Potential Ratings Upgrade To Take Indian Equities Higher

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Includes: INCO, INDA, INXX
by: Disruptive Investor

Summary

Moody's has upgraded India's outlook from "Stable" to "Positive," and I believe that a ratings upgrade is due later in the year.

Lower interest rates, lower oil prices and the government's push for reforms will position India for strong growth and trigger a ratings upgrade.

I remain overweight on India for 2015, and I believe that a ratings upgrade will trigger a strong equity upside through foreign investment flow.

India has been in the spotlight ever since the new government was formed in June 2014. With the government promising and gradually delivering on reforms, I have remained positive on Indian equities, and I still believe that Indian markets can be the star performer of 2015. From an index perspective, Indian equities have surged by 30% in the last one year, and the markets have move higher by 5.7% in YTD15.

The trigger for writing this article is the revision of India's outlook to "Positive" from "Stable" by Moody's. With a positive outlook, India is closer to a ratings upgrade, and I believe that a potential ratings upgrade is likely to come in 2015. This will trigger further upside for the Indian markets. This article discusses the reasons for believing that India deserves a ratings upgrade, and it also discusses the likely policy action by the Indian central bank in the coming months.

In my view, the policy stance by the Indian central bank is one of the triggers that will help in accelerating a ratings upgrade. I would, therefore, start with the central bank's policy stance and its potential impact on growth.

After two surprise interest rate cuts in 2015, the Indian central bank did not cut interest rates again in the April 7, 2015 policy meet. However, this does not signal an end to interest rate cuts for 2015.

My point is backed by the following comments by the Indian central bank in inflation:

However, at this juncture, these upside risks appear to be offset by downsides originating from global deflationary/disinflationary tendencies, the still soft outlook on global commodity prices; and slack in the domestic economy.

Considering this, the Indian central bank assigns a high probability of lower inflation in the coming months, and this will prompt policy response in the form of further interest rate cuts.

Interest rate cut is critical, as India's growth is likely to be driven by the manufacturing sector in the coming quarters with the "Make in India" campaign gathering steam. Relatively low interest rates would help accelerate manufacturing-driven growth that is capital-intensive in nature.

The RBI already notes that the manufacturing sector is gaining momentum:

The industrial sector, and in particular, manufacturing appears to be regaining momentum, with the growth of production in positive territory for three consecutive months till January.

In my view, this is likely to continue and contribute positively to GDP growth and ratings upgrade potential.

The second reason to be bullish on India from a ratings upgrade perspective is the point that energy prices are likely to remain low in the coming quarters. Even in 2016, I believe that oil is unlikely to surge. This assumption is based on the point that crude oil exports from Iran resume sometime in 2015. According to the EIA:

Iran is believed to hold at least 30 million barrels in storage, and EIA believes Iran has the technical capability to ramp up crude oil production by at least 700,000 bbl/day (bbl/d) by the end of 2016.

Therefore, if the sanctions are lifted in the coming months, it will keep oil prices sideways, and this is positive for India, with the country being a major oil importer. Lower oil prices will also help the Indian central bank continue with its accommodative monetary policies well into 2016.

In addition to the interest rate and oil factor, the Indian government has been pushing for reforms across sectors, and I believe that this will translate into a potential ratings upgrade later in the year. Just as an example, the Land Acquisition Bill was recently cleared, and it eases the land acquisition rules in sectors like power, housing and defence. This will accelerate many projects in the sector, and will form a basis of strong long-term growth. The government is also pushing for reforms in public sector banks, and this is critical for growth, as the public sector units can provide the large loans for big-ticket infrastructure and growth projects in the country.

Considering these factors, India is certainly on track for a ratings upgrade, and I believe that equities will continue to trend higher on a ratings upgrade possibility. From an investment perspective, investors can consider exposure to the EGShares India Infrastructure ETF (NYSEARCA:INXX), as lower oil prices and subsequent lower interest rates will accelerate the much-needed infrastructure development in the country. I am also positive on the EGShares India Consumer ETF (NYSEARCA:INCO), considering the point that the country's population has a low household debt, a high savings rate, and the young working population is likely to drive consumption driven growth. Besides these sector-specific ETFs, investors can also consider exposure to the iShares MSCI India Index ETF (BATS:INDA). This ETF gives investors exposure to all large-cap companies in India.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.