In the early 1960s when the Beatles first came to London, my mother was in the crowds to greet them, and as a young girl joined in the screams. Later, she admitted she did not see any of them, but was caught up in Beatlemania. If my mother was a young girl today, she would no doubt be a “Belieber”, which goes to show that you can choose your friends but not your relatives.
The latest pop idol in the capital markets is India’s new prime minister Narendra Modi. Since coming to power earlier this year, Modi has created a similar mania among investors, as they bet that his programme of reform and ability to cut the red tape will boost Indian businesses and spark a new era of investment and growth for the Indian economy.
The second-quarter economic report confirmed that India’s slow patch was coming to an end, as the economy expanded by 5.7 per cent year-on-year, the best annual growth since the first quarter of 2012. The details of the release were a little mixed, as the faster growth in the second quarter was largely caused by a boost from government spending rather than the hoped-for pick-up in private sector activity.
However, there were reasons for optimism, especially from investment. Investment, or fixed capital formation as it is officially known in national accounts, is the segment of the economy that suffered the most during the lengthy period of “policy paralysis”, as companies shelved any expansion plans in the face of huge political uncertainty and the weight of a heavy regulatory environment. The mild investment growth in the second quarter suggests that the Indian economy may be moving towards more investment-led growth, which should result in a more productive economy.
The resilience of the Indian equity market has been astonishing in the months since the election in May, which saw Mr Modi sweep into power. The rally in the Sensex was expected to be short-lived as some of the initial enthusiasm wore off, but this has not been the case and the market is up 22 per cent since the election. While the Indian economy was no doubt already improving before Modi took office, expectations remain very high that he can deliver on his ambitious programme of reform and drive growth. His Bharatiya Janata Party is the first single party since 1984 to have an absolute majority in the lower house of parliament, which should make passing new legislation easier.
While the lofty expectations that investors had placed on the pace and extent of Mr Modi’s reforms in his first year in office will inevitably be scaled back, they are not the drivers of the economy in the near term, as they will take time to mature in the economy. There may be a few clouds in the Indian growth story and reviving an economy that has been suffering from a long period of ‘stagflation’ (high inflation and weak economic growth) will be challenging. Nevertheless, the outlook is looking much brighter, with improving consumer and business sentiment expected to translate into stronger future growth as pent-up demand is unlocked, especially for business investment as the veil of political uncertainty is lifted.
The past 18 months have been remarkable for India. Last year it was one of the famous ‘fragile five’ emerging market economies that suffered at the hands of investors who pulled their funds out of countries that seemed to have weak fundamentals and were too reliant on foreign lending to keep afloat. But India should start to benefit from the revival in the global economy, while a stabilisation in the currency and oil prices will help to keep inflation in check and higher foreign exchange reserves will reduce worries about short-term funding.
The Indian equity market has performed strongly this year, but there are still investment opportunities based on the economic outlook and the resumption of capital expenditure by companies. But investors should be careful of being too caught up in Modimania, as Indian equities could no longer be considered ‘cheap’ based on historical valuations.
Furthermore, investors should remember the rules that come with investing in an emerging economy. They are typically more volatile markets and not for the faint-hearted, needing longer holding periods to cut through short-term volatility and really take advantage of the better long-term growth potential.
Kerry Craig is global market strategist of JP Morgan Asset Management
