Once considered one of the ‘Fragile Five’, India has returned to the forefront on the back of greater macroeconomic stability and accelerating growth, making this a good time to consider unlocking investment opportunities in a country where, according to the International Monetary Fund (IMF), GDP is expected to grow by 7.5% in 2015. This puts India ahead of China as the world’s fastest growing large economy.
The structural case: an unmatched demographic potential
With more than 1.2 billion inhabitants, India is home to one sixth of the world’s population. Most importantly, it benefits from favourable demographics. As the chart shows, in India the number of people typically not in the labour force (the ‘dependents’) as a proportion of those at work (the productive segment of the population) has been falling steadily, while in most of its major Asian peers, it has been rising, most notably in Japan.
India’s dependency ratio should keep declining until 2040
Source: UN Population Database (incl. estimates), Morgan Stanley, May 2014
At USD 1 trillion in 2008, India’s GDP is expected to exceed USD 2 trillion in the year to March 2016 (FY 2016). Its demographic profile means the decline in the dependency ratio should last another 25 years, which should provide strong support for long-term growth.
Macroeconomic stability: setting the scene for a healthy recovery
India’s fundamentals have greatly improved over the last two years, thanks to effective policies by the Reserve Bank of India (RBI). CPI inflation has fallen. As a result, real interest rates are positive again. The Indian rupee (INR) has been one of the world’s most stable and best-performing emerging currencies over the last two years.
India has benefited from the fall in commodity prices – especially oil – since the middle of 2014. Lower prices contribute to lower inflation, improved fiscal and current account balances and higher growth. They also provide the RBI and the government with additional room to promote India’s sustainable growth recovery.
Reforms and growth: towards long-term recovery
The government has already undertaken key reforms. These include the diesel price deregulation, the increase in foreign direct investment limits in defence and railways and the online clearance process for the environment and forests. It is also pushing for the implementation of the Goods and Service Tax (GST), while direct cash transfer schemes are expected to improve the efficiency of the subsidy system.While private investment will take time to pick up, the government’s push to boost investment in infrastructure (particularly roads and railways) and defence marks another step towards improving the economic growth rate.
We believe greater macroeconomic stability, a credible monetary policy and incremental progress in reforms will allow the equity market recovery to be secular rather than cyclical, which should benefit long-term investors.
Not just another BRIC in the wallWill the pickup in GDP growth be reflected in improved company earnings and better returns? In our view, India has an equity market that, especially when compared with those of the other BRIC economies, is particularly well structured towards converting economic growth into shareholder value.
This is a highly diversified market led by consumer-oriented sectors which stand to benefit from the long-term trend of rising domestic consumption, driven by the burgeoning middle class. It includes world-class companies, while the private sector represents 91% of the MSCI India index.
While the market carries what some have called the ‘India premium’, we believe the dominance of competitive private-sector companies in the consumer and services sectors provides good justification. And on a sector-neutral basis, India is neither cheaper nor more expensive than any other emerging market.
Providing secular support
Retail investors have turned net buyers of Indian equities, providing strong support for the market. They are being encouraged by favourable drivers such as lower inflation and positive real rates, while the property market has been under pressure and the price of gold has fallen. Even after the recent strong inflows, equities still represent less than 3% of total household assets and with household savings expected to grow, retail equity inflows could continue to support the market.
Churn offers stock-picking opportunities
The mix in India’s top league of largest companies has changed considerably over the years, with a healthy number of emerging, fast-growth companies taking over from businesses that are past their prime.
Such changes can mean attractive opportunities to own shares in the top companies of tomorrow. Investors can focus on listed companies that can be expected to endure among the top stocks. They can also seek to identify the smaller, fast-growing off-benchmark companies that are poised to gain market share and emerge as future leaders in their sectors.
Since in India, mutual fund schemes remain relatively small compared to the overall market, equity fund managers don’t have a significant impact on prices, making it easier for skilled managers to outperform.
In terms of sectors, private-sector banks are expected to be among the top beneficiaries of the reacceleration of growth and to experience better liquidity conditions due to the central bank’s progressive easing. Their absence from international indices provides one more reason for international investors to use an active manager with the flexibility to invest in off-benchmark positions to ensure a full exposure to India’s exciting recovery story.