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Modi’s India One Year On: A false dawn?

Indian equities have sold off in recent months, but opportunities may remain.

It has been a year now since Narendra Modi was swept to power as Prime Minister of India in a decisive victory for the Hindu nationalist Bharatiya Janata Party (BJP) in a crushing defeat for the Congress party which suffered its worst electoral result ever. The BJP secured 282 seats out of 543 in the parliament; a majority which was further cemented by the support of other parties in the National Democratic Alliance which extended the seats stacked-up behind Modi to 343 -  63% of the parliament.

With widespread support from across all sections of Indian society, Modi – a former Governor of Gujarat with a reputation for economic management but nevertheless controversial for his Hindu nationalism– was handed an almost unprecedented mandate for reform and consequently, as the chart below shows, Indian equities enjoyed an extraordinary rally until the start of this year both in absolute terms and compared to the broader benchmark of emerging market equities. However, since India’s Sensex Index hit a record high at the end of January, gains have been paired and there have also been a high number of earnings downgrades.

One year on from the election of the Modi government provides a time to assess whether India’s reformist BJP-led government has lived up to the incredibly high expectations set 12-months ago.

Graph 28-05-2015

The Positives

There is little doubt that the elections of 12-months ago have helped raise the profile of India on the world stage. On the back of his euphoric victory, Modi has been feted around the globe selling India as a place to do business and presenting a more confident, outward looking impression of India as an emerging economic giant at a time when its chief rival, China, has been grappling with its alarming credit growth and managing a slowdown in its rate of economic expansion to a more sustainable level. Perceptions are important as India seeks to attract more Foreign Direct Investment, especially when matched with tangible measures to open India up such as raising the level of FDI permitted in the insurance and defence industries from 25% to 49%, a move instituted in its first Budget.

The Indian economy is expected to grow by around 7.5%  during 2015 according to International Monetary Fund estimates, ahead of the 6.8% projected for China, and up from 7.2% in 2014. In this respect it has been helped by the weakness in global oil prices since last summer. India imports 80% of its oil, so this has proved a major boost to the economy and helped to keep inflation under control, in turn allowing the Reserve Bank of India to have cut interest rates twice and with the potential to go further. Although low oil prices undoubtedly represent a lucky break for the Indian government, not the outcome of its policies, it has provided it with the cover to implement cuts to fuel subsidies and increase in fuel taxes.

The Indian government has also made progress in areas such as the opening of millions of new bank accounts for the country’s rural poor, a crackdown on civil service absenteeism and so far there have been no large scale corruption scandals under the BJP-government which might be seen as a positive sign that Modi is delivering on his commitment to rid India of corruption.

The Disappointments

It is however also the case that markets have a habit of overreacting both on the way up and down. Having seen the Indian stock market propel to a record level on the back of Modi-mania, some investors have started to express feelings of being underwhelmed at the pace of progress in implementing deep structural reforms during the first year of the Modi premiership.

In particular, the creation of a unified Goods & Services Tax (GST) – a form of VAT aimed at replacing a swathe of indirect taxes - and a Land Acquisition Bill enabling the central and state governments to acquire land for infrastructure projects, have stalled in the face of opposition within India’s second legislative chamber.

Invest in India?

While the more incremental and pragmatic approach to reform may be frustrating to those expecting more radical measures, Rome wasn’t built in day. A key risk from all the exuberance a year ago was that expectations were running simply too high with little room for perceived failure. The sell-off in Indian equities – likely down to a combination of profit taking, earnings disappointments and hot money switching into Chinese equities - may actually prove healthy in taking some of the steam out of the pressure cooker and returning Indian equity valuations to levels that provide a more tolerable entry point for long-term investors convinced by the growth story. At just over 19 times earnings, the Indian equity market isn’t “cheap” – few markets are at the moment – and is at a premium to broader emerging markets but as the graph below shows, this is broadly in line with longer term trends.

Graph2 28-05-2015

For most investors we favour exposure to India from allocations within global emerging market funds or investment trusts. Amongst those we rate highly, the JP Morgan Emerging Markets Investment Trust, currently trading at 10.7% discount to net asset value, has a 20.4% exposure to India (compared to a 6.5% benchmark weighting) holding the likes of Housing Development Finance, Tata Consultancy Services, IndusInd Bank and information technology firm Infosys, while the Fidelity Emerging Markets OEIC has 18.5% exposure to India with large holdings including HDFC Bank and Tata Motors.

For those with sizeable portfolios and willing to take country-specific risk, we rate the Aberdeen Global Indian Equity D2 GBP fund, a concentrated 30-stock portfolio invested in leading India companies including HDFC Bank, Infosys, ICIC Bank and Tata Consultancy Services.

The value of your investment can go down as well as up, and you can get back less than you originally invested.

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