JPMorgan’s Bharat Iyer Says  India’s Economic Slowdown Bottomed Out But Earnings Recovery A Year Away
A worker flags down a vehicle outside the Daimler India Commercial Vehicles Pvt. manufacturing facility in the Oragadam district of Chennai. (Photographer: Dhiraj Singh/Bloomberg)

JPMorgan’s Bharat Iyer Says India’s Economic Slowdown Bottomed Out But Earnings Recovery A Year Away

The slowdown in India’s economy and corporate earnings growth has bottomed out, but the recovery needed to bring in a gush of foreign money is still a while away, according to JPMorgan’s Bharat Iyer.

Still, the enthusiasm to look at India as an investment destination hasn’t changed, Iyer, India’s head of equities research, at the global investment banking firm, told BloombergQuint on the sidelines of the JPMorgan Investor Summit in Mumbai. “Emerging market investors are running a neutral position in India vis-a-vis the benchmark. This neutral position has been despite earnings growth being underwhelming for the last four to five years.”

“This just shows how well they appreciate a structural opportunity. But for them to go overweight, we’ll have to offer a more robust earnings cycle. That should take time.”

Given India is going through an economic slowdown, Iyer expects earnings growth to remain “underwhelming” for another year before it begins recovering. The nation’s gross domestic product growth fell to a six-year low in the quarter ended June owing to a consumption and investment slowdown. Last month, however, the government announced several policy measures to revive demand.

India will now start seeing a gradual recovery from the 5-percent growth levels to 6-percent growth levels, Iyer said. “We have to appreciate that we’ve had a normal monsoon which will bring some kind of demand back to the market. We’ll see the return of government spending after the election cycle is done with, and I think monetary transmission on the margin will start picking up,” he said.

But for FY20, earnings growth is likely to be in lower double digits compared to the expected 20 percent and above, Iyer said.

Difficult To Tarnish India’s Appeal

Even as the world deals with trade disputes, growth slowdown and now a sudden spike in oil prices, it’s difficult to diminish India’s “appeal” as a market, Iyer said.

India is a fairly small part of the global supply value chain, which relatively protects it from volatility arising from the U.S.-China trade war. If anything, a global slowdown may benefit India in terms of lower commodity prices, he said.

Iyer, however, cautioned that a surge in oil prices after an aerial attack cut Saudi Arabia’s crude production by half could be a source of worry. “Currently, the view is that it’s temporary but if this is something that sustains, we really don’t need oil at $70-75 a barrel at this stage in our recovery.”

While the spike in oil prices raised inflationary concerns, it may also spook foreign investors who turned net buyers in the first two weeks of September after selling investments in August and July.

“The stress we are seeing in equities is a combination of muted flows into emerging markets at large and in terms of the slowdown,” according to Iyer. But one shouldn’t deny the structural opportunity that India provides for investors, he said.

India’s demographics and the deep need for infrastructure across sectors makes the market appealing despite the cyclical challenges, Iyer said. This, coupled with the fact that the government’s measures is likely to boost the economy, means there is money waiting to enter the Indian market, he said.

“If oil remains well behaved then there is no taking away from India’s appeal.”

Don’t Hold Your Breath For Auto Recovery

About the slowdown in India’s automobile sector, Iyer said unless there is a cut in the goods and services tax rate, a recovery in demand could take a few years.

“In an 18-month time span beginning September last year to March next year, you’re going to have the sticker price of vehicle going up by 15-20 percent,” he said. “In an environment where wage growth is 5-6 percent, a 15-20 percent cost increase means it’s going to take a couple of years till affordability matches up.”

Watch | What Bharat Iyer has to say about India’s economy and the stocks JPMorgan is bullish on...

You can also read the full transcript here:

What’s the sentiment like at the JPMorgan conference today?

There is a lot of enthusiasm there. There are 80 companies out here, we have 300 investors cutting across asset classes. We expect to have a lot of senior policy makers, so I think the enthusiasm to look at India as an investment destination has not diminished.

Really? Considering what we are looking at? Maybe the equity market is just a one point of view but considering nothing that has happened from a foreign investor point of view and what we did in terms of growth, is it still an attractive destination?

See, summits like these are meant to showcase the structural opportunity that India presents. Sure, there will be cycles and I think we are going through a cycle and perhaps we are at the bottom or we at least hope we are at the bottom of the current cycle. But I don’t think it takes away from the structural appeal and that’s what we are seeing in terms of enthusiasm around us.

Where do you see us going from here? Do you think we have sort of troughed out in terms of this slowdown that we are seeing or is it slightly more prolonged? Each and every sector is in some form of pain. It is actually going to take some time before you kick start the growth engine once again? Or maybe just the base effect plays out for you?

