In a detailed analysis of the emerging market economy, Jason Hollands outlines the case for investing in the subcontinent.
This week, in India, which is home to more than 18% of the global population, polls will open for its 2019 general election.
In a staggered series of votes that take place between 11 April and 19 May, an electorate of 900 million voters will be eligible to cast their votes in 543 parliamentary constituencies across India’s 29 administrative states, with the results declared on 23 May. Such is the youthful nature of India’s rapidly growing population, it is estimated that there will be more than 84 million first-time voters.
From an investment perspective, this election will be watched with keen interest because India is one of the fastest-growing economies in the world, posting average annual GDP growth over the past five years of 7.5%.
While the growth rate decelerated in 2018, in common with softening in other emerging markets, at 7% this nevertheless put India at the top of the global growth tables. Many forecasts for this year indicate that growth will dip below 7% before recovering in 2020.
These past five years have rewarded investors well, with the MSCI India Index of listed Indian companies delivering a total return of 86.9% in sterling terms, well ahead of the 56.1% gain from the broader MSCI Emerging Markets Index, and far ahead of the meagre 33.5% eked out by UK shares.
However, year to date, India equities have lagged wider emerging market returns, as tensions with Pakistan and election uncertainties have weighed on sentiment.
The election will determine whether prime minister Narendra Modi and his Hindu nationalist Bhatiya Janata Party-led National Democratic Alliance can repeat their 2014 success.
In 2014, the BJP were the first party to win an India general election with an outright majority in three decades and, along with its allies in the NDA, secured 336 seats in the Indian parliament.
Elected on a pro-business agenda, with promises to enact sweeping economic and administrative reforms and to create more than 10 million jobs a year, the market reaction in 2014 was one of euphoria.
Between results day on 16 May 2014 and the end of the year, the MSCI India Index delivered a total return of 15.0%, while the wider MSCI Emerging Markets Index returned just 2.0%.
Five years on, the race looks set to be tight with a recent forecast for The Times of India pointing to 279 seats for the NDA, a majority of six seats. Having set such high expectations five years ago, the pace of progress in many areas has disappointed.
This is not to say that there have not been areas of meaningful reform. For example, the Indian government has rolled out the world’s biggest biometric ID system, migrated various government services online, and through the Digital India initiative is connecting rural areas with high-speed internet networks.
These measures should have long-term benefits, helping to improve financial inclusion – with hundreds of millions of new bank accounts opened in recent years - and enabling benefits to be paid directly into accounts, thus reducing bureaucracy.
Progress being made
There has also been progress in making India an easier place to do business. This has included replacing a complex patchwork of different sales taxes across India’s 29 administrative states, with a single nation-wide Goods & Services Tax; as well as speeding up procedures for gaining construction permits and overhauling the bankruptcy code to streamline the insolvency process. Over the past four years, India has improved its position in the World Bank’s Doing Business report by 65 places.
There have also been steps to liberalise restrictions on foreign ownership in certain sectors to attract greater foreign direct investment, although more needs to be done to meet stated goals. Overall though, foreign direct investment has increased from $45 billion in 2015 to $61 billion in 2018.
However, there are also many areas of unfinished business, or where efforts to implement reform have faltered.
On the negative side, the economy was impacted by a surprise decision in 2016 to withdraw large bank notes from circulation, which saw over 85% of cash by value withdrawn from the system at short notice.
“Demonetisation” aimed to tackle the black economy; requiring notes to be exchanged at banks and, in so doing, flush out untaxed wealth and integrate it into the formal economy.
However, the near-term impact was highly disruptive as it was followed by weeks of cash shortages and it is estimated to have knocked more than 1% off GDP.
The policy was particularly difficult for small rural farming communities, which operate in a cash-based economy and that have struggled with the effects of weak food prices over the past two years.
Above all, it is the stubbornly slow pace of new job creation, at around 3% to 4%, well below the GDP growth rate, that is a source of frustration, given India’s rapid rate of population growth.
With more than 1.35 billion citizens, more than half of whom are under 25 years old, India is on track to eclipse China as the most populated nation in the world within the next decade. New job creation is therefore of paramount social and economic importance.
While investors should now be more measured in their assessment of the potential impact from policy reform than they were when Modi took office 2014, and while voters will likely be more sceptical of campaign commitments this time round, there are many compelling reasons to invest in India, whoever wins in these elections.
With a young and growing population, India has the most favourable demographic profile of all the major emerging market economies. This stands in marked contrast to China, whose working population is already in decline as the effects of its disastrous former one-child policy play out.
While India undoubtedly suffers from huge social inequalities, the wealth profile is evolving rapidly. According to estimates compiled by Pictet, in 2011-12, some 60% of the population was classified as low-income, but by 2016-17, this had fallen to 51% and, by 2022-23, this is forecast to decline to 38%.
The expansion of the Indian middle class is powering very high levels of growth in consumer spending and the service sector, creating opportunities for significant growth in areas such as financial services and mortgages.
Private domestic consumption in India is currently worth $1.5 trillion, but according to forecasts by the World Economic Forum, it is set to grow to $6 trillion by 2030. This would make India the third-largest consumer market (after the US and China).
As a fast-growth economy, modernising India’s creaking infrastructure is another important theme that will play out over many years both through public and private sector initiatives.
Significant projects already planned include investments in ports, railways, highways and industrial corridors. The BJP has just pledged a $1.44 trillion infrastructure programme in its manifesto, including metro trains in 50 cities.
These themes of strong consumer growth and a pipeline of significant infrastructure development, underpin the exciting long-term Indian structural growth story.
So, how to invest?
Although India is now the sixth-largest economy in the world as measured by GDP and one of the fastest growing, Indian equities are an underowned asset class for UK investors.
While the Indian stockmarket, at $2.1 trillion market-cap, is broadly of a similar size to the German and French markets, Indian equities have low representation in global indices, including just a 9.2% weighting in the MSCI Emerging Markets Index.
Last year, Morgan Stanley forecast that the Indian market would reach $6 trillion in size over the next decade. Over time, if India makes progress opening up access to its markets, as we have seen with China, there is huge potential for Indian equities to achieve much greater representation in global indices.
In our view, most investors should consider achieving their exposure to India through allocations to global emerging market or Asia Pacific ex Japan funds, where Indian equities respectively represent 9.2% and 8.0% of the relevant indices.
Well-managed investments that have materially higher India exposure include Stewart Investors Asia Pacific Leaders fund (30.3%) and the Pacific Assets Trust (32.2%). Also worth considering is the JP Morgan Emerging Markets Investment Trust (20.3% India exposure), which is trading on 9.5% discount to net asset value.
There are also a number of specialist India funds available. The most successful of these over five years has been the Goldman Sachs India Equity Portfolio, and over three years the Alquity Indian Subcontinent fund, which launched four years ago.
Both of these funds include significant investments in medium-sized and smaller companies, alongside the larger companies. Among investment trusts, the JP Morgan Indian Investment Trust – trading at an 11.4% discount to NAV - has greater exposure to larger companies.
Jason Hollands is managing director of business development and communications at Tilney Bestinvest.