Within the emerging market asset class, Asian equities remain attractive, supported by pro-growth policies and robust economic dynamics resulting from rising domestic and global trade demand. Within Asia, the region’s two largest economies, China and India, anchor our optimism.
China and India are uniquely positioned. An early year standoff in the Himalayan mountains and rising Chinese investments into Pakistan have annoyed New Delhi, while India’s support for the US’s Indo-Pacific initiative have aggravated Beijing. Both countries also share striking similarities, including elevated domestic political capital for Chinese President Xi and Indian Prime Minister Modi.
Such approval may suggest that the investor community holds a tolerance level of about 12 to 18 months for new initiatives to flow into the economy. In early 2016, markets were concerned that elevated debt levels would squeeze liquidity and generate an economic hard landing in China, forcing Beijing to deploy nearly a $1trn USD of its foreign exchange reserves to stem capital outflow. When Beijing commenced its 19th Party Congress in late 2017, many of these concerns faded as macro readings and equities rebounded following policy implementation over this period. India now hopes to emulate this.
In November 2016, PM Modi’s demonetization announcement was a major surprise, using the exercise as a political program under the aegis of weeding out corruption. The program received heavy criticism from opposition members, since almost the entire supply of paper money (approximately 86% of currency circulated) was deposited into banks. The program resulted in minimal fraudulent exposure and instead instigated major disruptions in business activity.
The goods and services tax (GST) followed six months later. Similarly to demonetization, poor follow through and uneven implementation produced additional havoc for a still febrile economy. The combination of a liquidity crunch and inventory destocking weighed on investments, evident by the 5.7% GDP growth during the quarter ended 31 March 2017, the slowest rate under the administration. Modi’s reforms were depicted as having wanton disregard for political opponents, pushing an agenda at the expense of the poor.
Despite the disruption, Modi’s approval rating remained high, as supporters displayed willingness to countenance the inconvenience. Changing consumption behaviors also emerged, with deposit inflows increasingly demanding mutual and insurance funds over traditional assets such as gold and real estate. Along with a newly passed bankruptcy law and ongoing push for Aadhaar cards, efforts to formalize the economy and reduce disbursement leakages were gaining pace.
This set the stage for the most recent events: the PSU (Public Sector Undertaking) capital injection and the sovereign upgrade by Moody’s. New Delhi’s announced plans to infuse Rs2.1trn ($32bn) into state owned banks came as a surprise in both timing and amount, which aims to ignite India’s lethargic investment cycle. This would later feed into Moody’s decision to upgrade India’s credit rating, coming slightly after the one year anniversary of demonetization.
So what has changed and why does this matter? The capital injection into public state banks increases the availability of credit to lend which previously had been sidelined, while the sovereign upgrade lowers the cost of funding for financial institutions. More importantly, the new bankruptcy law favors the creditor over the debtor, addressing the structural historical issue which had previously favored the borrower. Immediate benefits occur as distressed assets are better utilized, while capital expenditure projects involve longer integrations periods before producing economic returns.
These measures should portend well for investors as investment interest are aligned with politicians looking to drive growth and win reelection seats. While momentum is positive, the investment landscape is not without faults. PSU banks reflect Modi’s political will, while tighter credit standards and lingering bureaucratic red tape keeps loan demand hesitant. Defaulting borrowers are also not completely banned from bidding for distressed assets in bankruptcy liquidation, creating a moral hazard dilemma.
Addressing the aforementioned would be supportive for medium term growth prospects, carrying political capital for Modi’s administration to address other legacy burden such as agriculture and land reform which benefit the longer term outlook. While Chinese markets rose as robust economic environment became conducive for earnings this year, questions still linger over liberalization reforms that address state owned enterprises and market access to foreigners. New Delhi has already proposed guidelines to tighten the bidding process and ring-fencing investments to qualified investors, which would justify valuation premiums. Investors have already given China equity markets the benefit of the doubt in 2017, and perhaps may reward India similarly in 2018. That would be a good act to follow.
Christopher Chu
Fund Manager - Asia