After posting thumping gains over the past few months shares in India are set to consolidate as investors look to New Delhi for more action on the ground to revive investment in projects, particularly in rebuilding creaking infrastructure and getting the ball rolling on new manufacturing hubs.

Despite a feel-good sentiment after national elections in April-May produced the first single-party majority government in 30 years, and powered a stocks rally that at one stage took gains for the year to nearly 30 per cent — the most among major world stock markets, cash inflows are now slowing down indicating the emergence of resistance.

One of the factors for this has been the new administration’s inability to push reforms that are needed to give confidence for businesses to stake risk capital in ventures. Although New Delhi has started to remove obstacles for investment and opened single-window clearances, a lot more remains to be done.

For instance, a retrospective tax law — a draconian measure that the previous government brought in to circumvent a Supreme Court ruling in favour of British telecom giant Vodafone Plc — continues to remain in the statute despite a promise to repeal the act. Reforms to labour laws and land acquisitions also are needed to enable investment in manufacturing facilities.

The lack of progress in tackling these issues is taking a toll on the economy. HSBC’s PMI survey showed manufacturing sector growth in September cooled to a nine-month low as output and domestic orders slowed, particularly in the capital goods sector.

“Reforms to shore up business sentiment post-elections, so as to revive the investment cycle, are clearly needed,” Frederic Neumann, co-head of Asian Economic Research at HSBC, and economist Prithviraj Srinivas said in a statement.

“Growth in the near-term is likely to moderate as sub-normal rains, high corporate leverage, tight monetary policy and lingering structural constraints weigh on momentum going forward. The pace of reforms needs to be accelerated so as to blunt the impact of these headwinds.”

Wooing business

Talking to corporate honchos in New York and Washington, Prime Minister Narendra Modi promised to roll out the red carpet to attract substantial investments. Many of the CEOs from companies such as Caterpillar Inc, Pepsico, Boeing, Goldman Sachs and Google were impressed by his grasp of the situation and what needs to be done, according to media reports.

An accomplished speaker Modi also charmed the rich Indian diaspora at a gathering in Madison Square Garden, and invited them to partake in the development of India. He said that 65 per cent of India’s 1.2 billion people were below the age of 35, making the country with the youngest population, and also pointed out that India also possessed a huge domestic market.

Surely, these are strong reasons for businesses to make a beeline to India. However, they would also want to see transparent policies, fewer bureaucratic hassles, a commitment to honour contracts and removal of barriers to investment. The ball is in Modi’s court and investors will be watching if he lives up to his word.

The top-30 Sensex and the broader 50-share Nifty closed lower for the second consecutive week, albeit with minor losses, and the outlook is a bit hazy as foreign fund managers shy away from fresh commitments as they await fresh triggers. An imminent end to the cheap money in the US is also weighing on cash flows.

On its part, the Reserve Bank of India also seemed to hint that the government would have to push reforms to fix structural impediments that play havoc with food supplies and prices before it can consider easing monetary policy.

“Our conversations with international and domestic investors suggest that rate-cut expectations over the next six months are low,” Standard Chartered analysts Anubhuti Sahay, Nagaraj Kulkarni and Samiran Chakraborty wrote in a report.

“While there are mixed views on whether the monetary mechanism works in India, all agree that the RBI’s decision to keep rates unchanged over the short term sends a very powerful signal to market participants — and helps enhance the inflation-fighting credentials of the central bank.”

Investor expectations for a rate cut range from the second quarter to the fourth quarter of 2015, the analysts said. “Investors expect the RBI to trail inflation – and keep real rates at healthy levels: as inflation comes down, the RBI will lower rates — but it is unlikely to be proactive.”

Undertone bullish

Still, the outlook for stocks remains upbeat, especially on the longer horizon. “India is at the crossroads of a cyclical downturn and a structural upturn,” Morgan Stanley analysts led by Ridham Desai said in note. “We believe that India has the ingredients to deliver growth and stock market returns in the coming 3-5 years.”

They said the macro story was backed by demographics, productivity and globalization implying trend growth of 6.5-7 per cent.

“Profits are likely to gain share in GDP from their historically depressed levels, implying a CAGR (compounded annual growth rate) of around 19 per cent in the next five years. Absolute multiples for the market are around historical averages, and, together with profit acceleration, this could imply 16 per cent CAGR in share prices in the coming five years.”

Desai said Indian equities look appealing because of the potential earnings upside. “The market’s nearly 29 per cent rise since February makes valuations better-than-fair, especially relative to bonds and emerging markets. However, valuations still bear upside as the market attempts to price in the next growth cycle. The cycle appears to be turning up, and this augurs well for earnings.”

If the return on assets of companies that Morgan Stanley covers “mean-reverts”, there could be a 40 per cent upside to its estimates. “We are projecting Sensex and broad market earnings to compound at 19.8 per cent and 15.5 per cent, respectively, over 2014-15 to 2016-17.”

Earnings watch

Software services bellwether Infosys Ltd will kick off the quarterly earnings parade on Friday, and the results for the export-led sector are expected to be good thanks to improving outlook for outsourcing deals in the US and Europe.

“We expect steady growth from Indian IT vendors … with dollar revenues growing in the range of 2-7 per cent quarter-on-quarter for large players,” Rumit Dugar and Karan Taurani at Religare said in a sector preview.

“Margins are expected to improve led by rupee depreciation, operating efficiency and absence of visa costs. Overall demand commentary and outlook for the second half would be the key factors to watch. We maintain our preference for large-caps over mid-caps.”

They said Tata Consultancy Services and HCL Technologies are likely to be in the top quartile, while Wipro’s growth is expected to lag its peers.

Infosys could tighten its dollar revenue guidance band towards the lower end from the current 7-9 per cent for 2014-15, based on the performance in the first half and cross-currency headwinds on the dollar-euro.

“Wipro’s first half has been soft and thus the third quarter guidance will be closely monitored. We believe Wipro needs to guide for at least 2-4 per cent quarter-on-quarter growth in the third quarter to drive upgrades.”

 

The writer is a journalist based in India