While emerging markets (+45%) have generally lagged developed markets (+59%) since the start of second quarter of 2020, India has substantially outstripped both with a 103% return, making it one of the best-performing stock markets over this period. There are a number of reasons for this strong performance and why we are optimistic about the Indian market.
One of the key investment dynamics of 2021 has been an ever-increasing focus on the implications of China’s drive towards its stated goal of “common prosperity” – an umbrella term, deeply rooted in the current policy documents organising China’s social and economic plans for the coming decade or more.
The impacts of this drive range from the curbing of influence of major private businesses – especially in the tech sector – as well as increasing regulation of key sectors from eCommerce to property markets. In this context – as well as the country’s demographic advantages over China – India has risen in investors’ consciousness as almost antithetical to China. With a pro-business government and emerging investment cycle helped along by a newly loose fiscal policy, China’s loss has in many ways been India’s gain.
Part of India’s rapid recovery can be explained by the country’s experience of the pandemic. In the first Covid wave, India came through relatively unscathed, with a surprisingly low caseload due to its extremely young population, allowing the economy to re-open quickly. Although India was a high-profile victim of the so-called second wave this year – with daily cases rising to 400,000, more than double the previous peak – this was mercifully short-lived, with the number of cases soon collapsing again.
Moreover, the degree of lockdown this year was significantly less severe than the first round, and the impressive vaccine rollout has made India a rare emerging market success story in this regard: it has, at times, hit 25 million dosages daily, the equivalent of vaccinating the entirety of Australia or Scandinavia every day.
A further reason for the region’s strong performance lies within a broader cyclical economic recovery that pre-dated the pandemic, which was further boosted by a notably business-friendly budget announcement in February. In many ways, India has spent the past decade in low-key recovery mode; having been one of the ‘Taper Tantrum’ victims of 2013, the country has made huge strides to repair the health of its budget and external balances, leaving it much better insulated to outside shocks.
One element of this has been a concertedly tight fiscal policy − an austerity regime of sorts − with the Finance Ministry focused on protecting the budget deficit against calls for loosening the purse strings. In February this year, the Ministry finally announced a major spending plan, looking to both support and facilitate the economic reset under way in the aftermath of Covid. Key features of the $500 billion package included an increase in capital expenditure of 26%, a commitment to reforms such as strategic divestment, and increased foreign ownership limits for certain sectors. Importantly, the increased spending will be generated through an increase in the deficit and sale of government stakes in key sectors, and not through higher taxation. This marked a clear reversal of the fiscal contraction of recent years and set the stage for a re-ignition of the long-awaited domestic investment story.
India’s previous investment cycle played out during 2003-2010, a period that saw gross fixed capital formation expand emphatically along with an acceleration in credit growth, leading to a more than doubling of corporate profits as a percentage of GDP, a doubling of market Return on Equity and a near 300% stock market outperformance against developed markets.
However, following the financial crisis of 2008 and China’s economic rebalancing in 2010, the previous decade’s boom left India with over-capacity and asset-quality issues on bank balance sheets, leading to a multi-year reckoning for the financial sector. Much of the last decade has been spent dealing with these imbalances: banks were both unable and unwilling to lend, and the housing market has been dormant, with investment rates in the economy and corporate profitability both falling back.
A major milestone came in 2014 with the election of Narendra Modi and the pro-business BJP party. The years since have been spent repairing balance sheets at sovereign and corporate level and enacting sometimes-painful but necessary reforms such as the Goods & Services Tax − simplifying and rationalising a Byzantine inter-state tax regulations − new bankruptcy laws, and the digitisation of government records and the taxation system.
The fruits of these labours are now apparent − banking sector non-performing loans (and provisioning levels for them) are back to healthy levels, putting them in a strong position to lend. Corporate profits are sharply up and debt levels are low. One of the missing links, however, has been the dormant property market but we now see affordability at all-time highs, with inventory at extremely low levels. Property development is also beginning again, sparking a recovery in prices and investment plans.
This in turn has the potential to lead to a private sector capex revival to complement the government spending plans. Given the relative paucity of exciting investment stories in emerging markets in recent years, India has provided a clear investment opportunity and has duly attracted fund flows.
We believe this underlying investment upcycle will continue to drive the Indian economy for many years. Given extremely powerful demographic forces in India – a full quarter of the population is under the age of 14 – we see the cycle as structural rather than cyclical, overseen by a business-friendly government.
At a time when China’s labour force has begun to shrink, India offers the opposite: a young and growing pool of labour, low-cost of production and a government keen to allow private businesses to take the lead in growing the economy. We would therefore look at the long-term investment cycle in India mirroring that of China through the 1990s to the present day − potentially being measured in decades rather than years.
In addition, we also see the rise of the new economy in India as very much in its nascent stages –internet adoption has significantly lagged China’s, for example, with 300 million users in India in 2015 against China’s 700 million. However, India is now witnessing much faster growth in internet penetration, with 1 billion people forecast to be online by 2025, closing the gap with China (1.2 billion people by 2025).
Significantly, the internet sector is currently almost entirely unrepresented in the listed-equity space – this year’s high-profile IPO of online restaurant guide and food-ordering platform Zomato provided the first major investment opportunity in this sector. Compare this to China, where the eCommerce sector has dominated equity indices over the last decade, with a weighting in excess of 35% versus a zero weighting in India.
We expect this new economy sector to be increasingly represented in Indian indices in the coming years, with the arrival in the public markets of major private companies including insurance aggregator Policybazaar, online payment platform PayTM and eCommerce player Flipkart.
The long-term potential of India has been clear for many years, but the country has been held back by a gummed-up banking sector and overleverage in the corporate sector. Following years of reform following the 2014 election, however, companies are now in a position to borrow for almost the first time in a decade and banks are in a position to lend. Finally, the conditions for a resumption of the investment cycle are in place, alongside the rise of a new, online India, presenting one of the most compelling structural investment cases in emerging markets over the coming decade.
Key Risks
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