I think its going to be a recovery from here. I think we have largely troughed out but that’s why the recovery is going to be gradual. What drives the recovery in the second half, I can think of three factors. Actually, four now that you mentioned the base effect. Apart from the base effect, we can appreciate that we had a normal monsoon, that should bring some demand back to the markets. I think we’ll see the return on government spending after the election cycle is done with. I think monetary transmission on the margin will start picking up. So, we’ll start seeing a gradual recovery which takes us from the 5 percent levels to the 6 percent levels. But, as I said earlier, the recovery will be gradual. We shouldn’t expect a V-shaped recovery at this stage.

So even from an equity market investment standpoint it should not be hurried? Pace it out, as in, weight it out, see things changing?

Absolutely. That’s been our call too on some time now for the last two or three months. Look, this is going to be a year of modest returns in a volatile environment because volatility is not local right? Even if you look beyond India, we are in a volatile environment.

So far, the budget, it’s been India specific. We are charting our own course. Now, global factors are looming larger than our domestic issues. Add to that, the spanner in the works has been oil in Saudi Arabia. How big an issue is it going to be for India to cope with global issues?

See, I don’t worry too much about the global recession’s impact on India beyond the normal and the obvious because we are relatively a small part of the global supply value chain. Perversely, a global slowdown could help India on a smaller pace particular in the form of lower commodity prices. So that is something I think we can live with and the economy is largely economically driven and not driven by trade and exports. But what I do worry about is the spiking oil prices. I mean, currently the view seems to be that it is temporary, but if this is something that sustains then we really don’t need oil at $70-75 a barrel at this stage in our recovery.

And not to say the implications of a sustained higher oil price on the Current Account Deficit calculations and the overall.

It impacts everything. It impacts CAD, it impacts the currency and it can put a potential enquiry on either the fiscal deficit or inflation. That’s something one needs to keep an eye on.

So that is an eminent risk? That is something that if foreign investor is looking at and if you were to take call investing in India as an emerging market or another emerging market, why would you choose India?

Well, at this stage, you are right. If the oil were to stay at 70-75 dollars it does put pressure on India in a cyclical manner. But the expectation really is this spike in oil prices must not buy economic fundamentals but geopolitical factors which you’d expect to wane and in which you’d expect a policy response. And if that were to come through and oil stays well behaved, then there is no taking away from India’s appeal. There are both structural reasons and near term reasons as I mentioned. If trade wars is your main concern, then India is relatively insulated and in the longer term, the combination that we offer in demographics and need for infrastructure and investments, is something that is unparalleled.

So why have investors stayed away?

I don’t think investors have stayed away. If you look at it overall, emerging market investors on aggregate are running a neutral position on India vis-à-vis the benchmark. On the benchmark, our weight is around 9 percent and I think they are at 9.2-9.3 percent. So, I don’t think investors have really been underweight on India or have neglected this market. We have to appreciate that these earnings have been despite overwhelm for the last 4 or 5 years. So, this just shows how well they appreciate the structural opportunity. But for them to go overweight, we have to offer a more robust running cycle.

And that will take some time, you say?

That will take some time. Because as I mentioned earlier, the base case is 13 odds so the economic recovery will be gradual. So that means that you will have another year of underwhelming earnings. I think consensus earnings, expectations are north of 20 percent and perhaps, you will get low double digits. But that will still be an improvement in relation to the trend we’ve seen in the last four or five years but, 15 percent earnings growth that really will bring them back in a very meaningful manner.

And therefore, they find the valuations compared to other emerging markets expensive?

Absolutely, if you look at FY20, we are trading at about 20 times. If you look at FY21, we are trading at about 18 times. EM on average is 30 percent cheaper.

FIIs don’t have a separate allocation to India. I mean, it forms the emerging market basket and we are a part of that. While they have not really gone underweight, they have stayed neutral, do you feel that with China opening up and removing restrictions of investments, that pie for India becomes smaller?

In a tactical sense, yes it could happen. But I think there are factors that should drive India’s weightage back over a period of time because you’d argue that we offer superior and more sustainable growth. Because let’s face it, the rest of the world is also slowing. It is not just India that is slowing. and more importantly, our free float factors on the lower side and its perhaps the lowest downs that we are grouped. That’s where I think the government’s decision will increase the free float companies from 25 percent to 35 percent is actually, if implemented over the medium to long term, a very positive step. Because, it will take our weight in the indices up which is currently represented in relation to the size of our economy.

Since we are talking about slowdown and the global slowdown as well. The pain in the Indian equity markets is that much you feel is exaggerated? Or is it par for course and we’ve been seeing fundamentals don’t playing out and therefore, prices are coming down to what normal are?

