India’s position as the world’s largest democracy has been both a blessing and a curse. The country’s myriad of political parties has made it very difficult for any one party to win a national majority and thus lead an effective government.
This is why the BJP’s May 2014 election victory was such a game-changer. Three years on, many tangible reform successes are evident, such as Uday (power sector reforms); digital benefit transfers (with 1.1 billion accounts being created and which replaced the prior system of cash benefits) and the Goods and Services Tax Bill (which aims to replace the cascading tax system where goods were taxed at multiple points in the value chain).
But there is still lots more to be done. India is predominantly domestically-driven as an economy, and therefore viewed by many as a continent in its own right. This provides a strong diversifier to the Asia story, with a lower percentage of GDP linked to global trade.
However, the flip side is that risks to India’s global standing equally impact its domestic performance. The country’s reform agenda is crucial to its long-term structural growth, as is its ability to generate sufficient employment for a population that is becoming younger relative to peers.
With that said, there are many economic indicators that bode well for the economy. The decline in inflation is an important contributor to India’s macroeconomic destabilisation. And following initial signs of strain, the economy has bounced back well from the demonetisation initiative in November, with consumption growth in particular holding up well.
And thanks to a business-friendly government and policies which are becoming more stable and transparent, the current account deficit today is almost entirely financed by FDI (foreign direct investment) rather than the more flighty FPI (foreign portfolio inflows). In other words, companies and investors today are willing to invest “hard” assets in the country, resulting in a strong and stable currency outlook.
Compared to China, India is unlikely to become a regional power and appears to be focused on its vast domestic potential. The country is expected to produce over 10 per cent nominal growth annually over the next several years; and is a vibrant democracy in contrast to China’s one-party authoritarian state.
India continues to contribute to the global ranks of highly-qualified graduates, in particular across the financials and technology sectors, as well as provides valuable manufacturing labour. As Chinese wages have increased, global companies are finding Indian labour more attractively priced.
For talented active investors, the Indian equity market is a haven of inefficiencies which can be exploited when short-term momentum drives performance and the market forgets about the fundamentals. Overall, it remains a well-diversified market, with the financials and IT sectors consistently remaining the two largest groupings.
More recently, and in tandem with a growing middle-class, the consumer discretionary sector has increased, most notably driven by the autos and auto components grouping. Energy and health care also represent a good share of the index.
Whilst some commentators have questioned valuations, the returns and growth profile offered by Indian equities remain among the highest in the emerging market space, presenting an exciting backdrop to invest into high quality growth businesses. A 7-8 per cent real GDP growth should result in earnings compounding at double digits for the corporate sector in the long run.
This is not surprising if one looks at the breadth and depth of reforms that the government has put in place. As well as the macro reforms noted above, softer and more qualitative changes, such as reducing bureaucracy and corruption, have significantly reduced the “connections advantage” — evident in India’s rapidly increasing place in the World Bank’s “Ease of Doing Business” Index.
This has allowed genuinely good companies to flourish at the expense of corrupt or lower quality companies that were previously able to fall back on their contacts. Investors can gain exposure to a flourishing growing unlisted sector via the banks, and particular the private (i.e., non-state) sector banks, which have a high level of exposure to the SME sector.
The pace and breadth of IPOs has increased significantly, and recently there have been IPOs across industries as diverse as health care diagnostics, outsourced staffing and life insurance. This was not the case four to five years ago.
There are a lot of opportunities within the financials space. India has much lower debt/GDP levels compared to counterparts like China, despite the savings ratio being upwards of 30 per cent. This presents an interesting opportunity for the financial services sector, and well-managed lenders in particular, to grow ahead of nominal GDP and generate shareholder value.
These companies also indirectly play on India’s overall health and increasing prosperity. Private sector financials are one exciting space within that, given that 70 per cent of the market share is with inefficient public sector banks which stand to lose their market share incrementally over time.
Many sub-sectors like insurance and exchanges also have interesting bottom-up opportunities for active investors to tap into. Opportunities in the consumer sectors — where some great franchise businesses have been created by highly competent management teams over years, benefit from strong brands, distribution networks and business relationships.
The increasing income profile of the Indian consumer combined with currently low penetration levels should help these businesses to grow for many decades in a secular fashion and create significant value over the long term.
Finally, Indian entrepreneurs have developed globally competitive companies in industries such as health care and software; and this is now expanding into manufacturing sectors like auto ancillaries and textiles. These companies are taking advantage of India’s low labour costs and improving infrastructure to serve the global economy.
Modi government’s initiative of “Make in India” is clearly giving a boost to the exporters as well.
The writer is Senior Product Specialist at Pictet Asset Management.
