Pic By BLOOMBERG
Indian equities, as represented by the Sensex Index, clocked a 7.8% return as of Nov 17, since April, thus bringing a year-to-date (YTD) return to 22.9% in ringgit terms.
India’s macroeconomic picture remains intact with ongoing reforms constructive for equities despite challenges for the real economy.
India posted a 5.7% quarterly gross domestic product (GDP) growth, a three-year low figure due to the slowdown in investment activities.
Gross fixed capital formation (GFCF), one of the main thrusts to India’s growth engine as it accounts for close to 30% of GDP, has undergone a decelerating trend over the recent quarters, which coincided with the deceleration in headline GDP growth.
The deceleration has been noticed since GFCF clocked an 8.3% growth in the fourth quarter of 2015/16.
In periods between 2014 and 2015, the Reserve Bank of India (RBI) slashed its reverse repo rate by a total of 175 basis points.
The aggressive rate cuts successfully spurred lending activities to corporates and businesses, swelling the banking sector’s loan book and led to the rapid growth in GFCF across the period.
Indian corporates’ interest coverage ratio, a measure of the firm’s ability to repay debt, has also deteriorated over the past few years, depicting increased strains to the balance sheets of Indian firms.
Although the impact from demonetisation may have eased, the implementation of the Goods and Services Tax in July could have brought another wave of uncertainties for the Indian consumers.
The excess corporate debt also increases risks to banks as the overall quality of the banking sector’s loan book, as portrayed by the non-performing asset (NPA) ratio, has worsened over the recent periods, particularly at state-owned banks.
An increasing NPA ratio cripples the lending ability and reduces capital buffers of financial institutions, which may hamper India’s economic growth.
The slowdown in economic growth potentially reduces the ability of Indian corporates to repay debt, creating a vicious cycle.
Last week, Moody’s Investors Service Inc upgraded India’s sovereign rating from Baa3 to Baa2, India’s local currency senior unsecured rating to Baa2 from Baa3 and its shortterm currency rating to P-2 from P-3.
The upgrade was done on the expectation of continued progress on the economic and institutional reforms, which will continue to enhance India’s growth potential in the medium- to longer-term.
The current reforms and structural changes are also paving a stable financing base for government debt, which could help ease fiscal spending pressures over time.
The upgrade in sovereign ratings has the tendency to drive financing cost lower and stimulate the subdued investment activities.
The 2017-18 earnings estimates have been revised downward by 11% YTD, with analysts projecting lower earnings ahead for Indian firms amid a slowdown in the overall economic growth.
Valuation-wise, 2017-2018’s price-earnings (PE) multiple is now at 21.8 times, which is 21.1% higher than our fair PE of 18 times. Looking forward, however, 2018-19’s PE is still sitting at a slight discount of 5%, helped by a robust earnings growth projected in the next fiscal year.
To sum it up, we maintain a positive view on India’s economy as the reform stories are already underway and the overall macroeconomic picture remains intact.
While consumers and businesses may experience hiccup in the short to medium term, we are confident the reforms will eventually forge a stronger foundation for the Indian economy.
While equity valuation may appear steep at this juncture, we believe the Indian market is still an attractive option given its long-term prospects.