On January 1, 2012, the Indian government announced the opening up of its equity markets to direct investments from Qualified Foreign Investors (QFIs). As per guidelines issued by India’s finance ministry, QFIs are defined to include individuals, associations or groups resident in an eligible country outside India. India had earlier opened up it’s equity markets to Foreign Institutional Investors (FIIs) who are permitted to invest in Indian equity markets subject to caps. Over time, these limits have been relaxed and investments at higher threshold levels have been permitted in specific sectors or companies subject to approvals by India’s central bank. This latest move to attract direct inflows from QFIs into Indian equity comes in the backdrop of negative news flows and significantly higher volatility in Indian equity markets. So for a U.S.-based equity investor, does the policy change provide a long term opportunity, given all the recent loss of value in Indian equity?
Let’s answer that by understanding what drives the spate of negative news flows roiling Indian equity markets.
- Political compulsions on account of disagreements within the ruling coalition government have forced the government to go slow on its next phase of economic reforms. For instance, recently, the government had to shelve a proposal to allow Foreign Direct Investment (FDI) in multi-brand retail, owing to opposition from its coalition partners.
- Since early 2010, public governance issues especially in the telecom and mining sectors have threatened to tarnish India’s image as a preferred destination for foreign investment.
- India’s current account deficit is already taking a significant hit primarily on account of higher fuel import costs due to the depreciating rupee.
- India’s fiscal deficit is projected to push north of 5.5% as against a planned level of 4.6% of GDP, due to slowing growth and a delayed public sector disinvestment program.
- Consequently, equity indices have dropped over 20% in calendar year 2011. It is estimated that FIIs invested $29 billion into Indian equity during 2010 and withdrew net $600 million during 2011, due to a swing in sentiment driven by the above domestic triggers and international challenges. The Indian rupee (INR) rapidly depreciated nearly 20% in the last quarter of 2011, due to a higher current account deficit not offset by capital inflows.
Clearly, the challenging dynamics impacting capital market sentiments have prompted the Indian government to initiate tactical measures to raise levels of foreign capital inflow. In November 2011, the Ministry of Finance increased the limit for FII investment into government securities and corporate bonds by $5 billion each, in a bid to attract higher dollar flows to Indian debt markets. Now, allowing individual investors to directly invest in the equity markets is being looked upon as a supportive and less volatile avenue of foreign capital inflow (on the assumption that individual investors are likely to be more long term in their outlook). As per current Indian income tax laws, long term (over one year) capital gains and dividends from Indian equity are exempt from tax. Detailed procedures to facilitate direct equity investments are expected to be announced by mid-January.
So while the opportunity is now available for individual investors to take direct stakes in Indian companies, is this a good time to invest into Indian equity? A 20% depreciation in the exchange rate coupled with a 20% decline in the broad market index during 2010 means that Indian equities are on average 40% cheaper than they were over a year ago. Amongst BRIC economies, Indian equities have corrected most steeply in 2010. Sure, local macro-economic fundamentals look a lot shakier than they were over a year ago and there could be more bad global news in the offing. For a value investor however, current valuations for well managed front line companies look compelling and they have looked so for nearly a quarter now. On a one year forward conservative earnings estimate of Rs 1150 for index stocks and a 11 times forward Price Earnings multiple, we arrive at a floor value for the benchmark Bombay Sensitive Index (SENSEX) at 12650. This represents a 20% downside to the closing index value on January 4. It is worthy of note, that India has traditionally been a relatively expensive market in PE terms and has traded at a long term average one year forward PE of 15 to 17 times. So a 11 times forward PE scenario is close to the lower end of a decade long average. On the upside, several turnaround triggers are possible, including increased public sector investment (increased recent activity visible), policy action and softer commodity prices through 2012. It is also expected that India’s central bank may imminently halt its restrictive policy stance, if not reverse it, given growth concerns. It may be a great idea to scrutinize front line holdings of top India ETFs such as the iPath MSCI Index ETN (INP) and the PowerShares India ETF (PIN) to spot value buys in the beaten down infrastructure, banking and manufacturing sectors. These funds have lost nearly 35% in value over a year ago and present a good medium term opportunity in themselves.
Disclaimer: Views expressed by the author represent his personal opinion. The reader should exercise adequate due diligence on the suitability and accuracy of investment advice.