Our starting point is, as usual, valuations, and India trades at an estimated forward PE of 14.1x, close to its historical average of 14.2x and more than the region, which trades in aggregate at 11.9x (MSCI AC Asia Pacific ex Japan). Although there are more expensive markets within the region – Australia 14.6x; HK 14.8x, Malaysia 15.4x and the Philippines on 18.5x – the high valuation still needs more justification.
Unfortunately we do not find it, or rather we see more risks than lie elsewhere. India has a significant current account deficit, which has ballooned to 5.3% of GDP in 2Q13. Although it is likely to fall into 2014, it still means that India is more potentially exposed to the volatility from capital flows. This was evident in recent currency weakness that took the Rupee from 54 to the US$ in May to a low of over 68 in August (although this has recently recovered to 62).
The current account deficit is compounded by the ongoing budget deficit, with the 2014 year (ending in March) expected by CLSA to be approximately 4.8% of GDP. The year’s government spending seems to be reaching levels where it is less likely that government spending will be used to prop up the economy, even though the first quarter (until June) 2014 GDP growth reached a 17 quarter low of 4.4% year-on-year. India’s growth has been on a downward trajectory since it reached close to 10% in the first quarter of 2011. A government mired in corruption allegations and increased public scrutiny has led to an overcautious bureaucracy resulting in a significant slowdown in project approvals, which will impact future growth.
Given the upcoming national elections due to be held before May 2014, it is unlikely that any major reforms will be initiated in the near term. Also, recent opinion polls suggest a fractured verdict that means a weak coalition government dependent on the support of regional parties will be formed, which will be a further setback to much needed reforms.
This, and the imported inflation with a weaker currency that has made the government raise rates at a time when growth is so weak, make a strong recover less likely. To our minds, the lack of infrastructure investment over decades is likely to make inflation potentially a greater burden due to supply side constraints.
For these reasons, we would like to see a greater discount than the current valuations before investing in India in any size. Although there are a number of well managed companies in India we can find what we believe to be cheaper, potentially less risky investments elsewhere in the region.
