India Monitor India s Trinity Trilemma The sustained weakness and increased volatility of the INR have brought the fundamentals of India s economy into focus. Whilst many emerging market economies have been hit by expectations of tapering in the Fed s Quantitative Easing, India has been among the worst affected. Among its peers, the INR is the second-worst performing currency with a -12.6% 3m decline after the Indonesia Rupiah which has lost -14.5% 3m to date. The Reserve Bank India (RBI) referred to India s trinity trilemma in its last policy statement, highlighting slowing growth, a widening current account deficit and stubborn inflation as the main sources of India s vulnerability. 11 September 2013 To put this in context, in 2007 India s current account deficit stood at USD 8bn, but in 2013 it has increased to USD 300bn. Meanwhile, FX reserves in 2007 stood at USD300bn, but in 2013 these have fallen to USD 275bn. So the FX reserves now are just three times the size of the current account deficit, in comparison to 37.5 times in 2007. Similarly, the import cover currently stands at around 6 months, the lowest in 15 years, and significantly lower compared to its peers China (18 months) and Brazil (11 months). In terms of GDP, the current account deficit is at 4.8% of GDP, well above the RBI s comfort level of 2.5% of GDP. Inflation also remains stubbornly high above 5%. While supply side bottlenecks remain the main reason, a weak INR is aggravating the problem. India imports nearly 70% of its oil and a weak INR has increased the procurement cost of crude, resulting in pressure on the deficit and inflation. Growth became a casualty of the RBI s tight monetary policy, which was necessitated by high inflation and a widening current account deficit. A weak INR is also now weighing on growth as the RBI is being forced to pursue anti-inflation policies, to the detriment of short term growth. As a consequence India s GDP growth forecast for FY 2014 has been reduced to 4.0% - 4.5% from 5.5% at the start of the year. Economic data Weak, Weaker and Weakest A series of economic data releases over the past month has confirmed that the economy remains firmly in the grip of stagflation with the way out remaining uncertain, given sustained weakness in the INR. MSCI India index (1m) 800 780 Aditya Pugalia Analyst +971 4 230 7802 adityap@emiratesnbd.com 760 740 720 700 680 1-Jul 11-Jul 21-Jul 31-Jul 10-Aug 20-Aug 30-Aug Source: Bloomberg, Emirates NBD Research
India s manufacturing PMI for August came in at 48.5, falling below the expansionary threshold of 50.0 for the first time since March 2009. The weakness was broad based with new orders dropping 2.2 points and output declining 2.5 points. Surprisingly, new export orders also declined 2.6 points despite depreciation in the currency, which was expected to give a boost to exports. India s GDP growth for Q1 FY 2014 came in at 4.4% y/y, lower than consensus estimates of 4.7% y/y, with both investments and consumption slowing. Growth in the latter declined to 3.9% y/y from 6.2% y/y, while government spending increased 9.4% y/y compared to 4.0% y/y in the previous quarter. The GDP data reaffirms a significant loss of growth momentum. Whilst a good monsoon is likely to boost growth in H2 FY 2014, the weak currency and resultant tight liquidity is expected to remain a key drag on growth and put pressure on unhedged corporate balance sheets. Government spending, which was a key driver growth in Q1 FY 2014, is also expected to slow down amidst slowing tax revenues and fiscal slippage. According to recent data, the Government of India has already crossed 62% of its budgeted fiscal deficit in the first four months of this fiscal year. The wholesale price index inflation increased to 5.8% in July compared to 4.9% in June and higher than consensus expectations of 5.0%. Core inflation increased from 2.0% to 2.4%. Fuel price inflation was the biggest contributor, accounting for nearly 70 bps of the 100 bps m/m increase in inflation. This is significant because Indian crude basket has increased +22.7% in INR terms since start of July 2013, which has necessitated fuel prices hikes. Hence, we are likely