India Selloff Suggests Market Is Misreading Long-Term Opportunity

» Surprise move to remove the majority of currency from circulation has roiled the Indian equity market.

» In our view, market selloff overlooks the long-term benefits of demonetization: weeding out corruption in the underground economy, reducing counterfeiting, improving tax collections, encouraging expansion of the banking system and stimulating credit growth in the Indian economy.

» We view demonetization as a decisive step in President Modi’s long-term plans to strengthen the Indian economy and advance economic freedoms.

» India remains one of the most compelling stories in the emerging markets, and we are viewing the selloff as a buying opportunity.

India’s equity market has faced a fair share of headwinds in 2016. From January through the high in emerging markets in early September, India fell short of the broader emerging markets’ advance as countries with higher interest rates benefited more from the global fall in yields. Also, India was not immune from the toll that Donald Trump’s victory took on emerging markets more broadly. India’s recent decline, however, was significantly exacerbated by President Modi’s surprise announcement on November 8 to withdraw 500 and 1000 notes from legal currency. Under the demonetization directive, holders were given two choices for their old notes: exchange notes for new 500 or 2000 notes or deposit them into a bank account.

Not unexpectedly, the initial days of implementation saw considerable turmoil. These notes represented more than 85% of the currency outstanding in the largely cash-based Indian financial system. In practical terms, the notes serve a function within the commerce system similar to $10 and $20 bills in the United States.