Jonathan Schiessl, Chief Investment Officer at Ashburton Investments, is in Mumbai and Delhi meeting company management, government officials and the people who are driving the world’s fastest growing major economy.
It is a very unusual time to be in India. Not because markets are still trying to digest the possible implications of a Trump Presidency but due to fact that we are currently travelling in India during possibly one of the most unorthodox, radical, if not downright brave, policy reforms in the country’s history – demonetisation.
On 8 November, the Prime Minister cancelled 86% of the currency in circulation overnight. Such was the secrecy of the move that it is rumoured just three people were in the know prior to implementation, and this in a country of nearly 1.3 billion people. There have been plenty of coverage on the motives for this most unusual move so we will not repeat what is already known. Suffice to say that Modi campaigned for his election just over two years ago on a platform of delivering economic growth and stamping down on corruption. The hope of delivering the former has just been given a short term hit in his attempt to deliver the latter.
Mumbai is clearly not India, but life here is certainly not what we would normally expect to find. On arrival a few days ago, the hotels refused to change foreign currency, banks had run out of money and ATM’s were out of service. Ordinary citizens have been hit with a massive cash crunch as the government and central bank desperately try to get more new currency into the system as soon as possible. The good news is that queues are visibly getting shorter and one of our group even managed to get some money out of an ATM.
We are told that the shock is hitting discretionary expenditure hard but more concern is focused on the lasting impact to real estate where the presence of black money is perhaps most evident. Our view remains it is simply too early to tell but life does seem to be very slowly getting back to normal in the everyday sense. The impact to property and other areas will become more evident after a few months. What is in no doubt to us however, is damaged sentiment. People have accepted that the move was a stunning masterstroke to hit the black economy but the inconvenience and uncertainly have left plenty of risk for PM Modi if the situation does not recover soon.
Whilst the Indian rupee has taken the news in its stride and Indian bond yields have actually fallen, equity markets have taken the news badly, particularly the small and mid-cap stocks which are the favoured area for domestic investors. Is this forced selling to raise liquidity due to losses from demonetisation? Perhaps, but the short term hit to growth will certainly have an impact on the earnings recovery of which we had finally been seeing tentative signs.
But let’s not get carried away here. Demonetisation is deflationary, and the bond market is pricing in more interest rate cuts in the near future than were recently expected. In addition, the expected massive one-off bonus to the government that is likely from the disappearance of so much black money will very likely lead to some significant stimulus measures from the government. Modi’s political imperative is re-election and to be seen to enact measures both to help the poor for their inconvenience and boost infrastructure spending, thereby creating jobs, will help his chances. The fact that the annual budget has been pulled forward to the beginning of February is a clue, but we would expect news before this date.
Against this back-drop we see Indian equities being heavily sold off. Is the India story finished? Certainly not, but just delayed by a quarter or two. With index valuations now approaching long term averages and individual stocks re-setting at much more investible levels, we are deploying cash back into some fantastic existing holdings. We have also taken some profits on our put options. However, we are still maintaining a significant position in the options until the current volatility somewhat abates. As an investor, all we can control is the price we are willing to pay for an asset. The price for Indian equities has just become significantly cheaper.
Jonathan Schiessl is Chief Investment Officer at Ashburton Investments