Last January, India’s Sensex index was hitting new records after years of “rollicking appreciation”, says the Journal of India, and bullishness was pervasive. Few expected the subprime crisis to affect “the great India story in the way it has”. But since then the market halved as global risk-aversion returned and the local and global economic outlook darkened – and a fast recovery looks unlikely. India was supposedly insulated from a global downturn because exports comprised a lowly 15% of GDP. What was forgotten, however, was that India “has had one of the strongest credit cycles within the Asia ex-Japan region”, says Morgan Stanley. Over the past few years low domestic interest rates and strong capital inflows underpinned a credit and investment boom.
Investment spending accounted for just over half of GDP growth over the past five years, with Indian industry relying on overseas money for over a third of its financing, says Capital Economics. Now, capital inflows have dried up: overseas investors pulled out a record $10.4bn last year, following net inflows of $20bn in 2007.
What’s more, domestic banks are also becoming increasingly cautious. The central bank has cut interest rates by 3.5% since October, but since then the prime lending rate for the five major banks has fallen by just 1.5%. Three-month commercial paper rates are also still above the long-term average. The fact that non-performing loans are just beginning to rise will also make banks more risk-averse and reluctant to extend credit, says Chetan Ahya of Morgan Stanley. Year-on-year credit growth has cooled to 22% from 30% in the autumn.
The credit drought, along with slowing consumption and mounting job losses, will deter companies from investing. Investment bank CLSA sees investment troughing at 3.8% year-on-year; at the height of the boom it reached 20%. Meanwhile, exports are shrinking in dollar terms for the first time in seven years, says Capital Economics. Given relatively high government debt and a budget deficit of 8%, there’s scant scope for a significant boost through government spending. The upshot, says Capital Economics, is that GDP growth is set to halve to 4% this year.
Given the “pretty dramatic slowdown” as the country grapples with “a liquidity bind” following its credit boom, says Niall McLeod of UBS, “we’re not big fans of India” when it comes to equities. A particular reason for caution is that the scale of the potential downturn appears not to have been factored in yet.
Earnings for the Sensex index are expected to expand by 6.7% and 5.3% for the years to March 2009 and March 2010 respectively, but Ridham Desai of Morgan Stanley expects a 10% drop for 2010. India is also 28% pricier in p/e terms than emerging markets as a whole, he notes. Desai reckons the Sensex could finish 2009 another 11%-30% lower – and even if the market has hit bottom, history implies that another bull run is at least 14 months away.