India has been wrestling with higher oil inflation and a strengthening US dollar leading to the rupee selling off and bond yields rising. Mixed narratives on the economy are adding to a sense of confusion. In the long-term, the positives still outweigh the negatives while in the short term, a cyclical recovery is visible and getting broad-based, with a turnaround in infrastructure evident in recent commercial vehicles and construction data.
Emerging markets (EM) have endured a turbulent few months, with a sell-off in a string of economies stretching from Latin America to Asia sparking fears of global contagion. The Indian rupee, too, has come under pressure - with the currency falling to new lows against the dollar. Recent efforts by the government to stem this slide have not been met with success so far.
Chart 1: The Indian rupee has fared poorly against the dollar
Source: Thomson Reuters Datastream, Fidelity International, September 2018.
There is also some nervousness in the run up to India’s general elections which are scheduled for May 2019. From an investor’s perspective, the countdown to a country’s election is generally seen as an uncertain period for either tactical or structural reforms.
However, India’s growth outlook remains positive and once global headwinds subside, we believe that India’s long-term story will sparkle once more - provided it continues to focus on the right policy actions.
The Indian stock market has strongly outperformed the MSCI Emerging Markets Index given its deep investment universe and its corporates which are some of the strongest in the region. However, with a one-year-year forward P/E of 18x, valuations seem expensive relative to their historical average and other emerging markets.
Chart 2: MSCI India outperforms the MSCI Emerging Markets index
Note: Rebased to 100 as at September 16, 2008
But we still see good opportunities in areas such as financials, exporters such as IT services and healthcare, which are the beneficiaries of a strong dollar, and consumer staples which provide an effective hedge in uncertain markets.
We view consumer staples and financials, which have recently seen a rise in valuations, as more of a long-term bet. The re-rating of some of these stocks underscores the importance of selecting companies with robust corporate governance and strong balance sheets.
Compelling growth story
India’s economy has performed well according to some metrics, including the World Bank’s ‘Ease of Doing Business report’, driven by tax reforms and a new bankruptcy law. It is broadly in control of inflation but looks vulnerable on its fiscal deficit.
GDP grew strongly at 8.2 per cent year-on-year in the second quarter of 2018, albeit from a very low base, although a change in GDP calculation methodology may have flattered results.
Compared to some other growing economies in the region such as Indonesia and Philippines, the Indian financial markets are larger and deeper. There is also less reliance on foreign investors. In Indonesia, for example, foreigners hold about 40 per cent of the government bond market, whereas foreigners in the Indian government bond market only hold around 5 per cent making it less vulnerable to the risk of outflows.
With its domestically oriented economy, we believe India is in a better position to withstand a global trade slowdown. And while it may come under some short-term selling pressure, we believe India is still a compelling long-term growth story.