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India Strategy 2017:Favourable Tailwinds Continue for a Substantial Growth Rate

Author: iFAST Research Team

India Strategy 2017 - iFAST Financial India Private Limited

The year 2016 started with jitters in the Chinese markets, causing stress across the globe and in the Indian markets as well. We consider events like BREXIT and Trump’s ascent to power as surprises during the course of the year, but believe that the biggest surprise of 2016 was Demonetization, which finally decided the fate of the Indian market at the end of the year. On November 8, while the world was anxiously waiting to know the outcome of the US election, the Indian Prime Minister decided to take centrestage and launch the biggest backlash against corruption, jolting the world’s fastest growing economy in the bargain.

The International Monetary Fund (IMF)in the World Economic Outlook released in January 2017 revised India’s growth forecast for the current (2016-17) and the next fiscal year.However,we continue to be the fastest growing economy in the world, as can be clearly seen from the chart given below.

While demonetization has jarred the Indian economy for the short term, our positive outlook continues based on strong macro-economic indicators, attractive valuations and strong reforms push

Easing monetary policy, shrinking fiscal deficit and a more welcoming environment for FDIs will be key factors in ensuring stability of macro-economic factors

While the capital markets will experience volatility with net FII outflows due to global factors, growing domestic inflows and attractive long term valuations of Indian equity will bring in much desired liquidity

Key government reforms are expected to boost sectors like banking, infrastructure, real estate and NBFCs, among others

Key Points

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Figure 1: IMF World Economic Outlook Projections

Source: IMF, iFAST Compilation


We, at iFAST Research, are also of the view that despite demonetization, the growth momentum of the economy is on an acceleration mode. Our positive outlook on the country is based on the stable macro-economic indicators, attractive valuations and a reformist government at the centre.

To a question on why India’s growth was revised downward and when the country was expected to bounce back, in a press briefing on the Update of the World Economic Outlook,Maury Obstfeld, the Economic Counselor and Director of the Research Department replied as follows.

“The big factor in the short term has been the currency reform which apparently has led to

some cash shortage in the economy. When people are short of cash and don’t know when

they can get it, they tend to hoard, they tend to spend less, the economic wheels are less

greased. Even with our downgrade, India’s growth rate remains substantial. We think some

of this will persist into the following year’s forecast with a strong bounce back after that,

because this is likely to be a temporary factor. That being said, the government can help by

ensuring that cash supplies are adequate for the transactions the economy needs to carry

out. You know, we do agree with the general goal that motivated this which is reducing the

extent of illicit transactions in the economy”.


PromisingMacro-Economic Indicators

When demonetization was announced in November 2016, economists were worried that the government had suddenly applied brakes on an economy that was surging despite global tremors. The uncertainty caused by this reform led agencies right from IMF to Reserve Bank of India (RBI) to revise the growth forecast for India downward. This implied that the country had entered a gloom phase and would take a few quarters before it beat the blues of demonetization.

However, to the pleasant surprise of all, the GDP for the quarter October-December 2016-17 grew at 7%, against the expectation of a lower growth rate. A closer observation of the data points showed that among the sectors, only construction and financial, real estate and professional services had shown a decline in the current quarter. However, the question remains whether these are truly the only sectors impacted by demonetization, or will the revised GDP numbers that are to be released later bring out an altogether different picture?


Figure 2: GDP Growth Rates (Constant Prices)

Table 1: Quarterly Estimate of Gross Value Added (GVA) at Basic Prices

2016-17Industry Q1 Q2 Q3

Agriculture, Forestry & Fishing 1.9 3.8 6Mining & Quarrying -0.3 -1.3 7.5Manufacturing 9 6.9 8.3Electricity, gas, water supply & other utility services 9.6 3.8 6.8Construction 1.7 3.4 2.7Trade, hotels, transport, communication and services related to broadcasting 8.2 6.9 7.2Financial, real estate & professional services 8.7 7.6 3.1Public administration, defence and Other Services 9.9 11 11.9GVA at Basic Price 6.9 6.7 6.6

Source: Bloomberg, iFAST Compilation


Inflation and Monetary Policy Stance

India’s retail inflation number, as represented by the Consumer Price Index (CPI), is definitely on a downward trajectory. The CPI, which was as high as 8.6% three years ago in January 2014, has drastically fallen to 3.17% by January 2017 supported by the fall in food prices. On the other hand, the Wholesale Price Index (WPI), which started 2014 at 5.11%, entered into a negative zone by November 2014 and remained here till March 2016.Since then, WPI has been showing an increasing trend and stands at 5.25% by January 2017, aided by the rise in the Fuel and Power components of the Index.

While economists are sceptical about the data, it has given the world the confidence in the government’s ability to reform the country. In this scenario, we would only like to reiterate our view that despite the short term pain imposed by this measure, the

long term impact on the economy would be positive.