to see continued pressure on inflation in the short term, further complicating the policy outlook of the RBI. Earnings Season Also weak Earnings from companies in Q1 FY 2014 disappointed even as expectations were already low. The aggregate adjusted Q1 FY 2014 earnings for the Sensex companies declined -1.0% y/y while revenue growth for the companies in the same period moderated to a three-year low of +1.0% y/y. Operating margins held steady on a y/y basis but decline c. 100bps on a q/q basis. Weak commodity prices helped margins on a y/y basis. While defensive sectors like Healthcare and IT performed better as growth recovery in developed economies and a weak currency helped companies, industrial and consumer discretionary sector stocks lagged behind as economic growth slowed and inflation remained elevated. A weak Q1 FY 2014 earnings season and slowing economic growth have prompted revisions in forecast with earnings for FY 2014 been revised downward by nearly 2% since the start of Q2 FY 2014. The breadth of the earnings revision was also negative with 19 companies in MSCI India seeing their EPS revised higher while EPS for 54 companies was revised lower. The trend is expected to continue as expectations for Q2 FY 2014 earnings also remains weak. New RBI Governor First day promise In his first day in office the new RBI Governor, Raghuram Rajan, dropped broad hints of gradually opening up India s banking sector. He also attempted to walk the tightrope between promoting price stability and boosting economic growth. Most strikingly he also appeared to indicate that the RBI will act more swiftly and aggressively to arrest the slide of the INR. Somewhat surprisingly Rajan announced a number of new measures to help boost the INR, in addition to the steps announced by the RBI previously. Among these measures, the RBI will offer a special window for swapping foreign currency nonresident deposits with a minimum tenor of three years and more at a fixed rate of Page 2
3.5% per year. The central bank also raised the overseas borrowing limit of 50% of unimpaired Tier 1 capital to 100% for the banks and the funding mobilized under this provision can be swapped with the RBI at a concessional rate of 100bps below the ongoing swap rate prevailing in the market. Both these measures should help boost liquidity in the banking system of both the USD and the INR and will be available to banks until the end of November 2013. The RBI also allowed exporters to re-book cancelled forward currency contracts up to 50% of the value and up to 25% for importers. In other moves, Rajan said that the RBI will introduce inflation indexed bonds and steadily liberalize the market and ease restrictions on investments and position taking. He also talked about reducing the requirements for banks to invest in government securities in a calibrated manner. Financial markets Still vulnerable Indian equity markets traded poorly over the last month as markets was rattled by increased volatility in the INR and as investors reconciled themselves to the onset of QE tapering by the US Federal Reserve. A potential widening of the military conflict in Syria added to the downward pressure in the market. Indian markets have moved firmly into negative territory for the year (MSCI India index -7.1% ytd) after Nifty lost - 4.4% over the past month. Furthermore Indian markets continue to underperform global equity markets with the MSCI India index losing -4.4% 1m compared to -2.2%1m decline in the MSCI Emerging Market index and -3.1% 1m drop in the MSCI World index. The weak points in the Indian growth story were well reflected in the sectoral performances. Industrial and Financial stocks were among the worst performing sectors losing -14.8% 1m and -11.7%1m respectively. Slowing economic growth has a direct impact on both these sectors and with the GDP growth slowing to a four-year low it is not surprising to see them underperform the broader market. The Technology sector (+8.4% 1m) continues to remain a standout performer as signs of economic recovery in developed markets coupled with a weak INR boost their business prospects. Indian markets are also seeing a sustained