As what we expected earlier, emerging markets (EMs) equities have bounced back strongly in 2019 on low valuations, increasingly dovish outlook from most of central banks as well as a weaker USD this year. However, India was an exception so far, which has underperformed considerably in the region with MSCI India dropped by 1.2% YTD vs. +7.x% for MSCI Asia during the same period.
In fact, such underperformance was not a surprise to us as we mentioned in early October last year that India has been facing multiple macro headwinds, including deteriorating current account deficit (CAD), weakening Indian Rupee (INR), higher crude oil price, higher central bank policy rate and tighter liquidity environment in India. For now, the big question for most investors is, whether if such underperformance will continue and when will be the good timing for foreign investors to re-enter the market?
Fundamentals have been slightly changed for India, in particular, a surprise interest-rate cut at the Reserve Bank of India (RBI) on Feb 7th has indicated the beginning of monetary policy shift into loosening. The action is braced by falling inflation pressure on favourable food prices together with a moderation in fuel and electricity prices in India. With benign inflation level that is expected to stay within the RBI’s inflation target band of 4% -/+ 2%, India still has ample room to lower the interest rate for supporting the country’s growth in the next 6-12 months if necessary. However, current consensus forecast looks a bit too cautious that expects no rate cut for the next three quarters. Besides, the tight liquidity environment in India has improved and turned into surplus in February, with the weighted average call rate trading below the policy rate. Another positive change for India is that with current crude oil price is much lower than in 2H18, a further deteriorating CAD risk is less of a concern this year.
On the other hand, current underperformance of Indian stock market could be a mix of different reasons. First and the most likely concern from investors was the risks related to the upcoming general election that are due to be held between April and May this year. The battle for Prime Minister Narendra Modi’s re-election bid is closer than anticipated, which could result to Modi’s Bharatiya Janata Party (BJP) to fall short of a majority and the worst-case scenario may come if the government has to be formed from an alliance of many small and regional parties, meaning falling political stability and less investment-friendly business environment if compared to the current BJP-majority government. Secondly, a series of corporate governance issues (e.g., DHFL group, Essel Group and Vedanta) and a bankruptcy filing by Anil Ambani’s wireless carrier have soothed the market sentiment. Thirdly, the high real interest rate in India (almost 3%) relative to the rest of the world (negative or below 1% real rates) have dampened investment in India. Last but not least, the valuation gap between India and EM was still too large due to India’s outperformance in 2018, which has led to more flows into other markets.
Historical evidence has shown that stock markets generally perform well in election year, especially post-election irrespective of the disposition at the Centre (Figure 1), therefore it would not be a surprise to see a rally for India’s equities when we are approaching to the election or post-election. However, election itself generally only boost or hurt sentiment depending on the news flow, while it won’t necessary change the underlying earnings and growth of the country – the key determinants of the stock market over the long term. With current valuation of India’s stock market remain high on absolute and comparable basis, the country’s may need more evidences to reverse its underperformance.
Figure 1. Stock markets perform well around election date
Source: iFund/Noble Apex, Bloomberg
Figure 2. India’s valuation remain unattractive
Source: iFund/Noble Apex, Bloomberg