India Equity Research: J.P. Morgan -India and China: Currency Cross-Currents

India and China: Currency Cross-Currents

· Local political hope and global flows aided Indian equities’ outperformance last week; Capital goods sector was the top performer

· Aggregate trading volume trend reflects increased investor interest in Utilities, Financials, Industrials and Energy sectors

· Extent of FII overweight in India reaches an historic high; similar levels seen in 2004

· Geo-political risks around Russia and Ukraine could have a double impact for India – increased crude oil price and FII over-ownership

· 3Q FY GDP print in-line with consensus expectations; monthly vehicle sales indicate continued trend of weak car sales and robust two-wheeler & tractor sales

· Sharp CNY real appreciation vs INR has had a limited impact on bilateral trade so far; in a normalized supply-side environment, it’s an India advantage for key export sectors

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A world with limited convictions. After a solid performance last year, DM equities are unable to find reason enough to move decisively. Sectorally, only Health Care and Utilities have outperformed notably YTD, indicating a phase of risk-reward reassessment. The main support for equities is that despite a time-wise matured bull market (especially USA) there are limited signs of aging, especially the inflation problem. EMs, on the other hand, have a different set of macro challenges. YTD, only the IT Services and Health Care sectors have outperformed – a trend also seen in India. Local factors were dominant drivers of Indian equities last week. The Capital Goods sector was the top performer, indicating some pricing-in of political optionality post the National election. Recent geo-political development around Russia and Ukraine is a key risk, given India’s vulnerability to increased crude oil price and significant over-ownership by FIIs.

Political surprises over economic surprises. Political developments seem to have overtaken as the primary driver for investor sentiment. 3Q FY GDP growth of 4.7% oya was largely in-line with consensus expectations. The internals were not encouraging though. The print is a lag indicator for equity performance. Recent indicators also reflect a similar growth pattern. The latest monthly vehicle sales trend shows a continued trend of weak growth of car sales (2.3% oya) and relatively stronger growth in two wheelers (31% oya) and tractors (M&M 18% oya). Separately, the electoral hustle has entered its last leg. New political alliances are being announced. The ruling Government seems to be expediting its last set of policy approvals before the code-of-conduct sets in. Some of the key announcements last week are:

· The Ministry of Corporate Affairs has notified the final list of CSR activities. The new Companies Bill (effective from April 1, 2014), requires companies above a defined size* to spend at least 2% of last three years’ average net profit on CSR.

· Union Cabinet approved a wide range of proposals. Two key are: the announcement on 7th Central Pay Commission and release of additional installment of dearness allowance to Central Government employees and dearness relief to Pensioners.

· Delhi Mumbai Industrial Corridor launched in Uttar Pradesh.

Trading volume changes suggest preference for cyclicals. Risk indicators, before the geo-political developments, indicated further improvement last week. FIIs were buyers across key EMs. India also saw increased FII flows. As per EPFR information, FII’s overweight stance on India has reached an historic high (see chart below). It’s a risk, especially if expectations on growth revival do not improve post the national election. The trend in aggregate trading volumes suggests that investor activity has increased in domestic sectors such as Utilities, Financials, Energy and Industrials (see chart below).

India – China currency cross-currents. The Chinese currency market has been volatile of late, in a surprising contrast to the Indian currency. Our economics team views the Chinese development as near-term policy orchestrated volatility aimed to achieve export competitiveness and some targeted moderation in external capital inflows. The direct implication of this short-term currency volatility is theoretically a perceived relative advantage for Indian equities, with limited fundamental implications. On a longer-time horizon, India’s currency depreciation vs China has been a healthy macro development for India which could not be capitalized as much. See below some relevant facts:

· CNY has appreciated a significant 50% vs INR over the last three years. Adjusting for the inflation differential (CPI), the extent of real appreciation narrows, but still remains a meaningful 30%.

· Despite a significant currency advantage, India's bilateral trade deficit vs China has not improved. India’s import from China has declined a marginal 6% over the last two years. The change in import share is relatively negligible (see charts below). Exports, on the other hand, have declined a higher 16%, largely driven by specific bans of iron ore exports.

· India’s imports from China are relatively high value manufactured products, while exports are primarily ores and minerals. Electrical electronic equipment, boilers, machinery, organic chemicals and fertilizers account for 60% of India’s imports from China.

· Export-linked sectors that are relatively better positioned to capitalize on the “currency” advantage are: textiles, chemicals, engineering goods and refineries.

Figure 1: India's trade with China