Is India’s de-monetisation sell-off overdone?
UBS reported to Asia Pacific clients on December 13.
Investors are asking if the recent sell-off in Indian equities post de-monetisation is
overdone. Press reports and our Indian Strategists’ own channel checks (link)
suggest that the cash crunch is having an economic impact. The degree of the
impact, shape of the recovery, and potential policy response remain uncertain, but
Ed Teather and Gautam Chhaochharia (Indian economist and strategist) have laid
out three potential scenarios:
(1) ‘Quick recovery’ – disruption only lasts a month.
(2) ‘Slower Recovery’ scenario assumes ~6 months of disruption. FY17 real GDP
may be at 6%. Base effect and probably some mild policy stimulus may mean FY18
real GDP at 8%.
(3) ‘Informal Economy Dislocation’ scenario assumes prolonged slow activity
(business failures, layoffs) with associated impact even on the formal economy.
FY17 real GDP growth may be very weak at 3.2% but may recover in FY18.
Ed has now adopted the second scenario as his base case. He also now assumes
lower inflation and the RBI to cut rates 25bps at each of the February and April
policy meetings. Indian equities have corrected – MSCI India has underperformed
MSCI Asia ex Japan by 5% in US$ since the end of October – and we believe they
are pricing in somewhere between scenario 1 and 2 based on our assessment of
the impact using a residual income model . In our model we flex near-term
earnings based on the above scenarios and assume that the value attributable to
long-term growth remains unchanged as this is just a near-term shock but should
not impact the longer-term fundamental outlook.
Given current market levels look to be broadly pricing in our base case scenario,
we remain Neutral Indian equities. We believe it is too early to go Overweight India
and there are still downside risks – in scenario 3 we see fair value another 10%
lower and of course markets can overshoot theoretical fair value. However, if
markets were to price in this scenario, we believe the risk/reward for Indian
equities would start to look more attractive to us.
Image source: Shockwave. (Reuters/Amit Dave)