Figure 3: CPI and WPI Inflation


We are of the view that although the Monetary Policy Committee’s (MPC) tone seemed to be hawkish, the way forward for the policy rates is southward. Demonetization can be a big driver for this path and we like the fact that MPC is on a wait and watch mode

before taking a decisive call on policy rates.

An interesting observation is that since the announcement of demonetization, the CPI, which is the headline inflation that the RBI focuses on, has been below 4%.Ideally; such a trend in inflation should have given the central bank the confidence to continue with its easing monetary policy stance. Contrary to expectations, RBI did not lower rates in its Sixth Bi-Monthly Monetary Policy Review held in February 2017, changing the monetary policy stance from accommodative to neutral. The three upside risks to inflation, as stated by the RBI, include rising crude prices, volatility in exchange rate and the fuller effects of the house rent allowances under the 7th Central Pay Commission, which have not been factored in the baseline inflation path.

With regards to monetary policy, there is another aspect that is worth understanding. One of the main concerns that Dr.Rajan, the former RBI Governor, had about the easing of policy rates was that the banks were not transmitting the changes in policy rates onwards to the consumers. The following chart clearly shows the truth in his views.


Source: RBI, iFAST Compilation

Figure 4: Policy Rates

While there is panic when the RBI decides to change the monetary policy stance from accommodative to neutral, we should be more worried if the transmission of policy rates does not happen, as this means that credit growth is not being given the desired fillip. In this scenario, it needs to be mentioned that with the huge deposits garnered through demonetization, we have seen the lending rates coming down, which is a big

positive for the economy.


Fiscal prudence has been the top priority of the current Indian government. In the recently presented budget, the government has resolved to achieve a fiscal deficit of 3% as recommended by the Fiscal Responsibility and Budget Management (FRBM) Review Committee, within the next three years. Its commitment to lay more emphasis on the quality of expenditure and use the increased tax revenues garnered on account of demonetization to improve the fiscal deficit are measures in the right direction. As we mentioned in the Budget note to our Investors, it would be interesting to see how the government balances fiscal discipline with increased public expenditure and reduced net market borrowing.

Fiscal Deficit


Figure 5: Fiscal Deficit (% of GDP)

A prudent government roadmap for fiscal consolidation should give the RBI the confidence to consider easing its monetary policy stance. The easing, however, will be subject to the upside risks to inflation subsiding in the coming months.


India is now considered a preferred destination for FDI on account of (1) Stable macro-economic indicators,(2)Make in India project, wherein policies favouring FDI in government’s pet projects like infrastructure, Smart Cities,construction,defence, pension,etc.,have been put in place, and (3) Measures taken to improve ease of doing business in India.

Foreign Direct Investment (FDI)

Foreign Investments in India

Source: DIPP, iFAST Compilation

Figure 6: FDI Flows into India (US $ Billion)

*Data for 2016-17 is April 2016-December 2016


The efforts being made by the government to attract FDI are part of a well thought out strategy, and will lead to long term investments across different sectors.FDIs are desirable as they represent long term investments that will not move out the moment some country across the globe decides to sneeze. We believe that a conducive environment for doing business in India, without too many roadblocks in terms of policy uncertainties and political

disturbances, is the need of the hour for encouraging FDI into India.

Foreign Institutional Investors (FIIs) Investments into India

Source: DIPP, iFAST Compilation

Figure 7: Net Investment by FIIs (US $ Billion)

*Data for 2016-17 is April 2016-December 2016


Since the time the FED started hiking rates, emerging markets, including India, have seen massive FII outflows. To add to this, Trump’s policies to rejuvenate the US economy will only aggravate this outflow. We believe that India will be no exception when this

exodus worsens, leading to volatility in our stock market.

Source: : NAV India, iFAST Compilation

Figure 8: Net Inflows into Equity Funds (Equity, Balanced, ELSS, Other ETFs and Fund of Funds Investing Overseas)

Indian investors are showing an interest in equity funds on account of the falling interest rate scenario, which is making investments in fixed income instruments unattractive. Investors are also showing an appetite for financial assets against physical assets like gold and real estate on account of the uncertainty in this segment.

Domestic Inflows into Equities


There was a time when we used to write “When the global market sneezes, India catches a cold”. However, the huge net inflows into equity mutual funds are bringing ample liquidity to the market, and will buffer the Indian markets in the near future. This will, inturn, bring stability to the markets when FIIs

decide to exit India for greener pastures.

We saw yields cooling off across papers of different maturities in 2016 on account of favourable factors like the decline in CPI,the reduction in policy rate, change in liquidity management stance by the RBI, adherence to fiscal discipline by the government, and to top it all, the huge liquidity that came into the system via demonetization. However, we are seeing some stress on the yield curve especially after the MPC’s decision to change the stance from accommodative to neutral. We continue to maintain our view that RBI will start easing the rates once they see stability on the inflation numbers and other macro-economic parameters.