It’s a combination of factors. Because you know, its not like globally there is a tidal wave of money coming into emerging markets.

S&P 500 is in record high still.

That’s the exception rather than the rule. What we’ve seen is that the U.S. has been the outlier in terms of growth and in terms of market performance, whereas the rest of the world has trade, both in terms of growth and market performance. So, the stress we are seeing in the equity markets is a combination both of relatively muted flows in the emerging markets at large, including India and also in terms of the slowdown that we’ve seen. But again, you know, appreciate that if we start delivering appropriate response and growth, there is money waiting to be coming in. Just look at what happened over April-May-June. At one point we were having net inflows, this time in $10-11 million. Yes, we’ve seen an outflow in the last two months but that can reverse very quickly once investors start seeing signs that growth has bottomed out and we have seen pickup.

Are you happy with all the announcements that the finance minister has made? Do you feel that sooner rather than later the impact of that will be evident?

I think what the government has done is a series of incremental measures. Particularly, in sectors which are going through a lot of stress. See we have to appreciate that the government doesn’t have too much fiscal space to pump the economy at large. I mean, consolidated across the central governments and state governments and the balance sheet, we are running a deficit of almost 9 percent. It’s unreasonable to expect them to try and pump around the economy at large and compromise the economic stability. So, I think, what is necessary and what is being delivered is a more tactical response. Looking at distress sectors and giving them some leeway through the space of slowdown and giving them some monitory policy to do the heavy lifting.

Firstly, the consolidation in the PSU banks is a pain and do you feel it’s a right step at the right time when the focus should have actually been more on making sure there is enough transmission in the system, lending takes place, management bandwidth shifts towards making sure that mergers happen in a steadfast fashion? That being one and the another one, on similar lines, what they’ve been asked is the external benchmarking of regional and MSME loans to make sure that faster transmission happens. How did you make it into course?

In response to your first question, I think its always a good time to do something structural. I think we had too many PSU banks, it was very difficult to manage them, and I think consolidation is the right answer and I think they have done it. There will always be questions whenever you do it, people will say that is this the right time? You have a lot of political capital and goodwill at this point in time so you might as well get it done now. You have that capital and goodwill.

In terms you know, will it constrain lending? That is an operational issue. That is something that will have to be managed. But I think whenever the step had been taken, there will always be question marks on the time frame. And I think there couldn’t have been a better time frame given that they were at the back of such a thumping mandate and they have such a political capital and goodwill. In terms of benchmarking and linking rates, that is difficult question to answer because you know its each bank to its own. Every bank has its own profile in terms of liability franchise, the cost at which they can raise money, their customer segments that they cater to- both geographic and in terms of sectoral. So, I think a more nuanced approach is required there.

The auto industry, the struggle seems to be never-ending. Its been since we’ve been talking about the pickup, the slowdown, whether it is structural, whether it is cyclical. Nobody can really predict when it will turn around. What’s your gauge on the on-ground situation?

As far as the auto sector is concerned, they are at the receiving end of policy related costs bunching up. So, in 18 months time span, beginning September last year to March next year, we are going to have the sticker price of vehicle going up by 15 to 20 percent. You had an increase because of insurance, you had an increase because of safety and down the line, you’ll have an increase because of emission norms.

Let’s face it. In an environment where wage growth is 5-6 percent, a 15-20 cost increase means it will take a couple of years before affordability levels catch up with the new norm on pricing. So, it’s going to take time for affordability levels to catch up and feel good to come in. So, have we seen the worst month over month declines? I would say yes. But are we going to see a very sharp rally? Unless the GST is cut, I don’t see that happening and the recovery will be gradual.

Where is JP Morgan overweight in India?

In India, we are overweight on financials; particularly the large banks because we think the worst of the credit cycle issues are over for them. We see loan growth returning, we see policy being supportive and most of them have a liability franchise. We think that the incremental stress that we are seeing in the credit cycle issues are more mid-corporate level and they are going to impact the smaller banks more than the NBFCs and large banks. So that is one area that we think there is value.

We like the insurance space; we think that it’s a very underpenetrated market and it’s a very long runway. So, that’s another part of financials that we like.

We think that companies associated with the government’s investments and priority infrastructure areas, be it roads, be it affordable housing, be it water; will all tend to do very well. So, areas like cement, select capital goods and construction companies.

Lastly, I also think there is a lot of value in these state-owned companies. Some of them have very dominant franchises, they are trading at least a one-time book, offering you a dividend of 6-9 percent and I think if there is a well-articulated divorcement policy, then there is meaningful money to be made from here.

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