India Strategy The Great Transfer :: Morgan Stanley Research,

India Strategy
The Great Transfer
The Great Debt Transfer and its implications for
equity returns: India’s policy response to the global
financial crisis has been to reduce public savings to
boost growth. The collateral damage has been
persistent consumer inflation and declining corporate
savings or profit share in GDP.
Consequently, in the past five years, debt has been
transferred from the public sector to the private
corporate sector (the opposite of what’s taken place in
DM).
Persistent inflation has deflated public debt relative to
GDP – but it has also punctured corporate profits (and,
thus equity), causing corporate financial leverage to rise.
This also means that ROE is overstated relative to ROA.
Rising US bond yields imply that India will need to keep
real rates high – creating downside risks for ROE.
In such a situation, the valuation template for investors is
as it was in 1998 – not the P/B multiple – but the
earnings yield minus the short-term bond yield. This
metric is in negative territory – implying that equities are
not cheap, as they may have appeared before mid-July
policy action.
India’s macro construct threatens its relative gains
against its most relevant peer group (the BRICs) in the
18 months preceding mid-July.

��

-->
India’s policy response to the global financial crisis has been to
reduce public savings to boost growth. The collateral damage
has been persistent consumer inflation and declining corporate
savings or profit share in GDP.
Consequently, in the past five years, debt has been transferred
from the public sector to the private corporate sector (the
opposite of what’s taken place in DM). Persistent inflation has
deflated public debt relative to GDP – but it has also punctured
corporate profits (and, thus equity), causing corporate financial
leverage to rise.
The world’s reserve currency is no longer interested in funding
India’s external deficit (caused by the persistent fall in savings).
Thus, it becomes imperative for India to reduce this deficit. The
only path forward is to keep real rates high at the cost of growth
à la 1998.

The return on assets (ROA) for Corporate India has plummeted
to all-time lows. The only reason for ROE to be higher than its
historical low is that debt is higher than ever. However, with
high interest rates, this will change in the coming months
Given the similarities with 1998, the valuation template is also
1998. No doubt, the absolute multiple – especially the
ever-reliable P/B – is about to enter the bottom decile – a point
from where losing money is a rarity. However, this does not
work when the earnings yield is less than the short-term yield –
as in 1998. The short-term yield hinges on US outcomes. If the
US labor data remain strong, Indian yields will struggle to fall. In
the end, of course, India’s macro imbalances will moderate
because of high real rates (as in 1998) and cause a correction
in yields.
The macro construct threatens India’s relative gains against its
most relevant peer group (the BRICs) in the 18 months
preceding mid-July