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Can India step out of China’s shadow?

September 2016

Sukumar Rajah, MD & CIO, Asia Equities, Franklin Templeton Investments, tells Wealth Monitor while commentators often compare both China and India, there is significant differentiation between both economies

The recent rally in many stock markets around the world has been largely propelled by loose monetary & fiscal policies and low yields rather than fundaments and higher corporate earnings. Do you see it as an anomaly?
In many stock markets, the equity risk premium is currently above the long-term average. This implies that equities are currently undervalued relative to other asset classes. We also do not see the recent rally as being inconsistent with fundamentals and we remain broadly comfortable with market valuations and pricing. However, we do observe pockets of over and under valuation within the different markets from a bottom-up basis. As bottom-up investors, we seek to identify stocks that display Quality, Sustainability and Growth characteristics over the longer-term.

As per the IMF, India’s GDP is projected to grow faster than that of China in 2016 and 2017. But do you believe India still has a very long way to go before it can even think of stepping out of China’s shadow?
As two of the most significant economies driving global growth today, commentators often compare both China and India. However, there is significant differentiation between both economies. China’s economic growth is at a more mature level and it faces more challenges in terms of declining demographics and capital productivity. China is currently in the process of rebalancing its economy, addressing industry overcapacity, as well as reducing corporate leverage and overall debt. GDP growth should slow down as China goes through this challenging process.

In contrast, India is significantly behind in terms of development metrics such as GDP per capita and urbanization. As such, it stands to benefit from the “catch up” in economic growth.

More importantly, India benefits from structural drivers of growth . Over the next decade, India is expected to add more than 110 million workers aged 15 to 64 to its workforce, with the declining dependency ratio as another indicator of the country’s growing working-age population. India also has scope for further economic growth on the back of labour productivity, better education and urbanization in years to come. The above factors are coupled with low household debt and a decreased likelihood of inflation, implying that India’s favourable demographics should be able to sustain rapid economic growth with a lower risk of overheating the economy. These differentiating factors lead us to be more positive about the Indian trajectory of economic growth relative to China. Despite this, it is important to note that both India and China are at different points of economic development and India still has some ways to go in terms of catching up.

Contrary to public investment, private investment (which is the bulk of investor demand) is yet to pick up in India. Given the fact the many firms are debt-laden, what else is keeping corporate capex from gaining momentum?
A significant amount of excess capacity was created in the manufacturing sector between 2004 and 2012 on the back of excessive optimism and the availability of cheap funding. As such, capacity utilization in sectors like automobiles, cement and steel need to improve in order for private investment to gain momentum. Moreover, meaningful progress on infrastructure commitments and policy initiatives such as “Make in India” would also encourage a pick-up in corporate capex.

Where do you see the Sensex and Nifty going forward? Is high valuation a matter of concern? Q1 earnings in India have largely missed the consensus estimates. Do you see the mismatch between valuations and earnings weighing on the markets going ahead?
We do not predict the future value of indices. However, we think that the current market is reasonably valued. India has seen the worst of a prolonged slowdown and growth potential is improving due to an ongoing cyclical recovery and early-stage capital expenditure cycle pick-up driven by infrastructure spending and urban consumption, coupled with an accommodating rate environment. As such, we expect a recovery in corporate earnings led by top-line growth and margin expansion. Given the improving earnings growth potential, we expect the market to produce an average of double-digit returns in the next 3-5 years.

Which sectors do foreign investors see as having great potential for the long term?
We are bottom-up investors and our stock selection philosophy is focused on long-term Growth, Quality and Sustainability criteria. We make our decisions based on the upside potential of the individual stocks that we track. From a bottom-up perspective, we find more long-term opportunities in banks, consumer discretionary and industrials.

The current Central Bank chief Raghuram Rajan is leaving this month. What expectations do you have for the RBI going forward – do you expect it to be more dovish?
The government has maintained its commitment to set an inflation target of 4% within a band of +/- 2% for five years to 2021. This inflation target has been formalized between the RBI and the government and it is unlikely that the targeting policy will change substantially when Rajan leaves his position as RBI governor in September. Under Rajan, CPI was used as the predominant measure of inflation. This could change as Rajan leaves, with the RBI potentially moving towards the use of multiple measures of inflation such as the GDP deflator and WPI. We believe that using multiple measures would be more comprehensive given that the CPI is highly weighted towards food, which is not reflective of the average basket of consumption and is also not high influenced by RBI rates.

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