Is India’s recovery already priced in, or can value still be found?
By Narayan Shroff, Investment Director for Barclays Private Clients India
Despite being the first major economy to emerge from the Delta variant, India’s economy – and those invested in it – may still be in for a bumpy ride.
Following a sharp drop in COVID-19 cases, normal life has resumed across much of the country; and India’s economy is looking to claw back to pre-pandemic levels. Yet, fears remain a new variant could quickly derail any nascent recovery especially with the slow pace of India’s vaccination programme.
And given the uncertainties over inflation, central bank policy and how much of the recovery has already been priced into equity valuations, a review of your Indian investments may be on the cards.
Inflation poses problem for Reserve Bank of India
We’re seeing signs of a tepid recovery, but India’s rising inflation is creating a dilemma for the Reserve Bank of India (RBI). Much of India’s inflation comes from imports, so there seems little domestic monetary policy can do to address the issue. Also, the output gap remains negative, pricing power appears relatively weak and fiscal revenues constrained.
RBI governor Shaktikanta Das has been surprisingly dovish through the pandemic – with his accommodative policies to stimulate growth – and we don’t see any reason for this to suddenly stop. The governor appears committed to maintaining the central bank’s growth supporting bias, even at the expense of temporarily higher inflation.
Thus, the key risk is an uptick in medium-term inflation expectations. And while the RBI is beginning to slowly turn off the money taps to reduce the liquidity it provided during the pandemic, a rate hike does seem unlikely any time soon.
Meanwhile, Indian bank credit growth remains subdued, probably due to risk aversion – with deposits consistently outpacing credit growth. This excess liquidity is being parked with the central bank under the reverse-repo window, earning just above 3% – close to the savings deposit rate for banks.
However, the opening-up of the economy is expected to improve credit flows. The main downside risks are if COVID restrictions return should cases rise again.
Finding value in bond markets
While the supply of Indian government bonds, or G-Secs, remains high, primary issuances of corporate bonds in the domestic market are low – due mainly to volatile markets. Overall, local primary issuance between April and June was 70% lower than last year.
However, we need to factor in the changing sources of funding, especially for stronger Indian corporates, with record international bond issuance this year, a growing REITs and InvITs market as well as booming IPO and private equity markets.
Keeping core portfolios invested in high-grade corporate bonds of up to 5-year maturities seems preferable, ideally through a mix of roll-down strategies and actively managed portfolios in this segment. The steep rates curve appears to offer enough carry to compensate for any residual duration risk in these portfolios.
However, the term premia available on longer maturity bonds offers unattractive risk-weighted reward.
In a “core/satellite” strategy, it may be worth building a satellite fixed income portfolio across mid-yield, high-yield and structured credit at this stage of the broader economic recovery. Among bond segments, the non-AAA one seems preferable with a focus on credit/perception upgrade candidates.
We’re targeting sectors likely to profit from government policies and the economic revival, including infrastructure and residential real estate-backed debt, and certain non-banking financial companies. Prudent selection, diversification and monitoring is key in this sector.
Time to review equity allocations?
With the recovery in Indian equities this year, it may be time to review asset allocation and consider rebalancing portfolios.
Due to richer valuations, we’re focusing on superior-quality businesses with a resilience bias, pricing power and ability to acquire market share.
But it might also be worth weighting more to Indian equities using a core/satellite approach, with the satellite portion representing higher-risk strategies. Although staggering allocations and maintaining appropriate portfolio diversification may be advisable to mitigate potential volatility.
Meanwhile, valuations of Indian equity indices do not appear to be at exuberant levels. But neither do they seem cheap. Much of the expected earnings revival in stocks due to pent-up demand has likely been priced into valuations.
Active management therefore remains key, while market corrections – which might feasibly be short and shallow – may provide good buying opportunities.
Don’t get blinded by benchmarks
As the broader economic recovery solidifies, an exciting set of opportunities for satellite strategies in portfolios can be found in the wider equity market.
Such investments seem likely to outperform large-cap stocks over the next 12-18 months. This seems to be especially the case in the small and mid-cap space and in sectors and themes underrepresented in blue-chip indices, like the Nifty50 or Sensex.
Some of the sectors and themes that look attractive include engineering and capital goods, housing, industrial metals, manufacturing, financialisation and formalisation, and travel and tourism.
Unlisted opportunities and the surging IPO market also continue to attract attention, especially late-stage venture capital, private equity and pre-listing markets. The acceleration in progress made by domestic technology and technology-driven businesses during the pandemic is expected to keep primary markets abuzz for years to come.