Direction of the Fixed Income Market

Source: Bloomberg

Figure 9: G-Sec Yields across maturities


Index 2016 - 17 2017 - 18 2018 - 19

S&P BSE SensexEPS 1,433 1,717 2,021 EG 6.3% 19.8% 17.7%PE 20.1 16.8 14.3

Nifty 50EPS 437 527 622 EG 7.3% 20.7% 18.1%PE 20.4 16.9 14.3

S&P BSE MidCapEPS 594 772 958 EG 24.4% 30.0% 24.1%PE 22.7 17.5 14.1

S&P BSE SmallCapEPS 677 821 1,021 EG 161.5% 21.2% 24.4%PE 20.2 16.7 13.4

S&P BSE100EPS 461 553 660 EG 15.0% 20.0% 19.3%PE 20.0 16.7 14.0

S&P BSE200EPS 189 228 272 EG 13.4% 20.6% 19.5%PE 20.5 17.0 14.2

S&P BSE500EPS 598 717 862 EG 19.9% 20.0% 20.2%PE 20.4 17.0 14.2

Table 2: Valuation Matrix for the Different IndicesAttractiveValuations

Source: Bloomberg,iFAST Compilation

Data compiled as onMarch 8,2017


For the benchmark indices, S&P BSE Sensex and Nifty 50, earnings are currently in mute mode but are expected to recover in the next two years. It is interesting to note here that the companies included in the mid cap and small cap indices are currently growing at a much faster pace than the benchmark indices. Their forward earnings also look much more attractive, and we believe that is a compelling reason for investors to look at funds from this category. A growing economy with strong fundamentals will only aid the earnings growth in the mid/small cap companies.

Demonetization

iFAST Research has always been of the view that we like India not only because of the stable macro-economic indicators and attractive valuations, but the presence of a reformist government that knows its business. We believe that the macro-economic indicators and earnings of India Inc. will move in a positive territory only if we have good policy makers at the centre. Of course, external factors can still play spoilsport; however, a stable government with good policies can definitely help the country weather the storm. The central government is working on many projects, a few of which, we believe, could change the way our global counterparts view India a few years down the line. We chronicle some of the important ones here.

Reformist Government

The Prime Minister launched one of the biggest reform initiatives of his tenure on November 8, 2016 -demonetization. This measure was aimed at removing the high denomination notes of INR 500 and INR 1000 from the system, effective November 9, 2016.The government cited four reasons for one of the most secretive missions undertaken by North Block: curbing corruption, counterfeiting, the use of high denomination notes for terrorist activities, and especially the accumulation of ‘black money’, generated by income that has not been declared to the tax authorities (Economic Survey 2016-17).

As per the Watal Committee on Digital Payments, Medium Term Recommendations to strengthen Digital Payments Ecosystem, “India is a cash heavy economy, with almost 78% of all consumer payments being effected in cash. India’s preference for cash as a payment instrument is further reflected by India’s significant cash to GDP ratio of (12.04%), which is substantially higher


than comparable countries. Similarly, estimates indicated that foregone tax revenues from the shadow economy constituting 19% of India’s GDP, account for 3.2% of India’s GDP.”

To encourage digitalisation, the government has undertaken various initiatives like the launch of the Bharat Interface for Money (BHIM) app for smartphones, which will allow 350 million feature phone users to take advantage of the Unified Payments Interface (UPI).The Aadhaar Merchant Pay platform has been launched for the 350 million people who do not have phones; also, fees on digital transactions and those using the UPI have been reduced. All these measures will move the Indian economy from a high cash economy to a cashless one.

Systemically, demonetization will help drive down inflation, as well as the interest rates on fixed deposits.Investors will find it more rewarding to move surplus lying in fixed deposits into short term funds or dynamic bond funds depending on their risk profile. While the equity markets will see a short term correction, increase in government spending will fuel corporate revenues eventually. Investors should use the current correction in the market to enter equity funds depending on their risk profile. We maintain that despite global stressors, a reformist government at the centre will ensure that we will find ourselves in a sweet spot

three years down the line.


Pradhan Mantri Jan DhanYojana (PMJDY)

PMJDY, one of the biggest financial inclusion initiatives in the world, was launched on August 28, 2014.It not only aims at opening bank accounts for every citizen but also gives them an opportunity to take credit from the organized channel and makes pension and insurance available to them. The initiative will also facilitate the Direct Benefits Transfer (DBT) scheme of the government. As on March 1,2017, 27.84 crore accounts have been opened and the total deposits in the same are to the tune of INR 64,228.21 crore.

We believe that opening the gates of the banking system will promote savings and investment habits among the poor who were never covered by the organized financial system previously. These savings will not only increase the deposit base of banks, but can also find their way into the markets via mutual funds or equities. However, this will take time and will depend on the awareness created about investment opportunities that can help the

poor create wealth and achieve their goals.

