Indian stocks face big headwinds

While the long-term appeal of emerging markets remains intact, when looking at the asset class it is crucial to differentiate between different markets at a point in time.

India is a great example. Once a darling among its fellow Bric (Brazil, Russia, India and China) counterparts, India’s fundamentals have been rapidly deteriorating due to its political paralysis and deteriorating macroeconomics.

India is often contrasted with China. But while Indian fundamentals have lagged its Asian neighbour in the past 18 months, China is still stealing the headlines.

Indian GDP growth came in at just 5.3 per cent year-on-year in the first quarter, far less than the consensus expectation of 6.1 per cent. This is the worst performance for India’s economy in nine years and far worse than the situation in the wake of the global financial crisis and the collapse of Lehman Brothers in late 2008.

The larger-than-expected deceleration in growth was driven by the poor performance of the service sector, where growth fell to 7.9 per cent year-on-year in the first quarter from 8.9 per cent year-on-year in the previous quarter.

The dynamics of the current Indian economy do not make good reading. The low growth is accompanied by a high national deficit of 9-10 per cent of GDP. The ratio of private investment to GDP has been declining significantly.

Since the financial crisis, the country’s gross savings rate has fallen more than the decline in overall investment. This means India’s current account is even further in deficit. Over this period, overall saving has declined from a peak of 36.8 per cent of GDP to expectations of 30.4 per cent this year – a fall of 6.4 percentage points. The poor domestic environment, coupled with external global pressures, has led to a large decline in public and private corporate savings to GDP. Inflation is a major area of concern. Consumer prices index (CPI) inflation has reaccelerated to 10.2 per cent in April, higher than the Reserve Bank of India’s comfort zone. The underlying inflation pressures remain strong. Falls in the buying power of the rupee – together with a potential hike in the price of administered fuel products – are set to put upward pressure on Indian prices. With higher inflation, it makes it difficult for policymakers to take action to revive the country’s growth. Unlike China, India has less room to manoeuvre.

Another troubling area is the country’s banking system. Should growth continue to be muted until the middle of 2013 at the earliest, in line with consensus forecasts, it is likely to lead to a significant rise in impaired loans in the banking system, which would make a return to robust growth all the more difficult. Indeed, Morgan Stanley expects impaired loans for Indian banks as a whole are likely to rise from 5 per cent of loans as of March 2011 to more than 10 per cent in the next 12-18 months.