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Smart money bets on India’s turnaround story

Investors pin hopes on pro-business agenda promised by new government of Prime Minister Narendra Modi


Date: October 2,2014

Optimism about a revival of India’s economy has made the country’s stock market one of the world’s top performers, and smart money says there is room for further gains.

“It’s probably the one country in the emerging markets that I am most hopeful and most positive on over the next three to five years,” says Sammy Simnegar, a portfolio manager with Fidelity Investments.

Investors have pinned their hopes on the new government of Prime Minister Narendra Modi, who won a landside victory in May with promises to remove corruption, institute reforms, lower the deficit, tackle inflation and invest in infrastructure.

Even as valuations break away from the normal trading range of other emerging market stocks, professional investors remain bullish on India’s prospects.

Mr. Modi’s election is “the single biggest event in India in the last 50 years,” says Mr. Simnegar, whose Fidelity Emerging Markets Fund has 11 per cent of its holdings in the country’s stock market.

Already the prime minister has accelerated government approval for corporate projects, cut some fuel and transportation subsidies, lowered some barriers to foreign investment and encouraged a new culture of transparency and meritocracy within government.

Driven largely by manufacturing, India’s gross domestic product rose by 5.7 per cent in the second quarter from a year earlier, up from a gain of 4.7 per cent in the first quarter.

GDP growth could approach 6 per cent by December and reach 6.5 per cent by the end of 2015, according to a recent report by Moody’s Analytics.

Mr. Modi certainly faces high expectations, and a lot will depend on his ability to execute on his pro-business agenda in the coming years.

Despite investor reaction to Mr. Modi’s election, the new prime minister’s first 100 days in office proved “relatively uneventful,” according to Glenn Levine, an economist with Moody’s Analytics.

“India’s economy is a huge, slow-moving entity, to say nothing of the fractious political system. It was always going to take a while for the Modi government to find its feet,” he noted. “Policymakers should have their eyes on the longer term, rather than seeking easy, short-term gains. So far, the signs are promising that Modi will resist the mistakes of his predecessor.”

With the right reforms, it should be possible for the Indian economy to achieve long-term annual growth of as much as 8 per cent, Mr. Levine estimates.

The scale of Mr. Modi’s Bharatiya Janata Party’s victory is expected to enable him to execute on his agenda and duplicate some of the successes he delivered as a regional governor earlier in his career, Mr. Simnegar says.

Other factors that should drive returns for investors include growing demand from India’s young demographic, a natural cap on supply due to weak national infrastructure, as well as high profit margins and return on equity levels for Indian companies, he says.

India’s economy has also picked up a tailwind recently in the form of lower oil prices. India imports about 80 per cent of its oil, and declining prices reduce pressure on domestic inflation. The central bank governor, Raghuram Rajan, has managed to bring inflation down almost two percentage points, to 8 per cent, during his first year in office by raising interest rates three times. The reduction is important for the new government, which is trying to bring down food prices.

The turnaround story of Asia’s third largest economy garnered even greater investor attention when Mr. Modi visited the United States for three days in September. His agenda included meetings with President Barack Obama, senior corporate executives, institutional investors and an address to the United Nations General Assembly.

The visit was expected to bestow more credibility on Mr. Modi in the eyes of Western investors. This was the prime minister’s first trip to the country since the United States government denied him a visa nearly a decade ago for his handling of religious riots in Gujarat state, where he served as chief minister.

Since Mr. Modi became prime minister, India’s benchmark S&P BSE Sensex index has gained 12 per cent. It is up 29 per cent this year, making it the best performing index among the world’s 10 largest equity markets.

The stocks that comprise the index are trading on average at 15.9 times projected 12-month earnings, compared with a multiple of 11.5 for the broader MSCI Emerging Markets index, according to Bloomberg data.

Mr. Simnegar says he’s comfortable with the higher valuations in India because the companies he holds in his fund should be able to double their earnings over the next three to five years. In fact, the fund’s exposure to India at the moment is almost double its normal amount of 6.5 per cent, focused mostly on companies serving the domestic economy.

The fund is also “overweight” in stocks from Indonesia, the Philippines and South Africa, and has delivered a return of about 10 per cent this year.

Mr. Simnegar warns that many retail investors won’t have the stomach for the volatility that comes with ETFs with a 100 per cent focus on India.

Investors should also be aware that large emerging market ETFs usually hold large-cap companies whose markets are international rather than domestic, he adds.

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