Download Is it India`s time to shine?

Corporates & Markets
Is it India’s time to shine?
Peter Kinsella
HEAD OF EM
ECONOMIC & EM FX
RESEARCH
peter.kinsella@
commerzbank.com
2016 promises to be an interesting year for investors in India.
Declines in inflation imply that the Reserve Bank of India (RBI)
will be able to cut interest rates significantly. Consequently, we can expect fixed income assets to perform well over the course
of the year. However, political opposition to proposed reforms
means that large scale growth improvements above trend are
unlikely to manifest.
From zero to hero
In 2013, India was included among the so called ‘Fragile Five’
countries which were considered especially vulnerable to a
potential US rate hiking cycle. At the time, India boasted a
significant current account deficit of nearly 5% of GDP which
clearly put India at risk of a sudden stop in current account
financing in the event that external financing costs increased
markedly. Coming into 2016, investors are broadly
enthusiastic about the prospects for Indian growth and for
asset returns. There are two reasons for this large change in
investor sentiment. The first lies with the RBI’s monetary
policy and the second lies with political / economic reform.
In our view, the hype surrounding the RBI’s monetary policy
mix is entirely justified, less so the hype surrounding
political / economic reform.
Aggressive rate hikes stabilised the rupee
The RBI also undertook a series of rate hikes in 2013 which
increased the headline repurchase rate by 75 bps to 8%.
Higher rates stabilised the rupee (INR) which depreciated by
nearly 15% against the USD in the space of one month alone
during the summer of 2013. At one point, USD-INR traded
above 68.00 but it has failed to trade above these levels since
the RBI’s aggressive rate hikes. Although INR weakened
modestly over the course of 2015, it is an impressive
performance when seen in the context of the losses seen
elsewhere in the EM space. This is true not just for
commodity producers in EM but even for other commodity
importers in the EM space.
“India boasted a significant current
account deficit of nearly 5% of GDP”
Chart 1: C
urrent account shows large improvement
Current account as a percentage of GDP
4
2
0
-2
-4
-6
2000
2005
2010
2015
Source: Commerzbank Research, Bloomberg
Chart 2: C
PI well within target range
Consumer Price Index (CPI) year-on-year
14
12
10
8
6
4
2
0
Jan 12
Apr 13
Source: Commerzbank Research, Bloomberg
Jul 14
RBI’s reforms bearing fruit
In 2013, the RBI banned gold imports which accounted for
the lion’s share of the current account deficit. The deficit
subsequently contracted aggressively. At the time of writing,
it prints at 1.1% of GDP, which means that India is clearly less
exposed to an aggressive increase in external financing
costs. As a commodity importer, India stands to benefit from
lower commodity prices and lower energy prices and the
recent declines in commodity prices will likely continue to
have a positive impact upon Indian balance of payments
dynamics over the coming months and quarters. Put simply,
the current account is one area which the Indian authorities
do not have to worry about in the short term. There is a
lesson for many more emerging market countries from the
RBI’s actions: structural reforms can bear fruit.
Oct 15
The significant declines in commodity prices have already
had a large impact upon Indian inflation rates. Headline
Consumer Price Index (CPI) levels printed above 11% briefly
during 2013 but the most recent data show that CPI prints
come in comfortably around the 5% level. This is well below
the RBI’s target for of 6% for January 2016 and this gave it
the excuse it needed to cut interest rates in late 2015 to
6.75%. We expect that headline CPI rates will continue to
decline over the course of 2016 as the lagged effects of
lower commodity prices are felt. Indeed, we will not be
surprised to see inflation rates below the RBI’s target of 5%
by March 2017. The long and the short of this situation is
that inflationary developments will give the RBI significant
scope to ease policy over the course of 2016 and 2017. We
expect that the RBI will take a cautious stance initially with
respect to rate cuts because it will be cognisant of the risks
which come from the US, where consensus expectations
are now for at least two rate hikes from the Fed. From a
currency perspective, this implies that the rupee will
experience a modest weakening trend over the course
of 2016.
The prospect of RBI rate cuts has not been ignored by the
bond market. Indian bond markets enjoyed an excellent
performance in 2015 and we see no reason for this to cease.
Traditionally market participants were always wary of
Thinking Ahead March 2016
2
getting into long Indian bond positions due to highly volatile
inflation prints. What we now see is that inflation illustrates a
decreasing profile not just in India but globally. As the
prospect of further supply side reforms (more on this below)
comes into focus, this implies that Indian fixed income assets
should enjoy a decent year. The prospect of Indian bonds
becoming available through Euroclear later in 2016 will
doubtless add to investor interest. All told, we think there
are realistic prospects for further outperformance over the
course of 2016.
Chart 3: INR one of the ‘best’ performing EM currencies
in 2015
Total return of INR vs USD as a percentage
5
0
-5
-10
-15
-20
-25
-30
For the first time in a generation the prospect of an explicitly
market-friendly administration in India was a real prospect.
Equity markets rallied significantly. The Sensex index alone
rallied by nearly 35% during the second half of 2014.
Specifically Modi’s reform programme included promises to
liberalise the labour market, reform the taxation system and
institute land reforms. Any one of these reforms alone
would be enough to boost potential GDP growth over the
medium term, but all three together imply a sea change in
Indian economic performance. However, this is easier said
than done. Land reform, in particular, is fraught with
difficulty owing to incomplete property records in some
areas and a notoriously slow property registration system.
Although compulsory purchase orders would allow
investors to increase productive capacity in a meaningful
way, so far these proposed reforms were stymied by
growing political opposition.
Bharatiya Janata Party’s (BJP) loss of the Bihar state election
is a case in point. The loss prevents Modi from pushing
through reforms and consequently we have to acknowledge
that the chances of reform implementation are clearly
slipping. Indeed of all the ‘big ticket’ proposed reforms none
have been meaningfully enacted. Consequently, we maintain
a more sanguine view for Indian economic growth than
most. We envisage decent growth in the region of 6.5% for
2016, which is significantly below consensus expectations.
BRL
COP
TRY
ZAR
RUB
CLP
MYR
RON
MXN
IDR
PLN
THB
HUF
KR
CZK
INR
CNY
HKD
-40
PHP
-35
TWD
Great Expectations
Rarely has an Indian prime minister entered office with such
heavy expectations. What differentiates Prime Minister, Modi
from previous administrations is that his election gave a clear
mandate to effect wholesale reform. Previous administrations
were foiled at attempts to reform by vested interests and a
lack of political backing. This is why Modi’s election in 2014
was a game changer. Unlike previous administrations, Modi
enjoyed widespread political as well as popular support in
favour of his reform programme.
Source: Commerzbank Research, Bloomberg
Chart 4: Sensex gives Modi benefit of the doubt
If there is no Value then stretch the Chart to the top of the artboard
32
Sensex index in 000’s, ie the Index currently trades at 26,000
30
28
26
24
22
20
18
Dec 12
Dec 13
Dec 14
Dec 15
Source: Commerzbank Research, Bloomberg
50% Blue
Overall – a constructive outlook
In our view, there are good reasons to expect a decent
economic performance in 2016, albeit that this is largely
due to anticipated declines in inflation prints and
subsequent RBI rate cuts. Any windfall from political
reforms remains distant however.
Thinking Ahead March 2016
ITC Zapf Dingbats
medium square
3
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