The current consensus on India is very negative, and it is difficult to find a real bull among major market participants. Almost everyone is underweight India in a regional or even broader emerging markets context and we have already seen outflows of over $7 billion.
Trading volumes have collapsed, investor visits reduced and the hype around the India story almost totally dissipated. Analysts trying to market the India story keep reporting total disinterest among the investor base, and raising new money for India is extremely difficult.
With such a sea change in sentiment it would be helpful to remember as to how we got here in the first place. While financial markets globally are in turmoil, India has had some specific issues.
The India story got derailed for three or four main reasons:
Now let us look at all these factors as we move into 2009, especially mid 2009.
First of all, we will have a new government in place with hopefully a five-year term. Given the fiscal mess the new government will inherit, and the present government being in its first year, the chances of serious, meaningful reform are bright.
A first-year government with a slowing economy and fiscal stress will have the cover it needs to get things done, whether it be reducing subsidies or divestment.
Also from a practical viewpoint, as long as any coalition at the Centre is independent of Left support, it is difficult to imagine it getting more bogged down on fundamental reform than the UPA. Given the disappointment on this front in the last four years, any policy action will be a positive catalyst.
The penchant on the part of the new government to keep doling out freebies and playing to the gallery will also be reduced. The further we are from elections, generally the more responsible is government economic decision making.
Secondly, it is highly unlikely that commodity prices will have the type of parabolic moves we have seen this year, especially in oil. Even if prices begin to go up again, on a higher base the impact of price rises will be muted. The lagged impact of the RBI tightening will also have totally played out and thus the inflation rate will most likely be around 5 per cent.
With inflation under control and most monetary variables in check, the RBI will be about to commence an easing cycle. The new government will also be more focused on getting growth back on track, rather than remaining focused on reining in inflation at all costs.
Economic growth ultimately drives employment and tax revenues and no government can ignore this. Bond yields will have peaked and credit growth will start to accelerate again, especially retail, as the market recognises the peak in rates for this cycle. GDP growth will start accelerating and we should exit the year at an 8 per cent trajectory again.
Thirdly, independent of where oil prices go, the year ending March 2009 will mark the peak in India's macro-economic vulnerability to rising oil prices.
At 9 per cent of GDP, oil imports will naturally drop to below 6 per cent by YE 2011, due to the start-up of the RIL and Cairn oil and gas fields over the coming 12 months. (This will happen even if oil stays above $105).
While Cairn will help the balance of payments, RIL gas will improve both the BoP and also the fiscal, through lowering costs for fertiliser/power plants and thus subsidies. Longer-term, both will also yield substantial revenues to the GoI through taxes and profit oil.
By the time we hit mid-2009, assuming the markets are still at today's levels, we would be trading at about 12 times (March 2010 earnings), which is not really expensive considering that return on equity will be above 20 per cent, and earnings will have started to positively surprise and re-accelerate.
We would also have had an 18-month correction, more than enough time for corporate India to catch its breath, cut costs and consolidate. Just from a mathematical perspective, earnings will be accelerating as we move into 2010, purely from the coming on stream of the RIL and Cairn fields and their impact on the corporate earnings base.
India is going through a cyclical slowdown, part of a normal business cycle and not a fundamental break from its trend growth rate of 8 per cent. Such a slowdown is important to remind people of cyclicality, temper overheated growth plans and forcibly reintroduce risk into the equation.
Markets are leading indicators and normally bottom out a few months before the business cycle itself. Given the strong possibility of the RBI easing by mid 2009, and the economy and earnings bottoming out, markets should have a positive backdrop to 2009.
The difficulty will be in the performance of the markets in the interim till we get into early-mid 2009. Have markets and investors fully discounted the risk to earnings? How much more can PE multiples de-rate in the face of high and potentially rising bond yields? Will the RBI be too aggressive in its zeal to kill the inflation beast? What if oil goes to $150? We also have to accept that India can totally blow it, with a small possibility of a highly fragmented coalition coming to power in 2009, which will lack cohesion in economic policy making.
The odds are the markets will bottom out before mid-2009; one has till then to pick stocks, do the work and get your portfolio aligned for the next cycle. The key will be in finding which sectors will lead the market this time, for if history is any guide market leadership will move away from the capital goods/power and infra plays that led the market till January 2008.
