The date of the new prime-minister Narendra Modi’s election has coincided with a strong rally in the Sensex and with a significant volume of transactions, not only on that day but on the following days, bringing it to a new record high. Together with the breakout in March of this year and the recent one in May (probably in anticipation of the election results), the index confirmed the departure of the consolidation area, where it has been on the last few years.
The beginning of the recent correction in the last days begins to bring the index back to values closer to the “ideal entry”, because technically a more attractive value is around 23.500, 24.000 – closer to the short term moving averages and to the major gap, which appears not in the congestion area but above, which represents a very strong bull signal. Something important happened in the core psychology of those who follow the market, and in this case it is pretty straightforward to relate to the victory of Narendra Modi in India’s elections. This graphical behavior is known as a “breakaway gap”, and it is usually advisable as a trading tactic the placement of the stop just below the gap, just in case it doesn’t turn into an “exhaustion gap”. Thus, technically the signs seem very attractive for those who want to own Indian stocks. However, it is unusual for growth to be in a straight line, especially in a market like this that has demonstrated its volatility, so choose wisely between an immediate entry and one after a sharper correction.
SENSEX last year – daily candles
SENSEX on the last 5 years – weekly data
There are still some structural problems…
There are still serious structural problems in India and because they are so rooted they are not so easy to solve, as the report by Goldman Sachs “Emerging markets: As the Tide Goes Out” (December 2013) makes clear. In addition to the political consensus problem and bureaucracy involved, the report presents the 3 problems that most undermine India’s economic growth and which increase the vulnerability to internal and external shocks:
“First is a burdensome bureaucracy and regulatory environment. India is ranked as one of the weakest countries with respect to the burden that government regulation places on its society. On the Business Freedom Index, it scores below all other key emerging market countries (see Exhibit 31).
Poor regulation and rigid laws lead to considerable inefficiencies. For example, about 21% of India’s power output is lost during transmission and distribution, compared with 6% in China and the US. This is primarily due to the difficulty of integrating a state- and region-wide system into a national grid. Inefficiencies in the food supply chain are even worse. The government estimates that 40% of the fruit and vegetable production in India is wasted due to lack of storage, cold chain and transport infrastructure. And what food does make it to market is priced up to 50% higher than what the farmer earns because of the Agriculture Produce Marketing Committee Act, which forces farmers to use licensed middlemen.
Inefficiencies of this magnitude are even more striking when one considers that over 200 million Indians are undernourished. Yet they persist because the politically powerful agricultural middlemen resist attempts at reform. The country’s complex rules governing foreign ownership and management of stores recently quashed Wal-Mart Stores Inc.’s efforts to open retail stores in India.
A second structural fault line is India’s current mix of exports. India has shied away from expanding exports of light manufactured goods that would leverage its massive pool of unskilled labor. Instead, it has chosen to focus on exports such as prescription drugs, software services and machine tools, which all rely on relatively scarce skilled labor. Jonathan Anderson of Emerging Advisors compares India’s exports of light manufacturing goods to those of India’s low-income Asian competitors—Bangladesh, Cambodia, Indonesia, and Vietnam—and concludes that India will need to adjust its export model very soon in order to achieve high growth rates.
Third, India has a particularly unfavorable fiscal profile. Its government debt-to-GDP ratio stands at a high 67%, well above the IMF’s suggested 40% target for sustainable growth in emerging market countries. Moreover, India’s high budget deficit—at more than 8% of GDP—ranks worst among the key emerging market countries.
Furthermore, it has a current account deficit of 4.4% of GDP, illustrating how much it relies on foreign flows to support its economy. The IMF believes India’s debt-to-GDP level will be stable at 67% as long as GDP grows at 6.3% over the medium term; but should growth slow to somewhere between 4% and 5%, we project its debt ratio will increase to a high of 74% in the next five years.”
… However …
“We should note that while much has been written about high levels of corporate debt in India, we do not think the picture is as dire as many suggest. It is true that in absolute terms India’s corporate sector has significant debt, and that corporations are vulnerable to increasing amounts of leverage. However, corporate leverage as measured by debt-to-equity ratios is in line with that of many Asian countries and remains less than in China, the Philippines and Vietnam. That is not to say that incidents such as Essar Steel’s and Kingfisher Airlines’ recent missed payments will not continue. And the government may in fact have to recapitalize public sector banks, which account for about 75% of the country’s banking sector. But, in comparison to other troubled emerging countries, India’s corporate debt issues are not particularly troubling.”
Despite the immediate economic situation points to unresolved problems (such as high-level corruption, slow industrial production and disorganized public finances), and which have proven so far difficult to solve efficiently, there are factors that can boost long-term growth (not independent of each other):
The new prime minister Modi, who obtained a consolidated majority in the elections and that few people thought possible (he conquered 282 of 543 seats in parliament, with no party other than the one in power since independence had achieved so far. Along with close allies, the sum is 336 places), promises a radical shift in India’s policy.
Throughout the campaign the speech was often guided around the economic prosperity of the country and focused on increasing people’s hope: promises to improve the energy and aquifer system, the construction of new roads, improving the conditions in the industrial sector, between others. In his speeches he has highlighted the importance of implementing reforms and the corresponding results obtained, having as a demonstration of confidence his election by 3 times in the state of Gujarat.
As a sign of personality, it is mentioned, by close ones, that he behaves as a chief executive, assigning tasks with deadlines and waiting results in due time. This aspect can be important because it can solve many of the issues that so far have failed and have been identified as weaknesses and that most jeopardized the economic future of India: The uncertainty in Kashmir, weaknesses in public accounts, lack of infrastructure and energy resources, etc. Governing Gujarat is very different to rule India – true – but these are nonetheless good indications, especially now with a more smooth decision-making process, due to the majority in the parliament.
One aspect in which we already see some dynamism is on the foreign policy: the effort to improve the already long strained relationship between India and Pakistan, the expectation of a “strategic partnership” with Japan, and also what seems to indicate an attenuation in relations with the US. Although inexperienced in this field, when ruling Gujarat Modi proved to be open to the entry of foreign companies, and made occasional visits to Japan and China, in order to promote investment and trade.
There are also favorable macroeconomic forecasts:
- IMF: It’s expected a recovery in GDP growth of 4.4% in 2013 to 5.4% this year, 6.4% in 2015 and 6.8% in 2019, according to the IMF (http://www.imf.org/external/pubs/ft/weo/2014/01/pdf/text.pdf ).
Daniel Altman, professor of economics at New York University, built the ‘Baseline Profitability Index (BPI)’, which brings together eight factors that attempt to predict return before taxes in order to invest in a country and see how they can affect Foreign Direct Investment (economic growth , financial stability, physical security, corruption, expropriation by the government, exploitation by local partners, capital controls and exchange rates). In this study, India comes in 6th position worldwide.
Personally, although the mentioned structural problems, the Modi effect combined with the technical analysis signs are quite sufficient to be long here, on the short, medium and long term.