India’s stock markets have plummeted following rising foreign investment outflows. In response, Indian Prime Minister Narendra Modi has made the surprise decision to cut corporate tax rate.
Critics blame Modi's lack of economic reform for the recent sell-off that has seen foreign investors dump $4.5 billion in Indian equities since June. This firesale saw both the BSE SENSEX and Nifty 50 shed over 10% up until 18 September - the day before Modi’s announcement.
Yet India’s growing middle-class and population of 1.3 billion means the country, and India’s stock markets, is still a huge opportunity for foreign investors. Modi's bet is that these investors will come back by slashing tax on domestic companies from 30% to 22%.
Modi's corporation tax cut
Early signs are promising, but will this gamble pay off in the mid- to long-term?
What went wrong with India’s stock market?
Go back to May, and foreign inflows into India’s stock markets were at their best level in six years. Net foreign investment came in at Rs 76,051 crore ($ 10.9 billion) year-to-date. In 2018 it was Rs 1,599 and in 2017 it was Rs 49,737, according to NSDL data.
Yet, for five straight quarters economic growth in India has been decelerating. Now it is at its lowest level since 2013, one year before Modi came to power. Car sales and capital investment are way down, while unemployment is at a 45-year high.
It would be churlish to solely blame Modi - many of the problems predate his leadership - but critics point to his inertia on the economy. Expected reforms, such as the government selling shares in state-owned companies and labor law reform have not materialised.
If something doesn't change, the fear is that international companies like Netflix and Amazon won't invest. Unemployment could also continue to grow - a problem for Modi as those without jobs tend to vote for change at the top.
What’s going right?
Despite the outflows, net stock purchases by foreign investors are $6.8 billion this year. That's the second highest after China in the emerging markets.
Modi's tax cut was an unexpected move and investors have responded well. In the two days following the announcement, foreign investors bought up $461 million in stocks - the highest rate for India’s stock markets in two months.
Net stock purchases by foreign investors this year
Goldman Sachs, Morgan Stanley and UBS all upped their targets for key stock gauges following Modi's tax cut, while BNP Paribas reaffirmed its positive position on the country.
“The test in the coming months will be to see if corporates share some of the profitability boost into the economy in the form of greater investment or price cuts on products to stimulate demand,” said Nick Payne, head of global emerging markets at Merian Global Investors (U.K.) Ltd.
Indian stocks on the up
India's biggest bank is a solid compounding machine. Consistent growth of above 20% and, after a recent correction, shares have shot up to trade 1% off all-time highs. Now could be the time to buy before the stock breaks through this key level. The stock has jumped over 11% since the tax breaks were announced and carries an average Rs 2405 price target, suggesting 96% upside.
HDFC's share price gain since the tax breaks
SBI Life Insurance Company
As India's population becomes wealthier, life insurance purchases have been increasing. One Indian insurer worth watching is SBI Life Insurance Company. SBI's assets under management have grown 21% over the past 12 months and now stand at Rs 1,41,000.
Year-on-year, the share price has climbed 62% with EPS up 13%. A Rs 62.70 price-to-earnings ratio reflects the high valuation.
ICICI Prudential Life Insurance is another insurer to look out for. Since the start of the year the share price has climbed 40.70%, easily outpacing India’s wider stock market gains, with the Nifty 50 up just 5.5%.
Maruti Suzuki India Limited
Maruti was the first major company to cut prices following Modi's tax giveaway. September has already brought the company good news, with car sales up month-on-month. The hope is that the stalling car sales in the sub-continent that had seen the share price drop 9 4% so far this year, will now ease off.
Analysts have pinned a Rs 8,266.72 average price target on the stock. Hitting this would represent a 22% upside on the current share price.
If Modi's tax cuts kick-start the economy, the current share price could represent good value.
|Market cap||INR 2.03trn|
|PE ratio (TTM)||28.93|
|Quarterly earnings growth (YoY)||-31.70%|
Maruti Suzuki share price vitals, Yahoo finance, 30 September 2019
Undoubtedly, major foreign companies are still interested in India. At the end of September, Modi held talks in New York with the heads of 36 American businesses, including CEOs from JPMorgan, Bank of America and IBM to discuss investment in the country.
Executives voiced their concern about banking regulations and restrictions on foreign ecommerce markets, but the meeting represents just how big an opportunity Indian business represents. If Modi acts on these concerns then long-term investment will increase.
Analyst Nick Payne expects India's government to follow-up the tax cut with further stimulus measures. With both the BSE SENSEX and Nifty 50 up 7.5% after Modi’s surprise announcement, anything extra could spur a turnaround in India’s stock markets.