India cuts itself loose from the ‘Fragile Five’

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Considered one of the ‘Fragile Five’(1) just a year ago, India is currently at the outset of an exciting economic recovery story. After slowing for the last three years, GDP growth for the quarter ending in June accelerated to 5.7% year-on-year (YoY), marking its fastest pace in 10 quarters.

Structurally compelling
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. This chart shows that in India, the number of people typically not in the labour force (the ‘dependents’) as a proportion of those at work (the productive segment part of the population) has been falling steadily, while in some of its major Asian peer, it has been rising, most notably in Japan.

India’s dependency ratio should keep declining until 2040

Age dependency Ratio - AsiaSource: UN Population Database (incl. estimates), Morgan Stanley, May 2014

Japan’s dependency ratio declined after World War II, fuelling the country’s post-war ‘economic miracle’. Similarly, the ‘Asian Tigers’, followed by China from the 1980s, all benefited from a falling dependency ratio, providing abundant labour to sustain superior growth rates.

After doubling from USD 500 million in 2003 to USD 1 trillion in 2008, India’s GDP is expected to exceed USD 2 trillion in the current fiscal year. But unlike its Asian peers, India should now see a further decline in the dependency ratio lasting another 25 years and providing strong support for long-term growth.

Government with a purpose: a catalyst for growth
The foundations for the current turnaround in growth were laid by the authorities’ successful defence of the Indian rupee and their measures to fix some of the imbalances ailing the economy. The rupee has been stable since September 2013, supported by narrowing trade and current account deficits. Meanwhile, consumer inflation has fallen from more than 10% in late 2013 to less than 8% today, and appears to be on track for its target of 6% by January 2016.

India's INRSource: Bloomberg, September 2014. Rebased at 100 on 31/05/2013

The outcome of May’s general election is likely to provide a catalyst for further growth. Indeed, the decisive mandate for the Bharatiya Janata Party (BJP) has enabled new Prime Minister Narendra Modi to form a strong and stable, single-party government which should be well positioned to address key issues such as inflation, employment and fiscal deficit, but also to drive through much-needed reforms and boost growth.

For the next leg-up: earnings growth
With the economy bottoming out, India now appears to be heading towards a higher, more sustainable growth rate in the next two to three years.

India's equity levels
Source: Bloomberg, as at end August 2014. Performance of the MSCI India 10/40 NR in USD rebased at 100 on 1/1/2011

As equity valuations are already off their lows, improved earnings growth should become the next driver for stock price performance. In this context, we believe a stock-picking approach focusing on identifying companies offering sustainable and superior earnings growth at reasonable valuations should enable investors to benefit from India’s growth recovery story.

(1) Amid last year’s market talk of the US Federal Reserve being close to the start of tapering its pro-growth QE measures, the currencies of Brazil, Turkey, India, Indonesia and South Africa had suffered. These ‘Fragile Five’ came under pressure over concerns about the outlook for their wide or widening current-account deficits.
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Paul Milon

Investment Specialist, Indian equities

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