Of all the emerging markets that are out there, India is one of the more prominent ones. It's one of the BRIC countries, together with Brazil, Russia and China. India easily ranks as one of the more popular investment destinations among emerging markets. In fact, there are a large number of people who consider India as their number one pick when it comes to deciding where to invest in emerging markets.
Why some people may want to invest in India
There are many reasons why India is currently a favored destination among some investors. India is an economy with relatively fast growth, at least in comparison to most countries out there. It also has a very large and a fairly young population. India has the potential to one day become a leading economy and a large consumer of all sorts of goods and services. Investing early on could pay off handsomely some day.
Unlike many other emerging markets, India does not depend on the export of commodities. On the contrary, India is a major importer of commodities such as crude oil and gold. The big drop in commodity prices starting in 2014 has therefore not hurt India, in contrast to other emerging markets that have experienced much turmoil due to the drop in prices of commodities.
The year 2014 also saw the election of the Modi government, which is considered by many to be friendly to businesses and open to reform. This factor along with others combined to generate a lot of optimism about the future and India became one of the best performing markets in 2014 as investment capital poured into the country.
The winds are changing direction
However, in a couple of days it will be exactly one year since the new government in India was elected. India will at some point have to turn some of its election promises into action. It cannot rely on being given the benefit of the doubt because its honeymoon period is now pretty much over. The government will be judged on what it's able to accomplish and not just what it says it's going to do.
Unfortunately, some of the early signs are not very promising. For instance, foreign companies and investors are still in the dark concerning potential tax payments that no one was informed of but will still be held liable for. The Indian government has not done enough to resolve this and other outstanding issues. Frankly, the Indian government has little if anything to show for with its one year anniversary coming up.
Furthermore, the price of crude oil has stopped declining. If it continues to rebound, other commodities could follow suit because the price of oil plays an important role when it comes to extracting commodities from the ground. This is a significant development for India because crude oil accounts for about one third of its import bill.
The declining price of crude oil was thought by many to be the reason for optimism because it would allow India to turn its current account deficit into a surplus. This has yet to happen and the rising price of crude oil makes that possibility more and more unlikely. The deficit could actually increase instead of decline as some had forecast.
It's important to remember that India has a number of weak fundamentals. India has a problem with chronic deficits, including a current account deficit, a trade deficit and a budget deficit. The deficits force India into borrowing, which is not a good situation to be in at this moment. Interest rates are looking to go up, which means that India will have to pay more for its borrowing. You do not want to pay more if you're already short on cash.
India is trading in a range and the outlook does not look bright
Since the start of 2015, the Indian market has essentially been stuck in a range. ETFs dedicated to India, including EPI (EPI) and INDA (INDA), are either flat or down for the year. Other emerging markets are doing much better in comparison. For instance, EEM (EEM), the largest ETF for emerging markets in terms of liquidity, is up by more than 7.5 percent.
More importantly, several factors look set to make the second half of 2015 a difficult one for India. For instance, the optimism generated in India after the election of the Modi government is starting to wane. The Federal Reserve could tighten monetary policy in the United States and begin raising interest rates as soon as June, although later in the year is probably more likely.
Commodity prices are also looking to rebound, which works in favor of competing emerging markets such as Brazil and Russia and against importers of commodities such as India. Investors and their capital could respond by switching to the former markets and away from the latter. This is not good news when you're as dependent on capital inflows as India is.
Conclusion
In a previous article that I wrote late last year, I argued that India was unlikely to repeat its previous performance in 2015. This forecast has so far proven to be accurate as the situation in India has more or less developed as I reasoned it would in 2015.
For starters, I thought that the drop in commodity prices would not be the windfall that some analysts had predicted. One reason being that a large chunk of what India imports is actually destined for re-export and not to satisfy internal demand. While India has seen some benefits such as lower inflation, it hasn't been enough to make the problem of deficits go away.
India at 19 times earnings late last year made it one of the most expensive emerging markets. Valuations have since eased somewhat, but India is still among the more expensive. At the same time, there are a number of emerging markets trading at lower valuations than India, which makes them more attractive in that regard.
I also expected India to have trouble living up to the lofty expectations that some people had of the country after the election of the Modi government. That's because politicians in general find it much easier to make promises during election campaigns than to actually turn those promises into reality once they're in power.
On top of all of this, not enough consideration has been given by many to the fact that India remains fundamentally vulnerable to global changes in interest rates and the flow of capital that can result because of this.
Even if interest rates do not go up in the coming months, the mere threat of them going up is enough to cause problems for a country like India which has to attract foreign capital to balance its books. That the Indian currency, the rupee, is depreciating and yields of government bonds are being pressured should come as no surprise once you look deeper into the overall state of India's economy.
While there are some who consider India to be the best emerging market and recommend it as such, my own assessment is different. Whether it's relatively high valuations, weak fundamentals with persistent deficits, government bonds under pressure, weakening currency, rebounding oil prices, declining confidence in the government and so on, India is facing a ton of headwinds going forward. Far too many to be a number one pick among emerging markets.
There are many reasons to stay away from India in such an environment and very few not to. India may be better off than some emerging markets, but there are also plenty of other countries that possess a better risk/reward profile. Therefore, I will reiterate my previous assessment that India is not a buy in my opinion.
