Market Bulletin 31 July 2015
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Market Bulletin
31 July 2015
India and Mr. Modi: A progress report
In brief
Market reaction to the Modi government’s reform programme has cooled.
After a strong 2014, India’s equities market has grown only moderately this
year, with the MSCI India gaining 4.5% in dollar terms (USD) and 5.6% in
local currency.1
Nevertheless, the government has made much progress in the past 12
months, implementing measures to encourage foreign direct investment
(FDI) and a more friendly business environment for foreign companies and
promoting energy, coal and mining reforms, as well as implementing
enhanced social welfare programmes.
However, some reforms are still works in progress, and have not yet met
market expectations. Manufacturing growth has been disappointing and the
tax system is still unfavorable for foreign companies. Both the Goods and
Services Tax (GST) and land reforms have been delayed, casting doubt on the
government’s ability to push ahead with reform.
While we believe India’s reform agenda is progressing at a steady pace,
clearly more remains to be done—and to judge from the market’s reaction,
more will be expected in the second half of 2015.
A half glass of reform
It has now been over a year since Prime Minister Narendra Modi and the
Bharatiya Janata Party (BJP) came to power in India. As an update to our January
Tai Hui white paper: “India and Mr. Modi: After the honeymoon,” we review the progress
Chief Market Strategist, Asia that the government has made to date. As we previously wrote, while the Modi
government has met or exceeded expectations, in our view, further progress will
Ian Hui
Global Market Strategist depend on the pace at which Mr. Modi can implement his agenda and how his
policies have an impact over the medium term.
Anthony Tsoi, CFA
Market Analyst
1 Source: FactSet, J.P. Morgan Asset Management; data as of 23 July 2015.MARKET BULLETIN | 31 JULY 2015
For equity investors, the key near-term issue will still be India’s growing FDI inflows
EXHIBIT 1: FDI INFLOWS, ROLLING 12-MONTH (USD BILLIONS)
how long it will take before corporate profits and 35
margins start to respond to the improving economy. 30
Initial market expectations may have been overly 25
positive. Reforms have neither been as bold nor as fast 20
as investors had hoped. Earnings have disappointed, and
15
the economy has yet to take off. As a result, India’s
10
equity performance, year to date, has fallen short of
5
2014.
0
05/13 08/13 11/13 02/14 05/14 08/14 11/14 02/15 05/15
Our own view has been, and still is, that Mr. Modi is
taking a long-term approach to dealing with India’s Source: Reserve Bank of India, J.P. Morgan Asset Management; data as of 30
June 2015. The chart above, and the charts, graphs and tables herein, are
structural problems. We expect the pace of reforms to be for illustrative purposes only.
steady and incremental. The past year has seen a
number of initiatives. We consider most have turned out While politically and publicly unpopular, shifting to
more successful than not, but there have been some market-driven prices and cutting oil subsidies has greatly
letdowns. reduced the fiscal deficit and freed up spending for other
sectors. Gasoline pricing mechanisms have also been
What has worked? revised to align domestic prices more closely with global
market prices. The government has already relied on the
FDI REFORM
new mechanisms twice to adjust prices in India’s
Market-friendly regulatory changes have relaxed markets.
restrictions and have allowed more FDI into the
COAL AND MINING REFORMS
insurance, railways and defense sectors. By raising the
limit on foreign participation in defence and insurance Coal and mining reforms aim to increase transparency,
investment from 26% to 49%, the changes have enabled reduce corruption and cut bureaucratic red tape. The
more foreign flows. New rules have opened railway issue of coal mining rights dogged the previous
projects to full foreign ownership and reduced both FDI government, causing a scandal when it was revealed that
limits in construction and minimum project size as well certain entities benefited from the government’s
as budget thresholds for foreign participation. allocation systems, which was ultimately declared illegal.
Altogether, the measures have created opportunities for No longer do public sector companies have the exclusive
infrastructure improvement, and indeed 12-month rolling right to mine coal and sell to the market. Allowing
FDI inflows increased 48.3% in May, compared with a private participation has boosted supply, providing an
year ago. incentive for greater investment in the sector.
ENERGY SECTOR REFORM Similar changes have been pushed through for mining
and mineral concessions in general. Previous rights were
Energy sector reforms have moved forward as a means
granted by discretion, but a new auction system should
of improving efficiency and pricing mechanisms. The
increase transparency and reduce corruption.
collapse in oil prices gave the government the
opportunity to deregulate diesel prices, which it has
taken to free itself of expensive subsidies.
2 INDIA AND MR. MODI: A PROGRESS REPORTMARKET BULLETIN | 31 JULY 2015
PROJECT MANAGEMENT REFORMS SOCIAL WELFARE PROGRAMME REVAMPS
In a bid to revitalise capital expenditures and the Financial inclusion programmes to provide bank
investment climate, the government has devoted much accounts for Indian households, as well as new pension
effort to ridding India of its reputation as a difficult place and insurance programmes, are intended to reduce
to do business. It has rolled out an online e-business poverty and encourage household savings. The
portal that consolidates several government services and government has rationalised subsidies and adopted price
cuts the time required to legally establish a new business stabilisation measures to help check food-price inflation
entity and attract investment. Rules for environmental in the event of poor monsoons. Direct transfer of
approvals have also been eased and another new online benefits has greatly improved the efficiency and
system speeds up project approvals. The combined administration of programs helping the poor, while also
changes have already produced results, with new project saving the government money by removing the old,
announcements accelerating after a long period of poorly administered subsidy system.
stagnation (Exhibit 2).
