Morgan Stanley has identified 10 most relevant disruption themes for the coming decade for equity investors in India. These disruptions come with positive implications on India's long-term growth and negative implications on incumbents that don’t respond.
The striking thing about these themes (and thus providing some degree of certainty) is that they are driven mostly by regulation changes and actions by the government.
The most important takeaways for equity investors are a) Nominal INR equity returns are headed lower in the long run with likely lower volatility, implying lower equity risk premium for shares and therefore higher P/E multiples. b) Financials sector could witness major disruption with the SOE banks giving a share to the private sector, particularly in deposits.
Watch out for positive surprises in the capital market businesses. c) Discretionary consumption including autos is set to surprise on the upside; however, stock selection could prove tricky given valuations and likely disruption to brands and distribution channels. d) Real Estate companies could be major outperformers.
Here are 10 such disruptions which could impact equity investors:
Flexible Inflation Targeting Regime
Monetary policy is now conducted under a flexible inflation targeting regime, in which a six-member MPC decides on the policy with a headline CPI target of 4 percent and a broader primary objective of price stability.
If successful, inflation targeting will likely reduce the volatility in the inflation rate and, subsequently, in the growth rate. The cycle peak, as well as cycle average inflation, could settle lower than history. To that extent, India's interest rates may peak at lower levels and nominal growth may be lower than in the previous decade (we are forecasting 11% vs. 14% between 2004 and 2017).
The concomitant impact is that INR stock returns may compound at a slower pace than what we witnessed in the past. The USD returns could still be comparable with the past since the pace of INR depreciation may also fall consequently to lower inflation differentials with India's trading partners. With the asking rate of equity returns falling, India's P/E multiple is likely to be higher for longer.
Explicit equity mandate for Retirement funds
India's equity saving landscape is changing with demographics, regulation changes, investor education, growing risk appetite and improved macro environment for stocks (DREAM factors).
Small- and mid-cap stocks could outperform the narrow indices over the medium term. The domestic ETFs could become 20x bigger than today in market-cap terms over the coming decade. Domestic ETFs are currently sized at US$12 billion, about 10 percent of total equity assets.
The return correlations with global markets could ebb. Return correlations have been falling in recent months consequent to India's improved macro balance sheet and long-term reforms. The volatility could also remain below historical averages, and the capital market businesses will likely do well.
Financial inclusion and direct benefits transfer
300 million Indians have a bank account for the first time and are receiving their share of social programs in cash directly in their bank accounts via the Aadhaar platform. This is shifting the spending decision into the hands of these recipients while reducing income inequality.
The Supreme Court's recent verdict on Aadhaar ring-fences the direct benefit transfers which means DBT could gain pace in the coming months. We see consumer companies as the beneficiaries as income inequality narrows due to more efficient transfers.
Consumer companies that cater to middle-income consumer cohorts, including those in the sub-sectors of two-wheelers, entertainment/media, education, travel, leisure, retail, and select staples.
UPI - Unified payments interface
By FY2023, Morgan Stanley expects UPI to account for 50 percent of the digital transactions up from 3 percent in Mar-17 and 20 percent in Mar-18.
This would imply UPI growing at 90 percent CAGR over the next five years to US$400-450bn a year, equivalent to about 10 percent of the GDP.
Morgan Stanley believes that UPI will help banks deliver and recollect loans at a low cost to borrowers. It expects a 400-500bp improvement in the cost-income ratio over five to six years for banks that use the technology effectively.
These lenders will also gain market share, enabling stronger volumes. The weak SoE banks, while they have access to the same technology, will become less and less competitive given their relatively lower focus on this new platform.
GST - Goods and Services Tax
Likely increase in the share of lending to micro and small enterprises and to households accompanied by a reduction in loan sizes because of the lower cost of customer acquisition and broader dissemination of credit arising from the enhanced ability for credit assessment. Credit decisions move from collateral-based to cash flow-based.
For the first time, India's banks can obtain reliable data on MSME cash flows. Combined with the rise in the use of digital
payments (and their data trail), a credit provider can now make a much more informed decision on the creditworthiness of such small borrowers.
Unlike in the past, future funding to large corporates will be shared between banks and bond markets. From F2020, any company with a debt of greater than $150 crore will be defined as a large corporate.
These large companies will have to meet 50% of incremental funding through the bond markets. This will force the banks to look for new avenues of growth.
The global investment bank expects lenders to reduce spreads on MSME lending by up to 300bp as they gain access to reliable and better quality data. We think this will drive MSME loan growth at a high teens
Soil health card and direct benefits transfer
The national soil health card and Aadhaar fundamentally alter the way farm land will be nourished. Lower food inflation volatility will likely affect interest rate volatility (given that the RBI targets headline consumer inflation).
This, in turn, may reduce volatility in growth rates. We should, therefore, expect lower volatility in share prices, boosting the saving pool into equities and the P/E multiple. It is also quite possible that there is an income and wealth transfer to farmers
New, and especially small suppliers can now reach consumers both at home and abroad via e-commerce. If regulatory threats do not grow and e-commerce delivers its promise, there is a disruption for the branded goods companies that have hitherto relied on their brands and superior disruption to run high market shares.
While the overall market will likely expand, these companies could lose share to smaller firms that will see cheap distribution via e-commerce platforms.
India has 14 of 15 most polluted cities in the world and autos cause almost 40% of this pollution. In Morgan Stanley’s base case, the Indian Autos 2.0 market has revenue potential of US$265bn annually by 2030.
It sees three groups where terminal growth rates have upside risks from Autos 2.0: 1) infrastructure investment plays; 2) auto-related names, including data; and 3) credit providers that will fund the growth story.
The law envisages resolution of borrower defaults though collective decision making by the creditors. Apart from being process oriented, it is also time oriented because it specifies strict timelines for insolvency resolution, failing which the borrower would have to be taken into liquidation.
The immediate implication is that stock performance within banks may move from the so-called retail banks to the corporate banks (banks that dominated the previous loan cycle to corporate capex).
In the aftermath of the recent NPL cycle, it is quite possible that Morgan Stanley sees a more disciplined capex cycle to start with, which means profit margins could surprise on the upside.
This could lead to a sharp recovery in ROEs. Eventually over the cycle, as the new regulations and laws gain a foothold, we expect private sector banks to lead loan growth – especially when combined with all the other changes that are happening in the economy.
RERA - Real Estate Regulation Act
The act fundamentally alters the way business is done in the sector with significantly more regulatory oversight and customer protection making it more viable for banks to lend the sector Developers would need to alter their business models to comply with the RERA requirements.
Quarterly updates on construction progress, bookings/sales, completion targets will ensure greater transparency and accountability from developers.
The restriction on the use of collections (i.e., 70% to be maintained in the escrow account) will ensure financial discipline and thus timely project completion versus the earlier practice among developers of deploying collections from one project in other projects or land acquisitions.
All of these are likely to improve the corporate governance among developers. RERA will ensure greater transparency, accountability and financial discipline among developers.
Disclaimer: The above article is compiled from a Morgan Stanley’s report on India’s Disruption Decade, dated 18 October. Users should check with certified experts before taking any investment decisions.