Beating the slowdown: why domestic economy-facing sectors are better placed than their global peers
Even as inflation in developed markets is likely to peak soon, rising worries around a growth slowdown would keep globally exposed sectors more vulnerable in the medium term. However, in India, the demand is relatively robust despite the interest-rate hikes and inflation. Sectors that are inward facing (domestic economy) are relatively better placed than outward-facing (global economy) ones. We have already started to see the impact of a global slowdown on Indian exports, which were down by 16.7% year-on-year in October.
Domestic cyclicals such as BFSI, auto, and industrials are best positioned from a medium-term perspective. Also, certain segments of consumption, which are related to travel and weddings, have been witnessing a strong pent-up demand. In healthcare, segments such as hospitals and domestic pharma are better placed than the global pharma. Indian IT services are the beneficiary of a secular trend of digital transformation but growth in the short term is vulnerable to worsening slowdown in the developed markets. Commodities have peaked out and facing the brunt of a slowing global growth.
Here’s a lowdown on various sectors and how they are expected to fare.
Banking and industrial sectors: The Indian banking sector is witnessing a strong upcycle as reflected by sharp increase in NIMs (net interest margin), higher growth and lower credit costs. System credit growth has surged to high teens and may sustain 12%-15% growth in the medium term. Margins are also likely to be healthy while credit costs would go down to historic lows. This would imply a robust growth trajectory in profits. As valuations are still not stretched, this sector offers an attractive risk reward.
The investment cycle in India has been sluggish for a decade after recording a strong recovery from the lows of the global financial crisis. Now, there are multiple factors that can drive an upcycle in the industrial sector. Marked improvement in corporate balance sheets has driven rebound in investment demand despite inflationary pressures. This has been further aided by increased lending appetite by the financial sector. Government policies such as the performance linked incentive (PLI) scheme are undoubtedly focused towards encouraging “Make in India”. The PLI scheme can add around INR1 lakh crore annually to the overall capital expenditure in the country. Government capex forms more than half of the overall capex (INR18 lakh crore-INR19 lakh crore) in the country. Currently, the cycle is driven by government’s renewed thrust on spending on defence, railways, and road infrastructure. Private-sector capex is likely to pick up with a lag.
Given the disruptions in the global supply chain, large players are increasingly turning towards Indian manufacturing companies. India is set to become a hub for manufactured exports with supportive policies and cost competitiveness. Hence, the industrial sector is set to witness not only strong domestic demand but also robust exports demand. Valuations are demanding but still, it can fare well given the impending upcycle.
Automobile: The past decade for the auto industry was one to forget, as growth was elusive (0%-2% CAGR during 2012-22). The sector was plagued by various macro and micro headwinds. However, the sector has been witnessing strong rebound across segments in the current year on the back of easing supply-chain issues and improving consumer sentiment. Consumer-facing segments like two-wheelers and passenger vehicles are likely to grow at 15%-20% this year, while commercial vehicles are likely to grow at a much higher rate (25%-30% owing to a low base). On an annualized basis, passenger vehicle and tractor retails have crossed pre-Covid highs (FY19), while two-wheelers and commercial vehicles are still well below pre-Covid levels. Thus, recent growth trends, albeit positive, have significant headroom to expand further.
Electrification of the auto industry remains a key agenda for the policymakers. They have introduced strong policies (FAME, or Faster Adoption and Manufacturing of (Hybrid &) Electric Vehicles, and PLI) to support the transition towards clean energy in accordance with the COP27 targets. Electric vehicle’s share in the overall mix has significantly increased in the key states (Delhi, Maharashtra, Karnataka) and this trend is likely to gain more steam in the coming years. The key long-term drivers of growth remain favourable led by a young population, rising credit penetration, improving affordability.
Consumption: While consumption in India, especially discretionary consumption, is likely to grow in a secular way for a long period, valuations are expensive. We have seen strong pent-up demand trends in segments related to travel and wedding, but weak trends have been spotted in durables. While the sector offers attractive long-term growth opportunities, only selective bets provide decent risk reward over the medium term.
IT: Indian IT services have been a key beneficiary of a digital transformation adopted globally. The sector is well poised over the next three-four years, as cloud migration is still in its early phase and large corporates are adopting a multi-year digital-transformation journey. However, a worsening growth environment in developed markets may reduce the growth of Indian players in the near term.
Healthcare: Similarly, the healthcare sector is a mixed bag. Global pharma businesses are facing incessant price erosion in the US market. Valuations are reasonable but lacking catalysts for rerating. Relatively, domestic pharma and hospital segments are well poised for steady growth over the medium term.
(Mayur Patel is the senior executive vice-president and fund manager at IIFL Asset Management)
(Originally published in ET on Nov 25, 2022, 04:30 AM IST)
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