Indian financial sector rout: concerns for now

A debt crisis at a conglomerate sparked the decline in Indian financial names, but contagion risk seems unlikely. 

Sep 27, 2018 | Invesco Asian Investment Team

The Event

  • The MSCI India index and the financial sector have declined by 7.9% and 14.4% respectively in US-dollar terms since the beginning of September. The fall was triggered by the recent developments of Infrastructure Leasing & Financial Services Ltd (IL&FS), market concern over liquidity, and unfavorable global backdrop including rising crude oil price and depreciating EM currencies. 
  • IL&FS, an unlisted infrastructure lender, has failed to meet a series of repayment obligations in recent days and its credit rating was downgraded by ICRA Ltd, the Indian unit of Moody’s Investors Service. The situation was further worsened by liquidity concerns in the marketplace that some financial companies might face difficulties in obtaining funding. 
  • Global macro backdrop has turned less sanguine for India in recent months too. The rupee has depreciated at a faster pace as a result of the strengthening US dollar, and fears over contagion risk from other emerging markets including Turkey and Argentina. The climbing oil price is another rising concern, as major producers have decided to hold back additional rise in output.

What we think

The IL&FS event

  • We believe what has happened to IL&FS is a standalone case. We don’t see that this will lead to contagion risk to the broad financial sector. We believe the key would be regulatory actions responding to the situation to ensure ample liquidity. Indeed, we have seen regulators including the Reserve Bank of India (RBI), the Securities and Exchange Board of India (Sebi) and the Ministry of Finance have all stated that they are closely monitoring the situation and ready to step up actions. The RBI has also called for a meeting with shareholders of IL&FS, to be held on September 28, on potential capital infusion plans. We expect investor confidence to gradually return should there be resolution over the issue.
  • We will closely follow the upcoming earnings season (starting from second week of October). We currently don’t see any factors leading to material impact on earnings of quality financial institutions. We believe the situation now resembles the aftermath of demonetization in 2016, where investor interests in financial stocks were initially lukewarm post the event but started to recover once they were sure that earnings were heading towards the right direction.

Portfolio positioning

  • We have solid understanding over the business fundamentals of our holdings. We will closely follow the development of the IL&FS event. We will also monitor macro conditions, and constantly re-examine our portfolio positioning.  
  • Our holdings have no material direct/indirect associations with IL&FS, and are all companies with quality growth that can reap further gains from positive reforms in financial inclusion, financialization of savings, rising digitalization among others. We will continue to closely monitor their earnings in the coming months.
  • Meanwhile, we have been increasing our exposures to exporters, especially those IT servicing companies with reasonable valuation and robust business models. We believe they will benefit from depreciating rupee and strengthening US economy.

Market Outlook

  • On the macro front, we believe India is in a much better position nowadays than it was in 2013 (similar external environment to present), judging by a broad spectrum of financial sustainability indicators including FX reserve adequacy, current account deficit as % of GDP, inflation, and real interest rate. The magnitude of rupee’s depreciation was also noticeably less severe that it was in 2013. We believe the RBI has ample policy tools to put up multiple lines of defense to guard the value of rupee should external pressure continues to mount. We don’t see the trade tension as a major risk for India given its domestically focused economy. 
  • Real GDP growth accelerated to 8.2% yoy in 1QFY19, hitting a nine-quarter high and showing a broad base improvement in demand conditions. Looking ahead, we expect the domestic economy to continue to gather strength, supported by strong consumption, particularly in the rural areas on the back of a third year of decent monsoon. We also believe the earnings story has finally made a comeback thanks to improving domestic conditions and its growth will remain robust going forward.
  • We anticipate news flows on general election in 2019 will generate headline risks and warrant continued monitoring.



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