MRB's Chart of the Week: why now is the time to buy India

Investors have been disappointed with the long-term track record of India’s financial assets and some have characterised India’s fate as one of endemic stagflation. We disagree.

Three worries are paramount: the fiscal mess, inflation and the slowdown in growth. Each of these have investment implications, but are not reasons to avoid India. Indeed, the recovering business cycle means investors should now be positively geared towards Indian assets.

• India’s fiscal problem is a structural lack of central government revenue (see chart). The weakness of the current government guarantees a lack of progress on this front, and the recently announced budget does nothing to deal with the structural issue. In the absence of structural reform, monetary conditions will remain tight relative to other emerging market economies.

• Inflation is a cyclical, not a structural, issue. CPI is spiking, but only because of its high weighting in - food, and the fact that Indian food prices don’t correlate with the benign international food price environment. Core inflation is decelerating in line with economic activity, which means conventional monetary policy is still effective.

• Investment led last year’s growth deceleration and it is leading the current shallow recovery. India exhibits the signs of a classic business cycle, with none of the excesses associated with credit imbalances and debt overhang. This incipient recovery is driven by local factors, and is not dependent on a healing global trade cycle.

With monetary policy relatively tight, the beginnings of a cyclical turnaround, and a deeply undervalued currency, the primary play on India should be via the rupee. We recommend overweighting the rupee in a basket of emerging market currencies.

For the time being, we recommend a neutral weighting in an emerging market equity portfolio because the primary sources of risk and return are political in nature.

That said, we have a bias to increase exposure once the yield curve steepens and the underperformance of cyclically sensitive sectors ends.

Mehran Nakhjavani is a partner at the Macro Research Board