However, foreign fund flows are expected to be lower than in 2014.
A rising dollar may be a headwind in 2015, but JP Morgan highlighted this is unlikely to prompt large outflows from foreign institutional investors. JP Morgan’s medium-term outlook remains “highly positive” on the country, which it believes has strong secular domestic growth story.
Furthermore, reform initiatives driven by Prime Minister Narendra Modi’s government and monetary prudence shown by the Reserve Bank of India has the potential to revive the economy.
“As long as the Indian economy remains on a cyclical recovery track and Modi persists with his reform agenda, we believe the start of US interest rate normalisation by the Federal Reserve in 2015 poses a limited threat to India’s capital account,” the fund house said.
Taper tantrum repeat?
Brazil, Indonesia, India, Turkey and South Africa – dubbed the “Fragile Five” with large current account deficits were the worst hit markets in 2013, experiencing massive withdrawal of foreign capital and plunging asset prices due to the expectation of Fed tapering.
JP Morgan noted that since then emerging markets have made efforts to strengthen their economies and reduce external balances.
India appears better placed than most to weather future bouts of Fed-related market turbulence, the fund house said.
“Of those economies that have made significant improvements to macro imbalances, none has made better progress than India.
“So much so, that we, like the International Institute of Finance, believe that India has successfully exited the ‘Fragile Five’ class that became the centre of international investor concerns in 2013.
“Should market tremors accompany the first Fed rate hike expected later this year, we doubt very much that India will again be at the epicenter of emerging market concerns.”
Impact of strong dollar
A rising US dollar has normally acted as a headwind for emerging market equities by weakening local currencies, adding to inflation pressures, increasing energy subsidies and putting upward pressure on local interest rates.
“But in India’s case, the external financing need is now quite modest and should not prove difficult to finance, especially with domestic inflation clearly on a downward path and the current account balance much more under control,” JP Morgan highlighted.
“The next move in local rates is clearly down, not up. In the rupee’s case, there is perhaps less to fear from a stronger dollar in coming months than is the case for a number of other emerging market currencies.”
Correction – an entry point?
The reform euphoria led to a surge in Indian equity markets, which were among the top performers in 2015. The BSE 100 Index gained 32%, just behind China A-shares, which rallied by 53%.
JP Morgan believes a more meaningful Sensex correction seems likely, as technical indicators for Indian equities remain in overbought territory.
“If that happens, we advise investors to increase their equity exposure to India, as the market, in our view, has the best long-term growth fundamentals of any major emerging market economy.”
The factors that could trigger a correction and also test investors’ patience include: a weaker-than-expected recovery in private sector capex and thus productivity; a surprise rebound in world oil prices and the return of inflation; corporate earnings that remain slow to recover from the cyclical pressures of 2012-2014.
Investors in Indian equities should stay focused on domestic cyclicals, such as cement, materials, metals, automobile, infrastructure and private sector financials, instead of exporters and defensive sectors like utilities, the fund house said.
Reform drive succeeding?
“Modi seems to be taking a long-term view towards India’s structural problems. He knows that he has a full five-year term in which to push forward with his agenda, and more than likely two terms. After the passage of more than six months, we have a clearer idea today of what the Modi reform agenda entails.”
Raising economic growth from multi-year lows, taming inflation and getting previously spiralling external and fiscal deficits under control are the four key macro economic goals for the new government.
There has been reasonably good progress in the second half of 2014 on all four fronts.
“So far, the majority of policy measures tabled are neither surprising nor breathtaking. But unlike his [Modi’s] critics, we see this as a major strength of the government’s approach, not a weakness. Most measures appear achievable given sufficient energy on the part of the central government and a good working relationship with key state administrations.”
So far, policy actions have been concentrated on improving India’s current systems. Steps such as administrative reforms, simplification of approval processes, including online project approval and easier environmental clearance procedures, should improve business sentiment and the ease of doing business in India.
