Jefferies’ Chris Wood Cuts India’s Weight Citing Jammu & Kashmir Security Worries

Jefferies’ Chris Wood cut India’s weight in portfolio by 1 percentage point on worries that the security situation will get “significantly worse” after Prime Minister Narendra Modi’s government removed the special constitutional status of Jammu & Kashmir.

“Kashmir aggravation has added an additional negative,” Wood, global head of equity strategy at Jefferies, wrote in his weekly Greed & Fear newsletter, while also underscoring the falling credit growth, liquidity crunch and the bad loan problem of public sector banks. To be sure, Jefferies remains overweight on India.

India’s weight on the Asia Pacific ex-Japan asset allocation portfolio now stands at 15 percent as opposed to the 16 percent earlier. The one percentage point reduced from India was allocated to Indonesia.

Wood’s is a rare market voice on the potential fallout on stocks of the decision to abrogate Article 370 of the Constitution that granted Jammu & Kashmir more autonomy than other states in return for its decision to join India after Independence. Indian business leaders and market veterans have publicly commended Modi for the decision. Foreign investors and fund managers haven’t said much, at least publicly.

Greed & Fear has to admit that the surprise move by Modi on Aug. 5 to change the constitutional status of Jammu and Kashmir has given much greater credibility to the “longstanding attack on Modi by his domestic critics that his agenda is to build a Hindu ‘majoritarian’ state and turn India into ‘Hindustan’”.

While there is massive tourism potential in Kashmir, Modi’s goal to boost the local economy via investment will only happen if the security situation is satisfactory, Wood said.

The developments in Kashmir have so far proved more negative for the “already bombed out” Pakistan market, he said. “The MSCI Pakistan Index declined by 11 percent in U.S. dollar terms in the two weeks following the announcement, compared with a 1.5 percent decline in the MSCI India Index,” Wood said. “Though the MSCI Pakistan Index is up 11.2 percent so far this week, compared with a 1.6 percent decline in the MSCI India Index.”

Jefferies’ India Activity Index, comprising 10 high-frequency activity indicators, declined by 3.7 percent year-on-year in June and fell 3 percent on an average on a yearly basis in the three months to June, the lowest level in six years.

India’s credit growth has slowed compared to last year and tax revenue collection is also down, Wood said, pointing out that bank credit growth has decelerated from a recent high of 15.1 percent in December to 12.2 percent in early August while gross tax revenue growth slowed from 11.8 percent in FY18 to 8.4 percent in FY19 and, worryingly, was only 1.4 percent in the April-June quarter.

Wood said he is not so sure what Modi can do about the economy in the short term. “Some of this slowdown, particularly in the auto sector, reflects the continuing liquidity squeeze in the NBFC space triggered by the default of formerly AAA-rated IL&FS a year ago.”

While the auto sector is seeing a decline in sales, there is further delayed recovery in the residential property market with problem loans rising in the developer space, he said.

One area where government policy could have been much more proactive is the long-festering problem loan issue in the public sector banks, Wood said, adding that he is of the opinion that the government should have privatised state-run banks or sold down its controlling stakes. “That policy would have allowed for both recapitalisation and rationalisation of the public sector banks which still control 63 percent of deposits.” This, he said, is by far the “biggest failing of the Modi administration” to date in terms of economic policy.

“Modi has resisted such a policy for both political reasons, related to the problems of dealing with unionised workforces and the like, and seemingly ideological ones in the sense that he apparently wants, wrongly, to maintain public sector ownership,” he said.

Earnings estimates have continued to come down in the first quarter with Jefferies revising down the FY20 Nifty 50 earnings per share forecast by 7 percent since early July. As a result of the downgrades, the Indian market is not cheaper despite the 10 percent decline in the Nifty Index from the peak in early June, Wood said. “Investors are going to need to see evidence of a cyclical pickup to get excited since more monetary easing is already assumed, and there will remain legitimate scepticism about the impact of such easing.”