Indian economy to show signs of recovery in the medium term, says report by Alpen Asset Advisors

Alpen Asset Advisors Limited, the newly created Independent Financial Advisory and Asset Management Company and associate of the investment bank, Alpen Capital published its “India Market Outlook for 2013-14”.

According to the report, in 2013, Indian equities have been a lot more volatile vis-à-vis initial expectations. Also, 1QFY14 earnings season was below par, with net income down almost 7% YoY despite the 4% YoY growth in sales. Higher interest costs and depreciation led to a contraction at the net margin level. The sharp fall in the rupee also contributed to lower-than-expected operating performance. However, the performance of the IT sector was relatively better as improvements in the US economy accelerated revenue growth and weak USD/INR aided margins.

On the macro front, performances of key indicators such as inflation, IIP, and fiscal deficit have been mixed. In fact, the sudden sharp decline in the rupee has, to some extent, meddled with RBI’s plans of curbing the fiscal deficit and adopting a growth friendly stance on interest rates. Factors such as a stable and sustained recovery in the US, an unlikely scenario of further deterioration in the Eurozone, slow, but persistent improvements in the domestic policy, and investor-friendly investment and rate cycles could act as mid-term catalysts for a recovery in the Indian economy. However, the GDP growth forecast of 6.4% for FY14, as estimated by the Prime Minister’s Economic Advisory Council (EAC), is well above the consensus estimate and could still prove to be aggressive, given that GDP growth was just 5% in FY13. That said, India’s general elections, to be held in May 2014, could have some impact on market movements. Historically, election periods in India have been characterised by high market volatility, which seems likely this time as well, given the lack of clarity of the eventual mandate so far.

“Despite a choppy performance year to date, we expect the Sensex to close with a clear outperformance over the MSCI Emerging Market Index. The appointment of the new RBI Governor, Dr Rajan has come as a breath of fresh air and the announcement of initiatives have positively impacted the market. This was evident from the way the Sensex has recouped all the recent losses and Rupee from its all-time lows. While a lot needs to be done in terms of structural reforms, we believe it is a matter of time before the initiatives start bearing fruits. We are positive on the India’s growth story and look at the current weakness as an opportunity to add to our clients’ exposure”, says Rohit Walia, Executive Chairman, Alpen Asset Advisors Limited

Themes to watch out for
Alpen Asset Advisors highlights the existence of certain key themes that would be favorable for the India markets in 2013-14. The themes are mentioned below.

Time to act on those reforms
In late 2012, the government and the finance minister initiated structural reforms aimed towards economic development in the country. The government announced a clutch of policy measures, such as the opening up of certain sectors to foreign investment and rationalization of subsidies. In 2013, we expect the government to push ahead with discussions for passing several Union Cabinet-approved bills in the Parliament.

It remains to be seen whether these policies and reforms would have an on-the-ground impact and help the government achieve its goal of 6.4% GDP growth and easing fiscal deficit to 4.8% in FY14; irrespective of their impact, they are steps in the right direction for better execution. Furthermore, the government has recently postponed the implementation of the controversial General Anti-Avoidance Rules (GAAR) by two years. GAAR would now come into effect from April 1, 2016.

Stabilisation in oil prices and rising government spending
Recent stabilization in oil prices is likely to improve the fiscal position of GCC governments and encourage investments in non-oil sectors. Refining and infrastructure projects worth US$ 700 billion are likely to be undertaken in the region. Rising government spending would boost the region's economic performance in 2013.

Inflation now within RBI’s comfort zone
July 2013 saw an increase in inflation with the WPI print coming in at around 5.8%. The increase was largely on account of higher food prices and costlier imports due to weak rupee. While the pressure on the WPI is likely to stay in the immediate term, due to the sharp fall in the rupee in August, the overall inflation trend appears to be closer to RBI’s comfort zone. With rupee having recovered around 8% since its low of INR68.8 versus the USD, WPI should see an improvement and thus give RBI the window to cut rates. While the RBI has maintained a vigilant stance even at the time of the last cut of 25 bps in repo rate in early May, the most recent inflation print has prompted the Central Bank to acknowledge the fall. Furthermore, India’s consumer price inflation also slowed for the second straight month in August 2013 to 9.5%, however, still remains high in absolute terms as per RBI. The RBI expects FY14 WPI inflation to be below 7% and average around 6.5%. As we have highlighted earlier, we expect RBI to keep intent for policy rate cuts as and when rupee regains comfortable level. The RBI may continue to use Open Market Operations (OMO) to inject liquidity in to the system. However, at the same time, we advise keeping an eye open for a subsequent inflationary situation.

Deficits to determine rupee trend
For the rupee, we expect support to largely come from a pick-up in FII inflows into the Indian equity market. We believe a combination of the following factors should help the rupee in the near future:
• Credible roadmap to a deficit reduction program
• Continued QE-driven liquidity in Western markets, at-least for the next few quarters
• RBI’s ability to bolster foreign exchange reserves
• Rebound in macro economic data and improved market sentiment

Modest recovery in investment cycle
India’s investment cycle has slowed down considerably affected by the reforms deadlock arising from political uncertainty, slowdown worries, tight liquidity and a high interest rate environment. The measures announced in FY 2013-14 would at least incrementally shore up investment confidence in India and lead to capital formation over the next 12–24 months. Furthermore, a reversal of the interest rate cycle in 2013 would reduce the cost of capital and facilitate financing. Additionally, we expect capital raising activity by way of IPOs to also pick up in the second half of 2013, led by an improvement in market sentiment that will further aid fixed investments in the country. Limited downside to FY14 India Inc. earnings
The 1QFY14 earnings season was below par with net income down almost 7% YoY even as sales grew 4% YoY. Higher interest costs and depreciation led to contraction at the net margin level. The sharp fall in the rupee has also contributed to lower than expected operating performances. The IT sector however, saw a better performance given improvements in the US economy driving revenue growth and weak USD/INR aiding margins. Despite weaker than expected 1QFY14 results, a favourable interest rate cycle coming up, rupee stability from here on and expectations of improvements in global and domestic demand environment should limit downside to current FY2014 earnings growth

Expectations of higher volatility going into 2014 elections
India’s general elections have historically had an impact on the stock market, currency movement, and government yields. Although the direction of the movement depends on the anticipation and the outcome of the elections, market swings, in the past, have been fairly volatile during the pre and post election periods.

Select Sectors in Focus
While the global economy is still on the path to recovery, the areas of strength (US) are expected to sustain, whereas weaknesses (Eurozone) are unlikely to deteriorate materially. Also, India’s economic growth is unlikely to weaken further, given the government’s focus on eliminating hurdles in stalled projects, spurring investments in new infrastructure projects and easing foreign ownership norms. However, considering the slide in the rupee and uncertainty related to a reversal in the rate cycle, we believe a mix of defensive and rate-sensitive sectors, such as IT, FMCG, Banking, Auto and Realty would be in focus. The Indian IT Services sector is expected to benefit from an incremental leg-up in the global economy over the medium term. In our opinion, large-sized IT deals are likely to return to the market with increasing focus on offshoring resulting in market share gains for Indian large cap vendors vis-à-vis global peers such as IBM and Accenture.

For more details please click here to access the complete version of the India Market Outlook 2013-14 Report.