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Key Drivers Behind HSBC Downgrading India To Underweight

Softer earnings near term with delayed reforms and an existing overweight stance for FIIs on India makes it difficult for the country to sustain its valuations, and accordingly, HSBC has revised its Sensex target to 26,900 (from 30,100) for end-FY15.

Jitendra Sriram of HSBC in his May 15, 2015 research report titled: “India Equity Insight: Headwinds along the way,” however, believes India’s long-term growth potential remains intact.

Key drivers behind the India downgrade

As outlined by ValueWalk, in last week’s Asia Equity Strategy Report, HSBC cut India from overweight to underweight.

In their latest research report, HSBC sheds more light on the key drivers behind their downgrade.

Sriram points out that since the last year’s electoral mandate removed the cloud of coalition over the past 3 decades, FIIs have poured nearly US$24 billion into India since January 2014. However, the analyst points out that the markets were building in expectations of the recent budget session clearing a number of landmark bills such as the GST bill and the Land Bill by May. However, the analyst notes a push back of these bills to various committees would mean a 2- to 3-month delay to the process of clearance in the Monsoon session of Parliament. However, he is still optimistic on the passing of the GST bill, though he believes the Land Bill in the present form might encounter opposition.

Also of note, India faces the potential for back to back deficiency in monsoon rains, following the Indian Meteorology Department flagging risks of a deficient monsoon on account of El Nino conditions. Though the Indian government has taken a modest hike of 0 to 5% across minimum support prices for most crops in 2014, Siriam doubts the ability to again take modest price increases on the MSP in the event of a deficient monsoon. He also expresses concern that depleted water levels might lead to weak rural income and interest waivers through loan restructuring.

India MSP for various crops

The tailwinds of soft crude prices waning

Sriram points out that Indian markets benefited immensely over 2H14 and early 2015 following the drop in crude oil prices. However, the analyst notes the gains are now past with some small rebound in crude prices. Though the current price levels don’t pose threats to India’s fiscal consolidation, the analyst believes the tailwinds for the economy related to low oil prices over the last few months are now on the wane.

The HSBC analyst also notes that during the past year, India’s consensus FY 15 earnings for the BSE Sensexhave been   trimmed by 12% from April 2014 to April 2015, with the trend of cuts still persistent:

India 12-month forward PE MSCI

Sriram also attributes diminished returns from interest rate cuts as another reason for India’s downgrade. He notes despite RBI cutting policy rates twice in 2015, the 10-year sovereign is back to trading where it was prior to the cuts. The HSBC economics team anticipates a maximum of one more rate cut (most likely by June) after which there will be little support from the RBI for the Indian equities market:

10-year GSEC yield and Repo rate

HSBC FX strategists trimmed their forecasts for the INR/USD from 63.50 to 66 for the end of 2015, translating into a c.4% compression to FII returns on the Indian market. Sriram notes a combination of softer earnings with reduced USD returns could pose a challenge for a market where ownership levels are at historical highs.

HSBC's Asian Market Scorecard

Sriram anticipates India’s current PE to contract further to 15.5x from current level of 16.5x, to produce further near-term headwinds. As earnings are likely to come in 300-400 bps lower than the current consensus estimates of a 15-16% growth, the HSBC analyst revised the BSE Sensex target downward to 26,900 for FY15 end:

India PE band chart