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Indian economy expected to perform well on the back of healthy developed world

With growth in developed markets picking up and the U.S. Federal Reserve (the Fed) poised to raise interest rates, the Indian economy is expected to perform well, as it has always done during periods of recovery in the developed world.

While increases in interest rates are always a concern, the effect on global markets this time around is expected to be benign. In fact, with China joining the monetary expansionary policies of the Eurozone and Japan, the chances of serial rate hikes by the Fed seem limited at this point in time.

In the wake of the much-anticipated Fed ‘rate hike’, the U.S. dollar and treasury yields have been firming up while equity investors are seemingly more excited at the prospects of an economic recovery rather than the continuation of near-zero interest rates. These developments, in turn, are expected to reduce the persistent volatility that has plagued equity markets this year.

In India, efforts by government officials and the Reserve Bank of India (RBI) to bring more transparency in systems and procedures; better governance; speedy clearance of investment proposals; and rationalization of the tax structure have started to take hold.

Most of these initiatives have been complimented by global agencies, such as the World Bank Group, when it comes to improvement in ranks for "ease of doing business", “international competitiveness,” and the country’s rating outlook – all resulting in an influx of foreign direct investment commitments.

It is expected that the current quarter will witness a bottoming out of the earnings downgrade cycle and that earnings growth should pick up as corporations start benefiting from an increase in demand driven volumes, the resuscitation of stalled projects and higher profit margins.

Incidentally, India’s return on equity has bottomed out at around 13% in 2014 against a 20-year average of 18% with improved outlook on margins and asset turnover. The markets remain attractively priced at a near 10-year average valuation at ~16.1x earnings for fiscal year 2016, with an expected earnings per share growth rate of 8% for FY16 and 16% for FY17.1

Currently, India clearly stands out as a beacon within the emerging markets thanks to its improving macro conditions, evolving policy environment and attractive relative valuation. India is in a sweet spot to attract global capital flows. As a result, there has been a revival of initial public offering activity to satisfy this renewed appetite.

In addition, it is expected that there will be a revival of urban consumption on the back of better jobs data, low inflation and expected receipts for civil and military personnel on account of wage and pension revisions by the government.

The long-term potential of the Indian economy remains intact. The four key themes that drive India today are digitization, globalization, emerging demography and enforced governance. Each of these variables possesses disruptive traits that can challenge the current market structure – creating new businesses, new brands, new categories and new winners.

Although inflation has been a longstanding issue for Indian policymakers, the core inflation has consistently undershot the RBI’s expectation so far this year. A structural downshift in prices is

projected, against a backdrop of global deflationary pressures, limited pricing power, better logistics and technological improvements and sound strategies by the government and RBI.

The scope for additional policy cuts would largely depend on the medium-term inflation outlook. Interest rates may remain stable at least for the remainder of this fiscal year, with the focus of the RBI now likely to shift towards ensuring better transmission of rates especially in the loans market.

1 SBI Funds Management Private Limited, Market Outlook, November, 2015.

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