Housing ForAll by 2022

The government’s vision to ‘Provide Housing for All’ by 2022, is being fulfilled through two main programmes.

Pradhan Mantri Awaas Yojana-Housing for All (Urban)This initiative was launched on June 25, 2015 with the objective of providing housing to all urban poor households by 2022.PMAY’s aim is to build 2 crore houses with basic amenities, implemented through four verticals: slum rehabilitation, credit linked subsidy scheme, affordable housing in partnership with public and private sectors and beneficiary-led individual house construction/enhancements.Under this project, 14,508 houses have been constructed, while the central government has given approval to construct further 10 lakh houses. A central assistance of INR 14,954.97 crore has been earmarked for the states. (The data is as on September 30, 2016.)


Pradhan Mantri Awaas Yojana-Gramin (PMAY-G)Indira Awaas Yojana (IAY) which was launched in January 1996 to promote rural housing was restructured into Pradhan Mantri Awaas Yojana-Gramin (PMAY-G) from April 1, 2016.The aim is to provide pucca houses with all the basic amenities, and intends to cover 1 crore households living in mud/dilapidated houses from 2016-17 to 2018-19.In the Union Budget 2017-18 the Finance Minister has increased the allocation to this scheme from INR 15,000 crore in 2016-17 to INR 23,000 crore in 2017-18.

This is an action-packed sector, with a vibrant ministry that wants to change the way Indians travel. The biggest take-away from its 2016 report is that along with expanding the National Highways network in the country, India became a signatory to Brasilia Declaration, undertaking to ensure commuter safety and committing to reduce the number of road accidents and fatalities by 50% by 2020.In this regard, the Ministry has earmarked INR 1100 crore,of which INR 600 crore was for the year 2016-17.Some of the new government initiatives in this segment include Bharatmala (an umbrella program that will subsume unfinished parts of the National Highway Development Project (NHDP) and will focus on new initiatives), SetuBharatam(building bridges for safe and seamless travel on national highways), and the National Highways Interconnectivity Improvement Project, amongst others. In the recently announced budget, the Finance Minister increased the budget allocation to this segment from INR 57,976 crores in 2016-17 to INR 64,900 crores in 2017-18.

We are of the view that the mission is ambitious and will benefit sectors like banks, NBFCs, real estate and cement.

Road Transport & Highways


The current government has been giving infrastructure development in the country a lot of importance. The work being undertaken in the entire transportation sector, which includes rail, roads and shipping, will go a long way in supporting the growth momentum of the economy. This will

also aid job creation which is very essential for a growing economy.

In our note on recommended funds released for 2017, we had written that Trump’s policies and its impact on the global economy on the one hand, and Prime Minister Modi’s reform measures to maintain India’s position as the world’s fastest growing economy on the other, will be the trend setters for 2017.Today the entire country is interested in the outcome of the election in Uttar Pradesh (UP), the largest state in India. A win will help the ruling party get a majority in the upper house of parliament, which will make passage of bills significantly easier for the government.

We are of the view that regardless of the outcome of the election, the central government will manage to implement its most crucial reforms. The passage of the Goods and Services Tax (GST) Bill and surviving the demonetization drive implies that the government will continue to enjoy stable support of the country. However, India is definitely not going to be insulated from the uncertainties that are going to be caused by rising oil prices, FED rate hikes, strengthening of economies like US and China, and FII outflows. All these uncertainties will make the market volatile in the short term and will likely stress investors and their portfolios. The long term story stays intact, though, as we believe that the earnings of India Inc. will improve, which inturn, will see the economy growing at more than 7%.

Life moves on as usual for our investors and we continue to take exposure into the markets depending on the risk profile and investment goals.“Stay calm while the markets go slant and the very same market will reward you for your patience”.

CONCLUSION

DISCLAIMER: THIS REPORT IS NOT TO BE CONSTRUED AS AN OFFER OR SOLICITATION FOR THE SUBSCRIPTION, PURCHASE

OR SALE OF ANY MUTUAL FUND. ANY ADVICE HEREIN IS MADE ON A GENERAL BASIS AND DOES NOT TAKE INTO ACCOUNT

THE SPECIFIC INVESTMENT OBJECTIVE OF THE SPECIFIC PERSON OR GROUP OF PERSONS. PAST PERFORMANCE AND ANY

FORECAST IS NOT NECESSARILY INDICATIVE OF THE FUTURE OR LIKE PERFORMANCE OF THE MUTUAL FUND. THE VALUE

OF UNITS AND THE

INCOME FROM THEM MAY FALL AS WELL AS RISE. OPINION EXPRESSED HEREIN ARE SUBJECT TO CHANGE WITHOUT NOTICE.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.

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