India:is it more than just liquidity?What caught my eye?v.75

In this issue we ask why we remain overweight India. It is one of the best EMsYTD and (as usual) its EPS estimates and multiples are high, so why invest?India continues to present a mixed macro-economic picture. On the positiveside, demonetization turned out to be far less damaging than expected, withingenuity of India’s private sector rescuing the Government from a potentially fardeeper hole. Whether one looks at consumption, motor vehicle sales or domesticliquidity, normality has been restored. Also, the focus on agriculture and debtwrite-offs did not come at the cost of public infrastructure, with significantincrease pencilled-into FY’18 budget. The economy remains resilient, andalthough doubts remain whether new numbers overstate real growth rates, Indiaremains one of the few EMs that is able to deliver ~10%+ nominal GDP growth.

On the negative side, banking sector remains stressed, with no obvious solutionsin sight, while the corporate sector is devoting up to 35% of gross profit to payinterest on debt. The combination of low capacity utilization and over leveragingis precluding any meaningful pick-up in private sector investment. Hence, Indiacontinues to over-consume and under-invest. There is also no evidence of anymeaningful pick-up in manufacturing, while the services backbone is weakening.

Although we were never bullish on the prospects for Modi Government structuralreforms and viewed excitement of ‘14/15 as a form of collective hallucination,neither do we see any sustained structural agendas in other EMs, with not muchemerging from such potential candidates as Indonesia, Thailand, Mal or China,while some countries seem to be in danger of reversing (Mexico, SA and Phil). Inthis context, India’s introduction of a GST tax (which for the first time has thepotential to create an integrated national economy) and robust usage oftechnology to bypass bureaucracy and create a basis for less corrupt distributionof services and subsidies are steps in the right direction. Even demonetizationmight ultimately lead to a wider taxation net while lowering corruption. Limitedprogress on deep structural reforms is not unexpected (as domestic reforms aregenuinely hard), but India is progressing at a far more robust pace than most.

The promise of structural reforms is complemented by India’s stablemacro outlook and contained inflation. India remains the beneficiary of thecurrent global ‘goldilocks’, with China-driven reflation balanced by global CBsthat are keeping global liquidity, US$ and commodities broadly pinned down inthe middle of the range. This continues to reduce India’s external vulnerabilities.

Although fragilities remain, so long as commodities do not shift aggressively (upor down) and the US$ remains in a neutral gear, the Government maintainsfreedom of decision making (fiscal and monetary). At the same time, India’sdomestic liquidity continues to swell; confidence remains high while India’sexposure to any potential global trade dislocation remains one of EMs lowest.

Our overweight on MSCI India is therefore not predicated on expectation of anaccelerated pay-off from structural reforms or rapidly rising fixed investment, andwe continue to regard ‘Make in India’ campaign as a distraction; neither is itbased on EPS estimates that remain high (~19%) or multiples (17x-18x). We arein India because it is one of the few global and EM economies that is capable ofdelivering growth and productivity gains with a stable macro outlook and limitedexternal vulnerabilities. We are also in India because it is a domestic economy,populated by a plethora of solid corporates and finally, we believe that strongdomestic liquidity is more secular rather than cyclical in nature and should besupported by the Government’s structural agenda and demonetization.