One of the core tenets of our investment philosophy is to diversify our investments. India is one of the markets which investors have long overlooked. We believe India should be an integral part of any foundation allocation. There are three key factors supporting India’s structural bull story:
• Favourable macroeconomic backdrop, supported by demographics, policies and foreign currency reserves;
• Sustainable corporate earnings growth outlook; and
• Consistent fund inflows into not only Indian equities, but also, going forward, onshore bonds, as the latter gets included in a global bond index starting next year.
India on the rise
India is gaining global prominence, thanks to decades of economic growth and policy support, coupled with the recent push among major developed economies for supply chain diversification. For the past decade, India’s economy has expanded at a compounded annual growth rate (CAGR) of over 7%, making it the fifth largest economy in the world. According to IMF forecasts, India is set to overtake Germany and Japan as the third largest economy by 2027, just behind the US and China. GDP per capita has already more than doubled over the past 15 years to USD 2,600, albeit still less than 20% of China. We believe India has the potential to migrate to an upper middle-income economy over the next two decades.
Tailwinds behind the transition into an upper middle-income economy
We see several tailwinds behind this uplift for India. First, India’s demographic dividend is expected to persist at least until year 2050. India is home to 1.4 billion people, of whom 68% are within the working age segment (15-64 years old). Notably, 26% of Indians are within the age of 10-24 years old, surpassing that for China (16%). This younger demographic base with a sizeable employable population enables India to upskill and amass net savings for decades to come. Moreover, public sector spending on digital infrastructure has paid off, with digital transactions conducted via the IndiaStack system contributing over 75% of GDP. This has generated efficiency gains.
Policy direction supportive of investments
In addition to public spending on infrastructure, proactive fiscal policies have drawn private investments. Following tax cuts in recent years, India’s manufacturing sector enjoys one of the most competitive tax rates among Emerging Markets (EM). Another example of proactive policy is the Production Linked Incentive (PLI) scheme, which incentivizes manufacturers across more than 10 industries to sell and export more goods that are domestically made in India. These policies helped lift private investments to a historic high of 34% of India’s GDP. India will likely see continued growth in foreign direct investments over the coming years, fuelled by the additional driver of the global push towards supply chain diversification.
Fiscal discipline and FX reserves add to confidence
India’s fiscal strength and currency stability is a key factor which is likely to further boost confidence among international investors. India’s external debt, at 18% of GDP, sits comfortably below the 10-year average of 22%. Contrary to common belief, the rupee exhibits a lower 1-year implied volatility than its G10 and EM peers. Behind this relative stability are the strong foreign exchange reserves. According to the latest Reserve Bank of India report, India’s reserves stand at around USD 590bn, ranking the fourth highest in the world. With this level of reserves, which is equivalent to more than 7 months of imports and twice the external short-term debt, we believe India will be able to confidently address its external financing requirements and withstand major external shocks.
Enviable track record of earnings growth
A stable rupee provides a healthy backdrop for investing in India. Despite a strong US dollar, Indian equities have outperformed many EM equities so far this year, as a strong corporate earnings outlook outweighs elevated valuation, a common pushback against Indian equities. The current equity market valuation at over 18x 12-month forward earnings, while above many markets in absolute terms, is in line with India’s historical average and is arguably fair, considering the market’s superior high-teen earnings growth profile. Moreover, India has an enviable track record of corporate earnings growth closely tracking economic growth over the long term. A research study by Motilal Oswal illustrates that, over the past three decades, India’s nominal GDP grew at 12.6% per annum, while the benchmark Sensex stock index’s earnings grew at a CAGR of 12.3%. This explains why the Sensex index has delivered a stellar annualized return of 12.6% during the period.
Onshore bond market to attract foreign investors in 2024
India’s onshore bond market is USD 2 trillion in size, but foreign investor participation is low at just 2%. This is set to change, as JP Morgan announced in September it will include Indian onshore government bonds in its GBI-EM Global Index suite, starting June next year. Conservatively, assuming no other global indices follow suit, we estimate over USD 25bn of fund inflow within the first 12 months of inclusion into the index.
Risk considerations
There are risks one needs to consider when investing in India. Political stability is critical to fostering economic prosperity. The next general election is due in the second quarter of next year. Any change in leadership (not our base case) would impact policy direction and growth momentum, especially if there is a delay in investment spending or any impact to sentiment. Climate change, including the quality of monsoons, poses risks to agricultural output and prices. Externally, we are mindful of any global growth slowdown that could weigh on EMs. Rising geopolitical tensions, including a potential broadening of the conflict in Gaza, could have a far-reaching effect on oil prices and, hence, inflation in India.
Low correlation to global assets warrants diversifying into India
For investors, an important approach to managing risks is diversification. Since Indian assets have a historically low correlation with global markets, allocating appropriately to Indian equities and bonds will help optimize one’s overall portfolio return, in our view.
