Reforms push boosts confidence in Indian equities

Mumbai: A weekend decision by the government to decontrol diesel prices and put in place a new gas pricing regime, coupled with the stellar electoral performance of the Bharatiya Janata Party (BJP) in Maharashtra and Haryana, stirred investor hopes of a reform push and boosted the stock markets on Monday.

In Haryana, the BJP scored an outright win, putting it in line to form a government on its own for the first time in the northern state. In Maharashtra, it emerged as the single largest party in the state assembly, results declared on Sunday showed.

Cheered by the positive domestic developments and tracking overseas markets, benchmark equity indices gained on Monday. The BSE's 30-share Sensex closed 1.23%, or 321.32 points, higher at 26,429.85, while the National Stock Exchange's 50-share Nifty index rose 1.28%, or 99.70 points, to 7,879.40.

The Sensex is up 24.8% in the year to date, and is the best performing market across the globe, with the exception of a few smaller markets such as Qatar, Ukraine and the UAE.

"I've remained bullish about the Indian market and these policy moves add to my confidence," Jim O'Neill, former chairman of Goldman Sachs Asset Management Co. and the man who coined the popular acronym BRIC (Brazil Russia, India, China), said in an email.

"The pace of reform has not been dramatic but it seems to be picking up momentum," O'Neill added, reflecting the sentiments of a number of investors who had been disappointed by the lack of any, so-called big-bang reforms until recently.

On Saturday, the BJP-led government at the centre said diesel prices will be market-determined, and relaunched the bank transfer of cooking gas subsidy. The move followed business-friendly labour regulations announced earlier in the week.

The measures were seen as helping improve the government's finances via a reduction of subsidies, allowing it to shift its focus to capital expenditure and, eventually, attract greater investments into the economy.

"India has a good mix of an improving top-down macro-economic situation and excellent bottom-up fundamentals (demographics) and the recent pick-up in economic reforms will keep valuations and investor interest at elevated levels," wrote Sanjeev Prasad, Akhilesh Tilotia and Sunita Baldawa of Kotak Institutional Equities in a research note on Monday.

After expanding by less than 5% in each of the previous two years, the economy grew by 5.7% in the quarter ended 30 June-the fastest pace in two-and-a-half years.

The pick-up in growth and the hope that the momentum would be extended into the following quarters has bolstered investor confidence, especially in stocks of firms that are driven by domestic demand.

"We add a little more weight to domestic cyclical names (already a large weight in our model portfolio)," added the Kotak report.

Concerns over high valuations of the Indian markets have also eased after a 3.4% correction from all-time highs. The Sensex hit a record high of 27,355 points on 8 September.

According to Bloomberg estimates, the Sensex currently trades at 16.9 times one-year forward earnings, above its five-year average of 15.8 times, and at a premium of more than 47% to the MSCI Emerging Markets Index.

To be sure, key equity indices of Brazil and the Philippines trade at higher valuations than Sensex at 19.3 times and 19.8 times, respectively.

Despite the relatively high valuations, investors like Samir Arora, founder and fund manager of Singapore-based hedge fund firm Helios Capital, remain bullish on the Indian market.

"Global-led correction has made valuation more reasonable, diesel deregulation will strengthen India's finances and hedge it better against future shocks, focus on execution and strengthening government bureaucracy and cabinet expected in the next few weeks will help confidence and speculation about budget and general seasonality in markets will help sentiment," said Arora in response to an email.

Market experts believe that improving domestic fundamentals and India's relative strength vis-a-vis other emerging markets will mean that fund flows-both foreign and domestic-will remain strong.

"The announcements over the weekend are very positive because it shows that the government is willing to act when the iron is hot," said Nilesh Shah, managing director and chief executive officer at Axis Capital Ltd, adding that timing is critical in a democracy because many economically important decisions may be politically sensitive.

Shah pointed out that market-linked petrol and diesel prices will ease the government's fiscal burden and allow it to focus on capital expenditure rather than revenue expenditure.

He said global inflows will continue because India is better placed, compared with many other emerging markets, and domestic flows will continue because equities have outperformed other asset classes in recent times.

Foreign institutional investors (FIIs) have pumped a net of $13.2 billion into Indian equities so far this year, although the pace of inflows has slowed.

For the month of October so far, FIIs have been net sellers to the tune of $587.2 million. Domestic Institutional Investors (DIIs), on the other hand, have been net sellers to the tune of Rs.27,815.9 crore. In October, though, they have bought a net of Rs.4,792.4 crore.

"We continue to believe India is in a multi-year bull market," said Shah.

To be sure, global factors like the sharp fall in oil prices have been a key factor in the recent optimism around India. The fall in oil prices also made it easier for the government to move with measures such as diesel price deregulation.

"Diesel decontrol is a good move, but the government was handed a gift by God: crude prices had come down and, logically, it made it easy to deregulate diesel. A gas price hike does not benefit anybody except a single company, while hurting the rest of the economy; so I can't say it is a 'reformist' move," said Shankar Sharma, vice-chairman and joint managing director of First Global Securities Pvt. Ltd, who is known for his contrarian views.

Sharma said he is positive on stocks of export-oriented sectors such as information technology, pharmaceuticals and automobiles as he expects the rupee to weaken. He considers investing in cyclicals, infrastructure and power "a waste of time and money".

"That said, Indian equities continue to be a lucrative bet among their emerging market peers, based on their growth potential, low debt situation and demographics, and this has been so for the past 10 years," Sharma added.

Going ahead, global developments and economic data for the September quarter will be key for the markets, said Sharma. He expects gross domestic product (GDP) growth in the second quarter of the fiscal to fall short of the 5.7% seen in the preceding quarter, but remain above 5%.

Investors are also watching for more news on pending reforms like the goods and services tax (GST).

"Going forward and heading into the budget next year, we expect progress on coal block allocation, resolving labour sector, clarifying monetary policy objectives, etc.," Citigroup economists Rohini Malkani and Anurag Jha said in a note, adding that while pace and timing could be debated, they remain confident that India is heading towards 7% growth and 6% Consumer Price Index (CPI) inflation.

Disclaimer: This information has been collected through secondary research and IBEF is not responsible for any errors in the same.