Economic and policy issues in India have recently generated concern among investors and the Indian rupee has experienced sharp declines.
It is worth investors taking a step back for a broader view to consider the investment outlook for India in light of recent market developments.
With regards to recent policy action in India, our view is that several Asian countries and economies (India included) are vulnerable to external factors, primarily those with macro imbalances such as current account deficits. In the case of India, its current account deficit has led to significant currency volatility, especially in the current risk-off environment where we are also seeing capital outflows.
A current account deficit happens when the country's import bill is bigger than its earnings from exports. A widening deficit puts strain on the nation's foreign exchange reserves. India's current account deficit hit a record high of 6.7 per cent of gross domestic product (GDP) last year. India's position has been further complicated by the fact that foreign investors have been withdrawing money from the economy and the Indian rupee has fallen more than 20 per cent against the US dollar since the start of this year. That has made India's imports more expensive and added to the country's economic challenges.
Central banks and finance ministries across Asia are thus being forced to consider more than just domestic factors in their monetary and fiscal policies to achieve growth objectives.
In the case of India, the weak rupee has caused the central bank to have to defend the currency, which fell to an all-time low. The weakness of the rupee has become a key consideration in the outlook for monetary policy rather than the growth outlook. The central bank recently tightened liquidity and increased funding costs for banks significantly, resulting in sharp spike (200-300 bps) in bond yields and the curve itself inverting steeply. The central bank governor stated that these measures were taken to 'quell excessive speculation and to reduce volatility in the rupee'. However, in our view, the currency policy is unconvincing.
Our investment thesis for India has been that with inflation easing, the focus of monetary policy would shift to growth. The rise in interest rates has impacted this view and there is a risk that the rise in interest rates holds back the economic recovery that we had been anticipating. As GDP growth decelerates, we expect loan growth to slow and credit costs to rise.
However, over the medium term outlook, two factors should make us more constructive on the outlook for India. The RBI’s action should make rupee speculation more expensive. In addition, we expect the current account situation to improve as gold prices come off, which will help to put India on a more sound macroeconomic footing.
Despite the current growth setback, it’s worth bearing in mind that valuations of the Indian stock market are at near historical lows and we believe that investment into the Indian market offers upside both in terms of currency and market appreciation for a USD investor. One of the key risks to India remains the strong foreign inflows into the equity markets over the past several years and any reversal of foreign inflows would weigh on equity markets.
Rajendra Nair is manager of the JPMorgan India fund