4 Reasons We're Upgrading India

by: Russ Koesterich, CFA

Indian stocks have rallied recently, driven in part by improving economic conditions – and the fact that the government is beginning to relax some restrictions on foreign investors. In fact, in just one day this week, foreign investors bought more Indian equities than in the previous two months according to Bloomberg.

On February 6, we began advocating an underweight to India. Since that time, the MSCI India Index has fallen 4.3%, underperforming the broader emerging market index by 3.1% as of September 17th. All of these developments – along with the following four reasons – explain why we are now upgrading our view on Indian equities to neutral from underweight.

1. The stock valuations have returned to a more reasonable level: the price-to-book multiple has fallen 6%, to 2.51 from 2.67.

2. On the cyclical growth front, India’s economic activity is holding up as shown in better-than-expected second quarter gross domestic product (GDP), rising 5.5% year over year. We’ve also upgraded our view on India’s growth. Our new forecast projects 6.4% annual growth in GDP, up from 6.1%.

3. Supporting the case for higher growth in the medium term, we’ve recently witnessed several positive structural changes, including:

  • Further liberalization of foreign ownership limits in the retail sector;
  • Cuts of diesel subsidies; and
  • An aggressive growth target from India’s planning commission: 8.2% from 2012 through 2017, surpassing the 7.9% target achieved over previous five years.

4. Last but not least, compared to other emerging markets, investor positioning in India is very light so far in 2012. This should help support future price outperformance, if investor confidence returns.

Despite these positive developments, we are still some way from turning bullish on India. High inflation, together with the weak rupee, limit the scope for future rate cuts, which could stimulate the economy. Fiscal and current account deficits have been persistent, and policy making is slow and at times erratic. This hinders the follow-through that we would like to see in implementing structural reforms. But in the meantime, we would now favor a neutral, or benchmark position in Indian equities.

Source: Bloomberg

Disclaimer: International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.

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