We will get to see a recovery over the next 6-12 months
Ridham Desai, India Strategist, Morgan Stanley
Dec 01, 2017 | Source: Mint
Three to four questions have come up. First, are domestic flows sustainable? One of the big stories in India is the secular shift that is happening in the household balance sheet. We have no doubt that they are sustainable.
Second, the GST (goods and services tax) reform—will it work? I am actually surprised that people have doubts about this, because GST is the biggest reform that India has done but we’ve had a little bit of turmoil that is actually quite par for the course. When I look back and reflect on how we thought about this back in April and May, it’s turning out to be less problematic.
Third, what’s the next thing from the government? The government has done a slew of things the GST, DBT (direct benefits transfer), the state-owned bank recapitalisation, they’ve done well on infrastructure and have eased doing business to some extent. I don’t think there’s anything immediate in terms of legislation, it’s more administrative. There’s no major legislative agenda.
I think growth seems to be already on the mend, and we are seeing early signs of that. Earnings revision index in India has turned positive—this has been negative for seven years on the trot. So, you’ll be seeing that in earnings as well.
Any specific concerns on India: I think the one concern is about oil. Now, if oil prices rise because of geopolitical tensions in the Middle East, I would characterize that as a supply side shock. When oil prices rise because demand is rising, it’s not so bad for India because it gets matched by foreign flows. But when it’s a supply shock, there are no matching foreign flows. That puts some stress on the economy. Now, what choices will the government make—will they let retail prices rise or will they cut taxes? Either way it’s a problem, because if you let retail prices rise, then inflation nudges higher, and if you cut taxes, it reduces your fiscal flexibility. It will take something out of the capex that the government is doing, at a time when capex is very crucial for growth. To me, that seems to be a pretty big risk going into 2018, and hopefully nothing untoward happens in the Middle East...But we will have to watch that carefully.
Are investors concerned about India valuations? There is nothing to be worried about. People look at the PE (price-to-earnings) ratio, but earnings in India are depressed. When you want to look at the PE ratio, you have to normalize earnings. If you do that, the market is not as expensive. Another way of doing that is to look at price-to-book, which is a far more stable indicator. It looks through earnings cycles, and in India, that number is 3.1 times, which is bang in the middle of the historical average—so even relative to emerging markets, India is slightly below the historical average. People will make that call. Beaten down stocks where fundamentals appear to be weak but could turn around, are the ones in which you could actually put your money to work. The strategy we have is to focus on the change in return on capital (RoC) over the next two years as a filter to buy stocks, rather than the level of RoC.
Do you think we now have enough indicators to say that in the next six months to one year, private capital will take off? The answer is yes. Let me share numbers. Private capex in the previous cycle peaked at 18% of GDP and it’s now down to 6%. Frankly, I thought it will bottom out at 8%, but it has gone down to 6%.Now, we are hitting the trough—the fisc has probably done its bit in terms of tightening, export growth has recovered and banks have been recapped. So, it’s probably safe to say that in the next 6-12 months we will get a recovery. I’m seeing early signs— order books have started improving, largely led by government infrastructure spends and that’s leading the overall capex.
Does the jump in rankings in the ease of doing business actually correspond to increase in growth? The only number to look at is FDI (foreign direct investment) to GDP (gross domestic product)—that’s gone up steeply...fact is, the foreign investors have voted with their feet and they have put money to work and they are still putting money to work. So, there has been some change. Is it all done? No, there is more work to be done but, certainly the news is good.