Notwithstanding the temporary bearish sentiment, the overall rating of Indian equities still continues to be 'overweight' in the minds of most investors.
The three key areas where we appear to differ from the investors' views are:
- the role of cyclical versus structural factors in the acceleration of industrial production and GDP growth
- the extent of any likely rise in interest rates and
- the vigour of the capex cycle.
Role of cyclical Vs structural growth drivers
Market view: Market participants seem to be believing that the recent improvement in the industrial cycle and growth in corporate earnings is entirely a structural phenomenon and that this is likely to continue going forward, come what may!
Our view: We believe that, while the recent changes in the global economy direct towards a more structural framework for the long-term, a large part of the recent industrial production acceleration has been driven by cyclical global factors. Low domestic interest rates, premised on a weakening dollar, have supported industrial expansion plans and household consumption spending. In addition, the pick up in goods exports has supported industrial production. As low interest rates boosted consumption in the US, India's exports to the US and other US demand dependent countries remained high. Thus, the acceleration in India's export growth appears to be largely a reflection of the demand cycle in the US.
Interest rates rise
Market view: One of major arguments that have surfaced against the possible rise in domestic interest rates is that, with the central bank (RBI) having a significant amount of sterilized liquidity, there should not be any need to raise interest rates even if forex reserve accrual slows.
Our view: We believe that the Reserve Bank of India (RBI) no longer has a choice of maintaining low interest rates. Incrementally, the RBI has been concerned with low rates driving consumption, which in turn is pushing the trade deficit to an all-time high. With the US interest rates picking up at a 'measured pace' it will not be long before the domestic rates follow suit (albeit not at a similar clip as that of the US).
Vigour of the capex cycle
Market view: The government and corporate sector have raised the noise levels on their intention to invest in infrastructure and manufacturing respectively for the past two years. Most investors believe a strong pick up in capex will drive growth over the next twelve months even if the cyclical factors reverse.
Our view: We believe that the capex under implementation has only witnessed a weak recovery. Our interaction with some of the major banks has confirmed the fact that the corporates are yet to include capex borrowings in their 'non food ' credit demand and in contravention to the reports in the pink papers, the demand so far has mainly arisen for working capital requirements.
The bottomline is...
...that a major acceleration in investments and job growth will be critical for reducing the Indian economy's dependence on cyclical drivers. However, the likely rise in real interest rates and the slowdown in export demand driven by the global trend is likely to result in the withdrawal of the extraordinary external stimulus, which over the last few years has boosted the industrial growth.
Our intention of highlighting the above concerns is not to act as doomsayers but to caution investors of the possible slowdown in the economic growth and the resultant shying away of the foreign investors. What investors need to comprehend is the fact that there are certainly some long-term growth stories visible amongst Indian equities but they need to exercise caution about the value of their 'pick' and the price they are willing to pay. Reiterating Mr. Buffet's view "It is only when the tide goes off that you realise who is swimming naked."