Indian equity markets declined sharply in 2008 amidst foreign institutional investor outflows and concerns about the indirect impact of the global credit crisis on India. Frontline indices closed sharply down with mid- and small-cap stocks underperforming their large-cap counterparts.
The sharp decline in the Indian equity markets in 2008 needs to be seen in the context of the strong performance over recent years. For example, despite the year-to-date fall, the BSE Sensex remains one of the best performers over longer periods of time. Indian markets are expected to do well over the medium- to long-term horizon helped by strong fundamentals.
From a fundamental perspective, the Indian economy appears relatively less vulnerable to a sharp slowdown in developed economies owing to the lower share of exports in GDP (gross exports stood at 13 per cent of GDP in FY08, while net exports to GDP ratio are negative). Other key aspects in India's favour are low credit penetration, a robust banking system with most of the transactions in form of plain vanilla loans.
The sharp fall in global crude oil prices and commodities is a positive for the Indian economy from a current account and fiscal balance points of view.
In the near-term, GDP growth is expected to moderate due to a cyclical step-down from the high growth rates of recent years. However, India will still be amongst the fastest-growing economies in the world. From a medium- to long-term point of view, Indian markets are expected to yield superior risk-adjusted returns as the macro story based on rising consumption and investment plays out. On the back of the strong fundamentals, we believe Indian markets could be amongst the first to bounce back once the global situation stabilises.
In recent years, there was excess capital flow into certain sectors, which, due to the recent shift in macro-economic environment, will have to undergo restructuring/ consolidation. While we remain confident about the medium- to long-term growth prospects, we expect consumption and investment growth to moderate over the near term. Increasing fiscal deficit is a concern and this is likely to result in increased government borrowing, which could crowd out corporates.
From a near-term perspective, the key risks for India continue to be the increased risk aversion in global markets and possible escalation of geo-political tensions. It is important that the pace of reforms continues in the long term. There is a need for labour and pension reforms, which would further pave way for rise in productivity. Next year's national elections will provide clarity on the pace of reforms.
Given the vast diversity in terms of language, culture and income disparities, investing in India requires a thorough understanding of local drivers and cultural nuances. While Indian markets and companies have matured over the years, earlier we had to rely solely on internal research and company visits to get an accurate insight into operations.
This has helped us in creating an extensive research database, with a wide network of management contacts. We believe that this becomes critical as the on-the-ground experience helps us in focusing on bottom-up fundamentals that can translate into superior risk-adjusted returns over market cycles.
The global financial crisis has not impacted India directly, but the knock-on effect in terms of tightening of overseas credit has hit liquidity. This has been addressed by the India's central bank through various monetary measures. In that sense, there has been no material impact on our investment process or strategy.
We have seen situations like these over the past 14 years in India and believe that they provide a great opportunity to long-term investors like us. We have been closely monitoring the situation and identifying good investment opportunities.
Tougher environments amplify the difference between better quality managements and those with inferior governance standards. Under the current environment, we are seeing a divergence in stock as well as operational performance between companies. Our bottom-up focus on fundamentals becomes even more relevant in current conditions.
The recent selling in Indian equities, caused largely by panic in the global markets, has resulted in market valuations touching record lows. India has now gone from being one of the most expensive stock markets in Asia to being one of the cheapest.
While tight liquidity and demand slowdown are likely to impact earnings growth over the near term, the valuations seem to have factored in the downside and companies look attractive buys. Corporate India balance sheets are in good shape with relatively low gearing and higher cash surplus.
We believe Corporate India's earnings growth will moderate to an average of about 12-18 per cent over the next three to five years. Over the long term, growth in earnings will be supported by the positive demographic landscape and the need for infrastructure development. Besides, pressure on corporate margins is expected to ease going forward as borrowing costs come down and the sharp decline in commodity/energy prices reduces
- The author is Chief Investment Officer, Equity, Franklin Templeton Investments, India