India could well be the fastest growing Asian economy in 2021 with GDP growth expected within touching distance of the double-digit mark.
India is on the cusp of a cyclical recovery. However, Structural balance sheet challenges remain, particularly elevated non-performing assets in the financial sector, constrained fiscal space and a corporate sector focused more on deleveraging than capex. Owing to the lack of job creation, the cycle’s durability could be on shaky ground.
The proverbial Can has been kicked down the road as far as NPAs are concerned
A combination of the RBI’s moratorium relief, the government’s ongoing credit guarantee scheme, the Supreme Court’s freeze on identifying stressed loans, corporates pro-actively axing costs, and the negative credit perception around opting for restructuring have led to the deferring of bad loan recognition. Household balance sheets currently seem relatively sound, but owing to the lack of income growth, their debt service burden is also likely to increase, and the unsecured retail loan segment remains under pressure.
The ongoing balance sheet deleveraging will have two important medium term macro implications. First, it risks prolonging the slump in the capex cycle. Second, it risks widening the chasm between funding costs of the “have” and “have not” entities. Liquidity has gravitated towards stronger balance sheets, while leaving the weaker ones even weaker. Consequently, the risk of financial sector mishaps involving banks and financial intermediaries remains non-trivial.
K-shaped recovery implies not everyone will be back to normal in a hurry
India’s unorganized sector is large and has been hit disproportionately harder. A key concern in 2021 and beyond is the implication of this K-shaped recovery. A slower pace of recovery in the informal sector implies the cyclical recovery may be a jobless recovery; it can lead to lower per-capita income, higher inequality, pressure for more populist spending by the government and social tensions.
FX: A problem of plenty
INR has been the worst performing Asian Currency in 2020 despite India recording a sizable current account surplus due to import contraction as well as bumper FDI and FII flows. RBI’s ultra-aggressive intervention has raised a few eyebrows including dangers of India being labelled as a ‘Currency Manipulator’. India has added an unprecedented $120 bn of Forex Reserves thereby injecting massive INR liquidity into the banking system in a bid to keep monetary conditions accommodative as well as support the ‘atmanirbhar’ theme. It remains to be seen if a weak currency does help in facilitating exports because the correlation between INR and exports has been non-existent over the last 20 years.
Given the underperformance of INR in 2020 along with several macro tailwinds driving INR including surging Forex reserves, comfortable situation on the balance of payments, attractive carry play, capped oil prices, potential inclusion in Bond indices, gradual decrease in cheap Chinese imports ; we expect INR to outperform in 2021 riding on the back of decreased intervention from the RBI as unwinding excess liquidity may become a priority as we move forward given that inflation has overshot the targets recently.
INR may revert to pre-covid levels of 71-72 by the end of the year against a one-year forward rate of near 77 which presents an attractive opportunity.
Equities: Earnings cycle due for a rebound but too much good news already baked in
Earnings growth has been illusive for a while now. The annual earnings growth of listed companies in India in the decade following the Global Financial Crisis (2009-2019) has been a measly 4.1% whilst nominal GDP has grown at around 13% during the same period. The numbers are not only startling but also represent that the unlisted space is doing much better.
The earnings growth in the listed space is due for a rebound and the rebound may well be on its way soon, but the sky-high expectations may be a fly in the ointment even when we see companies post blockbuster earnings in the next 4 quarters.
Nifty PE is trading at nearly 38 times current earnings which is the most expensive in the last 20 years and is 4 standard deviations from the Mean which effectively means there is not much left on the table for the medium term.
Long term story is intact and Indian equities provide attractive growth potential, recommend accumulating during corrections.
Rates: Waiting to be included in Global Indices
The government is keen to include India in global bond indices. It recently announced a “Fully Accessible Route” (FAR) plan that allowed foreign investors to circumvent existing capital controls and freely invest in government securities. Nevertheless, bond indices continue to remain cautious on including India, owing to capital controls and operational hurdles.
Monetary policy is expected to be neutral in the short term with an expected gradual exit from accommodative policies (mainly liquidity) in the second half of 2021. We expect repo rates to remain on hold in 2021 with a strong possibility of a 25-50 bps hike in 2022 given that the RBI may want to normalize policy rates as the output gap closes.
Indian Fixed Income is attractive as an asset class mainly because of the likely outperformance of INR which potentially can lead to attractive yield in dollar terms.
