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India emerges as an attractive option as lower

Chinese PMI and steel output support the bears

July 27, 2015

By Himanshu Yadav
Assistant Manager - Investment Research at Aranca

The recent number for the Chinese preliminary Purchasing Managers Index (PMI) in July
surprised many on the downside, as it stood at 48.2 versus the Bloomberg consensus
estimates of 49.4. The PMI (previously known as HSBC PMI) from Caixin Media and Markit
Economics indicates a contraction below the value of 50. Growth concerns spurred by the
low PMI number also find support in lower crude steel output.
In its latest release on July 22nd, the World Steel Association (worldsteel) posted a 1.3%
decline in Chinese crude steel output for H1 FY15. Worldsteel represents approximately 170
steel producers (including 9 of the world's 10 largest steel companies), national and regional
steel industry associations, and steel research institutes. China continues to see lower steel
output due to a slump in the housing market, persisting credit crunch and weak
infrastructure investments. This negatively impacts the steel demand in the region that
accounts for 50% of global steel consumption.
It is being argued by the market participants that Chinese steel industry may have peaked in
2014 and now the days of record-high steel consumption are over. This is also the result of
the fact that China has been trying to move from an investment lead to a consumer driven
economy.

We argued in our recent post (read: http://www.aranca.com/knowledge-center/articles-andpublications/339-china-s-moves-to-counter-its-stock-market-freefall-riskier-than-perceived)


that the recent stock crash and the ensuing reaction by the authorities may have greater
negative implications than perceived by the market. The concerns are being shared by the
governments, corporates and investors alike.
The Chinese stock markets had recovered about 15% from their early July debacle, before
the Shanghai Composite Index experienced its biggest one-day drop since 2007. It lost
further 8.5% on July 27th. This is being attributed largely to the drastic steps the officials
tookfrom halting trading of more than 1,400 companies, to banning major shareholders
from selling stakes, to restricting short selling, and to suspending IPOs. The limited stock
price recovery since July 8th followed by the biggest drop of index in last 8 years, the weak
PMI and the steel data indicate the precarious situation that China may find itself in.
On the other hand, a direct beneficiary of the Chinese stock rout has been the Indian stock
market. International investors are pulling out of China and are looking at India as an
attractive option. The Shanghai-Hong Kong exchange saw record outflows amidst the US$
2.8 trillion plunge in the mainland equity values since June 12th. According to Blooomberg,
the international investors have invested US$ 705 million in India over the same period,
resulting in a world-beating 7% gain in the benchmark S&P BSE Sensex index.
Slowing China, which was the driver of previous commodity super-cycle, has also had a
direct impact on commodity prices that are on a downward trend. Lower commodity prices
have not only helped the Indian government in tackling the Balance of Payments (BoP)
situation, but also reduced the raw material cost for the Indian organizations.
Here, similar to our views that we had earlier shared in our blog, our perspective remains
unchanged that the global economy is at a greater risk from the slowing China. As a counter
move, investors may find the Indian stock market more attractive and a less volatile option.
India, as a net importer of goods and exporter of services, benefits from falling commodity
prices. Weakness in China makes India an attractive investment destination for investors
looking to allocate funds to their emerging market portfolio. Moreover, recent domestic
buying in India indicates continued hopes in the strength in the growth story as the majority
government strives to reform various sectors, though at a slower than expected pace.
Investors could use current weakness in earnings to hunt for value in Indian stocks. In terms
of positioning, the banking and industrials sectors have been punished due to high NPAs and
a slow pick up in investment cycle, respectively. We could see a re-rating there towards yearend.