While India has lagged other emerging market economies in 2016 and faced several headwinds more recently, Jupiter manager Avinash Vazirani believes the outlook for the market remains positive. 
“I don’t think I have ever been as positive on the profitability and growth prospects of companies as I am now,” said the FE Alpha Manager, with recent demonetisation measures and upcoming tax changes look to have permanently changed the country for the better.
This week Indian equities rallied and the rupee has climbed to an 11-month high after prime minister Narendra Modi won a resounding victory in state elections, boosting expectations for a continuation of his reform agenda.
Modi’s Bharatiya Janata Party won 312 seats in the 403-member assembly of Uttar Pradesh, according to the Election Commission of India, up from 47 in 2012.
The results in India’s largest state were seen as a barometer of Modi’s popularity and reaction to his reforms ahead of general elections in 2019.
Last year, the Indian government, led by Modi announced the demonetisation of all 500 and 1,000 rupee bills in a bid to reduce the amount of counterfeit cash and break up the ‘black market economy’.
Along with an expected goods and services tax (GST) which will merge all current taxes into one system, should be a long-term benefit for the country, says Vazirani (pictured).
This combination of factors should also provide a boost to listed companies, which already pay tax, he explains.
“The net impact is that businesses are moving from the so-called ‘unorganised sector’ which doesn’t pay tax to the ‘organised sector’,” the manager said.
“Vast chunks of the unorganised sector existed solely because of tax arbitrage which is means they weren’t paying any.
“So the differential in pricing between the organise sector and the unorganised sector was essentially the tax that the organised sector was paying.”
With companies in the unorganised sector now being forced to pay tax, many will struggle and likely go out of business, providing a reduction in competitors for listed companies already operating efficiently enough to withstand the effects of the tax changes.
“The organised sector invests in capacity so is a lot more efficient, whereas the unorganised sector doesn’t. If they are now being brought under the tax net these guys can’t compete,” Vazirani said.
As a result of this dynamic, in December GDP surprised on the upside, with company profits also ahead of expectations as these effects were taken into account extremely quickly.
However, the Jupiter manager says the “jury is still out” as to whether this trend will continue through the current quarter and into the June quarter.
“My own view is that profits for the March and June quarters – because GST is going to be implemented in July – will be weaker,” he said.
“I could be wrong and the shift from unorganised to organised sectors could be much faster and therefore the organised sector could be doing well but there isn’t enough data on the ground and there are not enough data points historically to say ‘I think this is what is going to happen’.”
As a result, the manager is sticking to his bottom-up fundamental process, noting that “sometimes the hardest thing is to do nothing”.
“You look at the businesses you hold and say ‘what is the long term impact on this business of the changes that have happened and that are going to happen’.
“You say ‘I am not going to worry about the last quarter’s numbers even though they were much higher than expected and I am not going to worry about the next two quarters’.
“We need to look beyond the possible turbulence” he said, but noted that it is yet unclear whether there will even be turbulence, given the strong than expected figures in December.
“It may well be that companies surprise on the upside and if they do the market has many legs because if you look at the valuations they’re not that stretched other than in some pockets.
“So if the markets aren’t that stretched and you are paying the average of the last 10 to 15 years price-to-earnings (P/E) and you have significantly higher growth for the next five to 10 years because of the structural change, then actually you are in a pretty sweet spot.”
Indeed, so far this year the market has responded positively, returning 8.90 per cent so far in 2017 as profits continue to surprise.
Performance of index YTD
Source: FE Analytics
“The market is up [almost] 10 per cent year-to-date in local currency terms despite foreigners pulling money out,” Vazirani said.
“I think what is really clear is that there is actually significant underlying demand – there hasn’t been a demand disruption.”
However, he says with the potential for some short-term underperformance, he says investors looking to buy Indian equities should invest for the long-term.
“If there is turbulence we need to stay with it and I am sounding very cautious for someone invested in a market that is up 10 per cent year-to-date but I think it’s good to have that little bit of caution because in the short term there is that uncertainty.
“But in the long-term – and I have been covering India for nearly 22 years – I don’t think I have ever been as positive on the profitability and growth prospects of companies as I am now.
“The simple reason is I think the country has crossed the tipping point of the positive change that everybody expected from Modi.
“I think if the result continues for the next couple of years, which I think personally in my mind I don’t have any doubt, then I think he will have changed the country for the better forever and from an investment perspective this move will be massively beneficial for listed companies.”
The manager runs the five crown-rated Jupiter India fund, which over the last five years has returned 110.80 per cent.
Performance of fund vs index over 5yrs
Source: FE Analytics
“What we are doing is looking at the businesses we own and seeing whether or not they will benefit from this change,” he said.
“At one end of the extreme you’ve got Exide – a car battery maker - which will benefit massively from this phenomenon and on the other side you have a specialist lender called Rural Electrification Lender which lends to the power sector where everything is completely organised already and they won’t see any benefit whatsoever from demonetisation. There are others that fall in between that spectrum.
“We shouldn’t make any knee jerk reactions. We are happy with the businesses that we own and we will wait for the evidence before we change our mind.”