Emerging markets such as India, long vulnerable to the whims of central banks in the developed world, now seem to be more Fed-proof than ever.
Sanctum Wealth Management
2017 will be remembered as the year India, and most global markets delivered stellar returns.
Let’s step back for a larger perspective. Viewed from the peak of 2007 (+9% CAGR), the bottom of 2009 (+17% CAGR), or from 2000 (+13% CAGR), India is now the top performing large market in the world.
Moreover, India’s acceleration in performance since 2014 has been impressive with two good years out of four.
Despite these strong performance numbers, foreign investors (FIs) state that India’s one percent allocation in the global MSCI is too small for it to hold a meaningful allocation – and attention – in their portfolios.
Per MSCI, emerging-markets stocks made up about 11.6 percent of the global stock market using the MSCI All-Country World Index as of the end of prior quarter.
Three decades ago, emerging markets represented less than 1 percent of the world’s investable equity market capitalization. Fast forward to today. There are projections that India will be a $5 trillion economy by 2025.
India’s $2.2 trillion makes it the seventh largest by nominal GDP. Yet, India’s allocation to the MSCI Global index is about one percent. A similar discrepancy seems to exist with respect to India’s allocation in the MSCI Emerging Markets index.
We think this is an important reason why greater FI flows have not found their way to India over the past few years.
Alongside index allocations, Indian corporates have not delivered earnings growth at the index level, and demonetization alongside the Trump reflation trade led to outflows in late 2016.
Looking ahead to 2018, the Citi Surprise index for developed markets is near the highest levels it’s been in the past few years, while India’s Citi Surprise index is trending higher into positive territory.
Based on extensive research we’ve conducted across timelines and geographies, we expect the reform agenda pursued by the government to deliver sustainable growth in 2018.Ground level green shoots are visible already. Sectors that were a drag on earnings at the index level are repairing themselves, such as PSUs, Telecommunications, Materials and Real Estate.
The government’s wave of reforms will yield multiplier benefits.
With an Aadhaar driven economy where every bank account, mobile phone, demat account, investment account and bill payment history is centralized, the government has effectively transformed the domestic economy in a matter of months from largely unorganized and unreported, to organized and reported.
The benefits are, in our opinion, likely to be substantial, with lower costs of capital, greater transparency, increasing tax collections, rising productivity and an improvement in operating efficiency.
Forward earnings growth estimates are also in favor of India. The projected three-year growth rate for earnings in India is 18.6 percent, whereas the projected growth rate for earnings in developed markets such as the U.S. is 11.9 percent.
We think FIs will return to India aggressively on debt purchases, with the recent rise in yields making domestic bonds look attractive. The Indian government is likely to allow foreign investors to increase purchases of the nation’s debt.
The cap on foreign portfolio investments may be raised by $5 billion to $10 billion. Additionally, the RBI’s decision to reclassify masala bonds by excluding them from the FPI investment limit will free up investment limits. We expect FIs to continue to snap up domestic debt, whether it be government, state or corporate bonds.
On equities, FIs were net buyers in 2017 but at lower levels compared to previous years. With the unwinding of central bank liquidity, FIs are likely to find increasing favor with emerging markets.
With GST and demonetization behind us, and easy compares on earnings ahead, we believe the relative attractiveness of India will stand out in 2018.
India happens to be home to 430 million Millennials. With strong demographics, a reform driven agenda that has addressed the nation’s systemic banking risk, and with a growth platform in place, we think 2018 will be a year the Indian economy experiences the pro-growth benefits from a wave of reforms.
Emerging markets such as India, long vulnerable to the whims of central banks in the developed world, now seem to be more Fed-proof than ever. The exchange rate has also remained stable and is likely to continue to do so.
Within emerging markets, as well, India remains well positioned. India’s earnings growth remains in excess of projections for MSCI Emerging. Further, the Citi surprise index clearly demonstrates that the upward trending momentum for India is more attractive than the downward trajectory for other emerging markets.
Finally, it’s unclear how developed markets will respond to the withdrawal of liquidity by central banks, and rising rates and a hawkish Fed in the U.S. Should the short end continue to rise, and the spread continues to narrow, a rotation to emerging markets remains an attractive option for FIs and India is likely to benefit.
More broadly, we question whether countries like India, already amongst the top 10 economies in the world on market cap, with low debt, a healthy banking system, strong reserves, stable strong growth, low inflation and a strong political regime, deserve the moniker of “emerging”, and whether a one percent allocation to the eighth largest market in the world is appropriate.
Disclaimer: The author is Chief Investment Officer, Sanctum Wealth Management. The views and investment tips expressed by the investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.