What could have gone better?
Positive results seen in new project announcements after period of
stagnation “MAKE IN INDIA”
EXHIBIT 2: ANNUAL NEW PROJECT VALUE (RUPEE TRILLIONS)
9 Our previous market bulletin on India made mention of
ousa ds
Government (latest: 485bn)
8 the “Make in India” drive. As we noted, the “Make in
Private (latest: 1,543bn)
7 India” campaign is not inward looking. Rather, it seeks to
6 supercharge manufacturing growth from 12% to 14% per
5 year by attracting more overseas businesses to set up
4 global manufacturing operations in India. So far, we
3 have seen only marginal changes in manufacturing
2 activity. As shown in Exhibit 3, there has been no
1 dramatic improvement yet, with manufacturing growth
0 stuck at single-digit levels as electricity shortages and
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 congested ports hold back growth.
Source: Centre for Monitoring Indian Economy,
J.P. Morgan Asset Management; data as of 30 June, 2015. Attempts to boost manufacturing take time, however,
and it is still relatively early into the campaign. India still
Related to these attempts at turning the industrial has plenty of opportunity to turn itself into a
environment around have been changes in labour laws manufacturing hub and meet the government’s target.
to increase business flexibility while still protecting
workers. As an example, the apprenticeship policy has
been made more flexible, reducing punishments for
violations and encouraging worker training. Smaller
businesses now have incentives to improve labour force
skills and will see less harassment from authorities.
J.P. MORGAN ASSET MANAGEMENT 3MARKET BULLETIN | 31 JULY 2015
Manufacturing merely stable Although failure to pass the GST and Land Acquisition
EXHIBIT 3: MANUFACTURING GROWTH, % YEAR-OVER-YEAR,
3-MONTH MOVING AVERAGE bills has cast doubt on the government’s ability to push
25% ahead with reform, we still believe it is a matter of when,
and not if, the revision in the GST will go ahead.
20%
15% NEW GDP GROWTH CALCULATION
10%
India’s new GDP growth figures have been a source of
5% much confusion. The new methodology should have put
0% it in line with more generally accepted standards, but
the results do not seem to line up with other indicators
-5%
or the general public’s perception of India’s growth rate.
-10%
The new numbers show growth increasing at a faster
'10
'11
'12
'13
'14
'15
'00
'01
'02
'03
'04
'05
'06
'07
'08
'09
pace than China, despite most other measures indicating
Source: Ministry of Statistics & Programme Implementation,
J.P. Morgan Asset Management; data as of 30 June 2015. a sluggish economy. Exhibit 4 shows the significant
difference between the two GDP growth methodologies
UNPREDICTABLE TAX COLLECTION that has caused uncertainty over how to interpret the
data.
As part of trying to improve its image, the government
has tried to turn what has been seen as unpredictable
Significant difference between new and old GDP growth series caused
tax enforcement into a more consistent tax collection uncertainty over new GDP figures
system. When the courts found for the defendants in tax EXHIBIT 4: GDP GROWTH SERIES COMPARISON
cases against several major foreign corporations, the 14%
decision from the government not to appeal seemed to 12% Previous GDP growth series
signal that it was serious in its effort to improve India’s Difference between new and old
10% GDP growth series
business climate. Then, in late April, it levied a
8%
retroactive tax bill on foreign investors, much to their
surprise. This has led many to question once again the 6%
government's intention to improve the tax regime. 4%
2%
GST AND LAND ACQUISITION BILLS
0%
The two biggest disappointments in reform hopes—the
-2%
failure to date to pass the GST and Land Acquisition
'10 '11 '12 '13 '14
bills—illustrate the legislative difficulties the government
Source: Ministry of Statistics & Programme Implementation,
still faces, despite the BJP’s control of the lower house. J.P. Morgan Asset Management; data as of 30 June 2015.
The GST policy would have combined different state and
central tax systems in an attempt to simplify tax codes. It
appeared to have support from both the Congress, the
principal opposition party, as well as the BJP. It has
nevertheless been delayed. The Land Acquisition bill
would have made it easier for land to be used for certain
categories of projects, speeding up negotiations with
owners and subsequent development. The opposition has
thwarted passage of the bill by portraying it as overly
favouring big businesses.
4 INDIA AND MR. MODI: A PROGRESS REPORTMARKET BULLETIN | 31 JULY 2015
Investment implications
Despite policy setbacks that have caused some loss of
faith in the Modi government, we still believe reforms
are moving at a steady pace, even if more has to be
done. The large scope of reforms initiated bodes well. A
pickup in investment and the positive impact of reforms
should eventually turn markets around. Our medium-to-
long-term outlook is still highly positive on India.
While valuations are a bit stretched and trading above
historical averages,2 the key headwinds for India equities
are weak first-quarter earnings and negative earnings
revisions. Yet, within the overall constrained outlook, we
are noting diverging sector performance, with some
sectors performing relatively well—for example,
financials—in response to the government’s bank account
reform for rural population. However, in order for
markets to respond positively and re-rate valuations
more extensively, the Modi administration will have to
deliver even more effectively on what it has promised.
2 MSCI India’s forward P/E trading at 16.6x vs. 10-year historical average of
14.8x. Source: IBES, MSCI, J.P. Morgan Asset Management; data as of 30
June 2015.
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