Despite the sharp slowdown of growth in recent years, very few observers of the Indian economy
question the country's robust fundamentals. Strong domestic savings and investment behaviour, rapid productivity gains, strong entrepreneurial spirit, access to a large pool of English-speaking skilled manpower at reasonable costs and the demographic sweet spot are some factors that have made India an emerging superpower.
In the past few years, several adverse developments, such as the global financial crisis, decline of domestic business, high inflation, high fiscal deficit, inertia on reforms, government delays of critical decisions and sharp rise in the cost of borrowing, have severely dented India's growth.
Going by the current indicators, it appears that 2014 will be a watershed year, when many of these factors will change for the better. In such times, equity investors benefit the most, almost always. So, my vote is strongly in favour of equity to be the strongest performing asset class in 2014.
Despite the challenging domestic environment, both fundamentals and perceptions about the economy have improved. GDP, gross domestic product, growth in the quarter ending September has been ahead of the two previous quarters and expectations.
Most industry, mining and infrastructure indices show signs that the worst is over and a slow recovery has begun. Rise of food and fuel prices, the main drivers of inflation, is abating. India is recording robust export growth, while imports are lagging, bringing the current account deficit down. Concerns of tapering of quantitative easing (QE) notwithstanding, India is experiencing a strong inflow of portfolio equity. India's bellwether equity indices have bounced back by nearly 20% since late-August.
With growth in most segments of the industry and some service sectors bottoming out, and assuming a normal monsoon, India's GDP growth should nudge towards 6% in the next financial year, compared with 5% in the current year. Given the disinflationary trend in most countries, both wholesale and consumer price inflation will be substantially lower, between 150-250 basis points, in 2014 from current levels. This would allow the Reserve Bank to move from a hawkish to a neutral monetary policy this year, bringing down cost of funds for the corporate sector.
The elections also matter. The recent results have political parties thinking. The new generation wants jobs and business opportunities and are not looking at subsidies and doles. Irrespective of the outcome of the general elections, the popular mood is likely to take India towards a more transparent, proactive, and development-oriented governance.
The immediate aim of the next government would be to speed up decision making, drive major economic reforms (including GST and DTC), push infrastructure projects and make economic growth inclusive. There should be a considerable turnaround of the business and investment climate in India. However, the impact, meaning a decisive turnaround in the investment cycle, may take some time.
There is consensus that liquidity infusion will be scaled down, as part of QE-III, in the next four months. However, we feel that, despite recent improvement of the US economy, tapering in the first half of 2014 would be mild. In addition, the continued supportive monetary policy by other central banks will counterbalance QE tapering. While tapering can dampen global liquidity and investor sentiment, the impact on risk assets, including Indian equities, is likely to be far lower than during May to August 2013.
Foreign Institutional Investors, or FIIs, have been allowed to invest in Indian equity during the past two decades. In this period, despite the many market fluctuations, net FII investment in India was positive in all but two years. This reflects on the conviction in India's strong fundamentals.
Over the years, investment by FIIs in listed Indian equities has gone up substantially and currently stands at about 40% of the overall free-float market capitalisation. Therefore, a large-scale sell-off of Indian equities by FIIs would hurt them more than any other investor group.
Given these positive trends and buoyant business expectations, Indian equities could provide about 20% returns in 2014, taking the Sensex to 26,500 by December 2014. Despite the likely delay in the investment cycle picking up, the expectation of it happening is likely to help investment-theme stocks to outperform consumption-theme stocks in 2014.
Companies with strong corporate governance, positive cash flow and modest leverage are also likely to remain attractive. Apart from current favourites such as IT and pharmaceutical sectors
, we expect the financial services sector, segments of automobile industries and companies associated with industrial capex to perform well in 2014.
In contrast, some consumption-theme stocks may underperform on account of rich valuation. In addition, overly leveraged infrastructure and construction companies are likely to underperform.
In the recent past, investors of Indian equity have been extremely discerning. The recent rallies have been driven by a few stocks. Even within the same sector, price performance of companies has been drastically different. While picking profitable individual stocks is extremely satisfying, it is often a tough task and requires active investment management. This is generally beyond the capacity of individual investors. Therefore, I think indirect exposure to Indian stocks through collective investment vehicles, such as mutual funds, is a good idea at the current juncture.
Moreover, risks such as the disorderly impact of QE-III tapering, a fractured verdict in the 2014 general election, inefficiency of or inaction by the next government, reversal of ongoing growth and lowering inflation trends cannot be disregarded.
Structured equity products, if designed innovatively and managed prudently, offer great returns in a buoyant equity market, while limiting losses if the market fails to deliver.
Chairman, Anand Rathi Financial Services