India’s growth outlook keeps getting better

December 8, 2014

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

India’s economy, which has slowly been getting back on its feet in 2014, may be perfectly poised for an outstanding 2015. Although the Reserve Bank of India kept policy rates unchanged on Dec. 2, its dovish stance and indications regarding a change in its future monetary policy decisions have been greatly encouraging and should delight debt and equity investors alike.

If lower inflation persists along with restrained inflationary expectations and an encouraging fiscal position, we may see interest rates being cut in the first quarter of next year.

Another enormous economic advantage we now have is that the commodity super-cycle of the past few years has come to an end. Energy prices have fallen and crude now languishes below $75 a barrel. This will give a huge fillip to the Indian economy as every drop in energy prices has a positive impact on GDP growth. Lower commodity prices in base metals also help lower input costs for the manufacturing sector and boosts corporate profits.

Cut to another segment – savings. With inflation dropping to a new multi-year low in October, the real rate of returns for investors has risen. This will attract more of them to financial assets and wean them away from physical assets. It may be recalled that in the past few years, we have seen investors seeking physical assets to hedge against the vagaries of inflation and volatility. With inflation now benign, that would be a thing of the past. As a result, the savings rate could pick up going forward.

India’s robust population has the potential to see substantially increased savings in the next few years and sustainable economic growth rates in the years ahead. An economy derives growth from savings multiplied by the incremental capital-output ratio (ICOR). After China, India has the highest savings rate, ahead of many advanced economies. As a result, an increase in savings should easily reflect in higher GDP growth rate.

The present 2.3 percent allocation of Indian household savings toward equity is not encouraging. This clearly shows that retail investors have under-invested in financials such as equity and debt and over-invested in physical assets like gold and real estate. At this juncture, given where the economy and interest rates are headed, it’s prudent for Indian investors to align their investment with financial assets, which will help create wealth in the long run.

If interest rates are cut, bond markets would certainly do well in the next few years. The RBI has given ample opportunities to investors to add debt assets to their portfolios by holding the repo rate unchanged at 8 percent. Another positive for the bond market is that India’s current account deficit has corrected considerably.

Judging by past valuations, equity markets are fairly priced. But, in the next three years, as we see rising growth rates and greater capacity utilisation, earnings upgrades of Indian companies are on the cards.

In all likelihood, the EPS (earnings per share) of Sensex companies could grow a sturdy 20 percent between in 2015 and 2017 – a rate not seen in a long time. This would provide structural opportunities to Indian investors. Sectors like banking (which could see a revival in credit offtake) and infrastructure (which would benefit hugely from an interest rate cut) appear attractively valued for the long term.

While we are positive about the long term, investors must take into account the risk of short-term volatility due to global factors. The possibly of a higher interest rate regime in the U.S. and Europe is a factor that all investors should be cautious about. Investors can consider strategic equity funds that are defensive in nature along with some fixed-income asset allocations in their portfolios. Defensive strategies can help investors accumulate equity assets due to market volatility whenever the opportunity arises.

For those who have not yet invested in financial assets, there is no doubt that the Indian economy is powering ahead. Therefore, taking the slow and steady route of systematic investment plans is one of the surest ways to navigate the market since it helps accumulate financial assets for the long haul.

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