OMGI’s Crabb: The Indian Summer is just getting started

Crabb Josh Old Mutual 2014

After five long years in the wilderness, Asian equities are finally back on investor radars, the combination of China’s growth stabilising and a reining in of the US dollar’s inexorable rise. Historically, a stronger dollar has hurt Asian economies due to the extent of their large dollar-denominated borrowings. Yet, if political jitters over Brexit, as well as uncertainty over forthcoming European and US elections, is driving fund flows back to Asia, one jewel is shining brightly. That is India.

While more needs to be done, significant progress has been made on both the economic and political fronts. The benefits of living with a lower oil price (India imports over 80 per cent of its oil consumption currently), a more controlled inflation rate (just over 6 per cent) and corresponding currency stabilisation of the Indian rupee, mean analysts are confident of growth hovering around 7.5 per cent for the full year. This despite first quarter GDP numbers coming in slightly below expectations.

Rising demand at home and attracting foreign investment abroad are just two objectives to ensure growth stays on a sustainable path. Prime Minister Narendra Modi’s attempts at making foreign investment a priority is paying off in spades. The healthy flows are, in part, due to a radical liberalisation of foreign investments by relaxing ownership restrictions on companies ranging from pharmaceuticals to defence.

According to recent statistics, as a percentage of GDP, India has overtaken China as a global destination for attracting net foreign direct investment flows, securing $63bn worth of projects in 2015. This is testimony to Modi’s ‘Make in India’ campaign, an ongoing initiative designed to put India on the world’s manufacturing map.

Increased government infrastructure spend is also a key initiative as a means of bolstering the country’s tired infrastructure network. Government spending on projects is particularly prevalent in the construction, engineering, machinery, cement, defence and railroad sectors. In an ambitious drive to speed up execution, the Indian prime minister has set targets for key ministries that have to be met by the end of the financial year and which will be reviewed by him, personally, on a quarterly basis. Yet despite intervention at the highest level, it appears more funding is needed. According to analysts at Goldman Sachs the country may require at least $1trn in investment over the next five years if Modi is to fulfil his promises to spur growth.

A notable weak spot in the Indian economy has been the banking system, something Modi is keen to address. Reform of the country’s banking sector has made some significant headway recently with the passing of a new, single bankruptcy code, making it easier and quicker for banks to recover bad loans.

The key initiatives of government capex spending and structural reform reinforce our belief that India’s cyclical recovery is not only underway but well on track. With significant exposure to India, we are positioned in economically sensitive companies, rather than, what we consider to be, expensive defensives. This means our company holdings are different from those of our peer group. We believe trades in quality stocks such as Hindustan Unilever and ITC, trading on 44x and 29x forward earnings respectively have become too crowded and, sitting on such rich multiples, leave no room for earnings’ disappointments.

Amongst financial stocks, which we see as key beneficiaries of banking reform, our principal holdings constitute State Bank of India, Bank of India and Allahabad Bank. In infrastructure we favour the Steel Authority of India, Ramco Cements and Adani Ports. We also continue to like downstream energy stocks on the back of improving marketing margins.

At the time of writing, the S&P BSE Sensex index trades on a forward earnings multiple of 15.3x earnings. That’s not particularly cheap relative to the MSCI Asia Pacific ex- Japan index which trades on 12.8x earnings but sectors within India, particularly those cyclical companies that are poised for an upturn in earnings, are attractive in our view. It’s not just a favourable combination of economic and political factors that have come together. Nature, too, has played her part in adding to improving prospects, with heavy rains boosting the yields of kharif, or Monsoon-related, crops such as rice and millet, (and which, in turn, has helped our holdings of a ‘monsoon basket’ of stocks). While Modi is keen to speed up the movement of workers from the countryside to the towns, that’s good news for the country’s 500 million people, over half of whom continue to depend on the country’s agricultural sector.

Josh Crabb is head of Asian equities at Old Mutual Global Investors.