted that in Mid 2011, the investment demand for gold formed about 40% of the total gold demand in India. This is nearly twice than what the long term average suggests. Therefore if the investment demand for gold has to go back to the long term average and if consumption demand maintains its long term trend, then we could indeed save on some precious foreign exchange reserves and in the process sustain our strong current account position.

As for non-gold imports rising as and when GDP increases, the report goes on to indicate that there is no correlation between the two. And with prices crude oil - the key contributor to the non-gold imports - remaining low in present times, the normalized CAD level is expected to remain at comfortable levels in the coming future.

Well... according to us, the only long term solution to curb the volatility in CAD is to increase exports.

As for investment in gold, it seems in the short run the yellow metal may not be in favour considering that inflation is expected to cool down. However, we hold on to our view that given the many uncertain factors outside of India - especially at a time when everything seems hunky dory - it would be advisable to keep a certain amount of money invested in gold.

To answer the main question, on whether India is completely out of the woods? Well it may be too soon to conclude such a thing as the real challenge is likely to lie sometime in the coming future.

According to you, is it time for India to be excluded from the 'Fragile Five' list? Let us know your comments or share your views in the Equitymaster Club.

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02:15  Chart of the day
Banks in India are a very diverse lot. On one hand, you have some PSU entities struggling with bad loans. On the other, there are few private sector ones that have hardly been impacted by the growth slowdown and loan restructuring in India Inc. What really binds the banks of different sizes together is the regulator's (RBI's) prudent policy making. Hence while investors might want to evaluate each bank on its own merit, the RBI's conservative stance is a huge assurance. In fact the central bank has consistently proven itself to be ahead of the pack when it came to proactive risk mitigation. Hence a recent report by Credit Suisse quoted by Economic Times does not quite surprise us. The report questions whether banks in India should be valued at a premium to their Asian counterparts.

Indian banks: Not so cheap amongst peers?
Indo. - Indonesia, Phil. - Philippines

Now it is not as if valuation of all banks in India is within a narrow range. In fact there is a huge gap between the valuation of PSU and private sector banks. Yes, the average may still be higher than the Asian peers. However, the banks that have established an impeccable track record in quality and margins certainly deserve a premium. More so because given the high savings rate and low credit penetration in India, banks here could possibly have the highest growth rate in the coming decade. Therefore instead of writing off all Indian banks as expensive and risky, investors would do well to evaluate them on case by case basis.

Peter Lynch's biggest contribution to the world of investing is perhaps the now famous PEG ratio (price to earnings growth ratio). Mind you, the ratio does have its limitations. It is nevertheless a great shortcut to compare relative attractiveness of stocks across sectors. A high PE stock cannot automatically be dismissed if it also has high growth rates attached to it. What more, the ratio can be applied equally successfully to arrive at the relative attractiveness of the wider markets as well. In fact Indian markets don't look all that overvalued when one takes into account its PEG ratio.

As per a leading daily, India has one of the lowest valuations relative to its growth amongst a group of 13 Asian countries. And this does make sense according to us. There's no doubt that at 18x-19x, the Sensex PE is certainly amongst the highest. However, what also needs to be taken into account is the expected growth rates in earnings. And with this likely to be in the region of 18%-19%, Indian markets don't look expensive at all. At the most, they are fairly valued; investors investing at the current juncture can certainly hope to make mid to high double digit returns over the long term.

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In a landmark decision, the Supreme Court (SC) cancelled 214 coal blocks that were allocated to corporates on an ad hoc basis over the last two decades. Deeming the process as arbitrary and without any logic it has asked companies to return these coal blocks. Even those who have started mining will have to surrender the blocks. Power and metal stocks witnessed knee jerk reaction after this decision. And understandably so. Shortage of coal is already hurting these sectors. De-allocation will further aggravate the issue.

However, we welcome this tough decision. The argument that public interest will suffer as power crisis will worsen because of such a decision is naive. Coal is a natural resource, belonging to the citizens of India. One cannot loot the nation in the name of public interest. If any decision was unethical and corporates benefitted out of the same it has to be reversed.

Hence, we reckon the SC has done a good job. However, we fail to understand why it chose to ignore the politicians who decided to allot these blocks arbitrarily. It is obvious that they would have received kickbacks for illegal allocation. And hence politicians are equally to be blamed for this mess. By just punishing the corporates, SC is setting a wrong precedence. The real villains are politicians. Bringing them under the clutches of law is what is required.

The Indian stock markets continued to trade weak in the afternoon trading session. At the time of writing, the BSE-Sensex was trading down by 188 points (0.7%). Barring IT and pharma sectors, all the sectoral indices were trading in the green. Metals and PSU bank stocks were witnessing maximum selling pressures. Most of the Asian markets were trading negative led by Taiwan and Hong Kong. However, China was trading in the green. European markets had opened the day on a firm note.

04:55  Today's investing mantra
"The intelligent investor is likely to need considerable will power to keep from following the crowd." - Benjamin Graham
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2 Responses to "Time to shed India's brittle image?"


Sep 25, 2014

No. India is still vulnerable to foreign flows. Crude oil price,USA'FED rising of rates, Inflation,policy formulation delays,so called financial bubbles of easy money policies of central banks, fiscal and current deficits may play havoc and hence we should be watchful and make efforts to address the said things.However challenges are solvable.Discipline and wisdom to contain twin deficits, elimination or control of subsidies, creation of infrastructure,lmproving health care, higher education can make India excel


ravi chopra

Sep 25, 2014

I am pleased to read your view of the SC's decision cancelling 214 coal block allocations. I agree with you that you cannot loot the nation's natural resources in the name of public interest. It shows that you value ethics and justice over profiteering.

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