After a stellar run in 2007, India was amongst the worst-performing equity markets in 2008, a situation exacerbated by its inflated valuations and high beta characteristics. FII inflows of around US$17 billion in 2007 were followed by approximately US$14 billion of outflows in 2008, on the back of the global financial crisis, a collapse in investor risk appetite and a loss of faith in the decoupling argument. In absolute terms, the global flight to safety drove the country’s benchmark BSE Sensex Index from a high of 20,873 on 8 January 2008 to a low of 8,451 on 20 November.
India has also faced several major challenges from a macro perspective of late. With exports of goods and services having risen to from 15% to 25% of GDP over the past five years, the country is considerably more exposed to the global economy than has been the case in the past. The economy is clearly slowing; Q3 GDP growth of 7.6% is the lowest figure for four years and annual GDP is forecast to tick down to 6-7% in 2009 versus 9% for the fiscal year 2007-08. Exports are declining; October saw a 12.1% y-on-y decline (the first fall since October 2001), due to lower demand for clothing textiles, leather goods and jewellery. Inflation has been a further headwind this year, peaking at 12.9% in August on the back of higher food, energy and materials prices. Lastly, the currency has depreciated by over 20% this year, not helped by the heavy FII outflows; this decline in the rupee more than outweighs its 15% rise in 2007. Whilst this is positive for the exporters, it has negative implications on returns for foreign investors.
In India, as elsewhere, this year’s flight to quality has seen the strong outperformance of defensive sectors such as consumer staples and healthcare and the heavy underperformance of cyclical sectors such as real estate and construction. Not only has the domestic property boom in the country come to an end, but the tighter credit conditions and increased cost of funding have put future infrastructure projects and other capital expenditure into question. Tighter credit conditions have also impacted consumer demand for high ticket items such as cars. By contrast, personal care and other staples companies are enjoying rising demand as higher incomes lead more and more Indian consumers to use these products and move up the value scale.
The shift to a more defensive stance can be seen in the dedicated Indian portfolios; the fund managers have raised their exposure to large caps and increased their focus on companies offering quality management, unleveraged balance sheets and sustainable earnings. They are clearly stress testing companies to a greater extent and carrying out more scenario analysis on the assumption the global environment will remain extremely challenging and trading conditions will deteriorate further from here.
Looking at India in a wider context, it is notable that, whilst the PE of the Sensex has halved to around 10x, which is comparable to developed markets, the market has historically traded at a premium to other emerging markets, largely due to the quality and the high ROEs of its companies. Although it is more exposed to the global economy than previously, it is notably less dependent on exports than many other emerging markets and boasts a broader mix of goods and services exports. On a relative basis, its forecast GDP growth of 6-7% in 2009 looks very appealing in the current, fast-deteriorating global economic environment.
This leads us to believe that the long-term investment case for India remains intact, as it captures a growing percentage of the global economy along with China and continues to benefit from strong secular growth themes such as consumption, outsourcing and infrastructure. We are less comfortable with its short-term prospects; its high beta characteristics require a marked reduction in global investor risk aversion and more certainty on its political environment ahead of the general elections which must take place by May 2009. The recent tragic terror attacks in Mumbai have also raised its risk profile in the very short term and, additionally, could impact trading patterns if there is a significant decrease in visitors and exports.