Consumer Spending and Government Investment Increases

I do find valuations in the Indian equity market a little bit challenging, at least in the short term, because we have seen very strong market performance. It seems that the market is perhaps oblivious to some risk areas in India. For example, we do see certain states having a pretty bad fiscal situation because of the farm loan waivers and outlays on energy because of the electricity distribution reforms. So certainly, fiscal policy at state level is not as good as the overall macro picture. For the quarter we have just finished, I don't expect earnings to be particularly strong. I don't see the NPL situation in the banking system being addressed fast enough. When you take these factors into account, in the short run, valuations may look a little bit excessive relative to where they have been in the past. The GST is there, but the effects of the GST have largely been priced in. Given the valuations, which are rather high in India compared to other markets, if we are going to sustain the improvements on the reform  side, particularly on NPL side.

We will get a little bit more. We could easily hit 20% for this year but it is not going to be a completely straight line. We expect financial markets to see a pull back and have a softer performance over the next few months. So in the second half of the year, you will see substantially smaller returns than we have seen in the first half, because we have moved a little bit quickly in the first half.

There are two areas. One is the process of privatization of Air India. If a successful privatization happens, then this could be the beginning of a broader set of privatization programmes which could be extremely exciting for the equity markets. The other thing we have to watch out for is that as we get closer to the political season again, there have seen some inter-communal tensions in India that are beginning to emerge. We have to watch out, because those can sour sentiment, particularly among foreign investors.

We like sectors that can benefit from government spending on infrastructure. GST will improve government's fiscal picture and more money will be available for infrastructure spending. We like the consumer segment because the deflationary environment is good for real disposable income for consumers. We are also looking very carefully at banks. Even though I would like to see more action on the NPL situation, if we are right about consumer spending and government investment picking up over the next couple of years, then that should be good for the government's popularity. If that happens, then the political capital will be sufficient for the government to get more aggressive on dealing with NPLs.

The main takeaway is that the Fed is going to normalize policy extremely slowly. There is clearly disagreement emerging about when is the appropriate time for them to begin to scale back quantitative easing. The market should definitely expect the central banks, not just in the US but also in Europe, to move extremely slowly. They will continue to be a source of short term volatility in the market but I don't think we should expect the central banks to take an action that in any way whatsoever threatens stability in the markets in long run.

It is a potential source of market volatility in the short term, but regardless of the relationship between North Korea and the US, I don't see any serious fundamental risks to most EMs arising from that particular issue except that there may be some impact on market sentiment in South Korea. Any short-term volatility will be an opportunity to buy EMs.