Are the prospects still bright for Indian equities?

Indian stocks remain a bright spot on the horizon in Asia, even though the MSCI India posted a gain of over 20% in 2014.

Cooling inflationary pressures, a pro-growth government and an economy relatively sheltered from a potential economic slowdown, should provide long-term support for Indian shares.

Inflation easing

One of the key factors driving this optimism is that India’s chronic inflationary pressures, which have plagued the economy over the last few years, have finally started to subside.

Weak commodity prices, particularly the plunging price of oil, have contributed in bringing down inflation to the current level of around 5% compared to the 11% at the end of 2013 (see Figure 1).

Figure 1 – Moderating inflationary pressure

Source: Office of the Economic Adviser, Citi Research, December 2014.

Easing inflation pressure has set the stage for the monetary easing cycle to commence.

Modi government laying foundations for growth

In addition, the strong mandate given to the pro-growth and pro-reform government of Prime Minister Modi makes it more likely that India’s vast long-term economic growth potential will be realised.

A lot of media commentary has been focused on the recent Indian budget at the end of February, with talk of ‘big bang’ reforms for the economy. Although it was not as revolutionary as many were hoping, there were still many positives.

These included a 25% increase in budgetary allocations to infrastructure capital expenditure, which should support growth given the economy’s infrastructure is in dire need of investment (see Figure 2).

Figure 2 – Trends in investment

Source: CSO, Citi Research, December 2014.

With the economic outlook improving, sentiment in markets has been high.

Indian stocks could provide storm shelter

If the regional or global economy were to experience a sudden slowdown – investors remain concerned over the stability of the recovery in the US and the economic struggles in China and Europe – we believe that the impact on the Indian economy would be negligible.

Luckily for investors, India’s economy is largely domestically-driven and if there is a global slowdown then it should only negatively impact niche sectors like IT services, which derive most of their revenues from developed economies.

As for the rest of Asia, India has limited trade flows with the region and is, therefore, relatively sheltered from any such dip in growth rates. However, the outlook does not come without risks.

Risk reversal

India is a large net oil importer and is currently benefitting from the lower oil price in terms of reduced import costs and fuel subsidies. So, the key risk would be a reversal of the sentiment that has been driving stock prices; namely the reversal of weak commodity prices.

Besides this, India faces many of the same risks as other emerging markets such as fund flow reversals on the back of weak sentiment for the asset class or a stronger US dollar.

Focus on fundamentals

When seeking out which stocks to hold, we are fundamental bottom-up investors, which means we are looking for good quality companies and not choosing companies based on which sector they are in, and we stick strictly to this principle. Our investment horizon is long term.

Typically, this means we look for earnings growth, competitive positioning of a company in its industry, overall returns of the business, valuations and corporate governance.