withdrawal of funds from foreign investors. Foreign Institutional investors (FIIs) sold USD 903mn of Indian equities and USD 1.4bn of Indian debt in the month of August. Domestic Institutional Investors (DIIs) were net buyers for a third consecutive month, buying USD 1.1bn in equities in August. Insurance companies and mutual funds bought equities worth USD 936mn and USD 163mn respectively. The INR had yet another weak month with the currency losing -9.6% 1m. While a possible tapering in the Fed s QE program, as well as India s huge current account and fiscal account deficits weighed on the INR, exacerbating these woes was the policy response of the Government of India and the RBI. Until the new RBI Governor took office, the policy response was too often seen as reactive and incoherent. While the INR may be supported in the short term by uncertainty over possible Fed tapering, and as military tensions in Syria play out, it is evident that the steps taken by the Government of India to address structural issues and revive economic growth will take a long time to succeed, especially in the context of a crucial election year. With broad USD strength also expected to continue over coming months, we are revising our 3-month and 6-month INR forecasts to 68.00 and 65.0 respectively. Aditya Pugalia 04-2307802 Page 3
Market watch and flows 6200 Nifty (1y) USD INR (ytd) 72 68 5800 64 5400 60 56 5000 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 52 31-Dec 28-Feb 30-Apr 30-Jun 31-Aug 10y GoI yields (%, ytd) 10.0 FII flows (USD mn, ytd) 1500 9.5 9.0 8.5 8.0 7.5 7.0 31-Dec 28-Feb 30-Apr 30-Jun 31-Aug 1000 500 0-500 -1000 31-Dec 28-Feb 30-Apr 30-Jun 31-Aug Source: Bloomberg, Emirates NBD Research Page 4
BeST PB Ratio Performance and Valuations Nifty Sector Breakdown (1m return, %) Sensex continues to command premium Industrials -14.8 Financials -11.7 3.0 2.5 y = 0.1284x - 0.0045 R² = 0.6253 Sensex Telecom Con Goods Healthcare Utilities Tech -2.8 1.5 3.9 4.1 6.3 2.0 1.5 1.0 MSCI BRIC Shanghai MSCI EM Bovespa Oil & Gas 7.8 B Material 27.8-20 -10 0 10 20 30 MICEX 0.5 4.0 8.0 12.0 16.0 20.0 BeST PE Ratio Nifty performs in line with its emerging markets peers (ytd) 110 Nifty underperforms most developed markets (ytd) 155 100 130 90 105 80 70 4-Mar 4-May 4-Jul 4-Sep NIFTY Index MXEF Index SHCOMP Index IBOV Index INDEXCF Index 80 4-Mar 4-May 4-Jul 4-Sep NIFTY Index MXGS Index SPX Index DAX Index NKY Index Source: Bloomberg, Emirates NBD Research Page 5
Economics GDP growth slows further (y/y, %) 12 IIP too declines (y/y, %) 10 8 10 8 6 6 4 2 0-2 4 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13-4 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Inflation sees an uptrend (y/y, %) RBI forced to pursue price stabilisation 9.0 8.0 7.0 6.0 5.0 4.0 Jan-12 May-12 Sep-12 Jan-13 May-13 9.0 8.0 7.0 6.0 5.0 4.0 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Repo Rate (%) CRR (rhs) 6.5 6.0 5.5 5.0 4.5 4.0 3.5 Source: Bloomberg, Emirates NBD Research Page 6
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Emirates NBD Research & Treasury Contact List Emirates NBD Head Office 12th Floor Baniyas Road, Deira P.O Box 777 Dubai Aazar Ali Khwaja Group Treasurer & EVP Global Markets & Treasury +971 4 609 3000 aazark@emiratesnbd.com Tim Fox Head of Research & Chief Economist +971 4 230 7800 timothyf@emiratesnbd.com Research Khatija Haque Senior Economist +971 4 509 3065 khatijah@emiratesndb.com Irfan Ellam Head of MENA Equity Research +971 4 509 3064 Mohammedie@emiratesnbd.com Aditya Pugalia Analyst +971 4 230 7802 adityap@emiratesnbd.com Jean-Paul Pigat MENA Economist +971 4 230 7807 jeanp@emiratesnbd.com Sales & Structuring Head of Sales & Structuring Sayed Sajjid Sadiq +971 4 230 7777 sayeds@emiratesnbd.com London Sales Lee Sims +44 (0) 20 7838 2240 simsl@emiratesnbd.com Saudi Arabia Sales Numair Attiyah +966 1 282 5625 numaira@emiratesnbd.com Egypt Shahinaz Foda +20 22 726 5050 shahinaz.foda@bnpparibas.com Singapore Sales Supriyakumar Sakhalkar +65 65785 627 supriyakumars@emiratesnbd.com Group Corporate Communications Ibrahim Sowaidan +971 4 609 4113 ibrahims@emiratesnbd.com Claire Andrea +971 4 609 4143 clairea@emiratesnbd.com Page 8