Indian Equities: Rising on Macro Trends

Many asset managers assume a zero-sum game between Developed Market (DM) economies and Emerging Markets (EM) economies. However, this excludes macroeconomic data and empirical observations. Indian equities stand as possibly the greatest case in point and have been witnessing an upsurge in recent time on the back of a number of structural reforms.

Macro Trends

The International Monetary Fund (IMF) estimated that the Indian economy’s GDP in real terms will display a growth rate that would outstrip that of most Emerging and Developing Asian countries as well as that of all Advanced Asian countries over the course of this year and the next, at the least.

The expectation is that India will grow by 5.9% in FY 2023–24 and by an average rate of 6.1% over the next five years. This growth story isn’t necessarily a novelty. Experienced “India watcher” investors have long noted that India’s growth rate was second only to that of China among BRIC countries since the early nineties until around 2014 – when India’s growth rate skyrocketed to first place.

In May this year, Morgan Stanley’s India Desk highlighted ten factors that have been boosting growth. Chief among them are “Supply-side Policy Reforms” with two components:

1. A corporate tax rate that was already competitive against nearly every Advanced Asian and most Developing Asian economies is projected to be further liberalized for companies commencing manufacturing before 2024 ends

2. Infrastructure completion progress have been at all-time highs for the past eight years

Other factors include the fact that Indian companies are at 12-year lows in impaired loan ratios (with corporate debt expected to moderate down from 62% in 2014 to 50% of GDP by the end of the current year), digitalization of social spending easing transfers to beneficiaries while whittling down waste and losses due to fraud, flexible inflation targeting since 2014 which effectively decoupled the Federal Reserve’s rate hike cycle from that of the Reserve Bank of India (RBI), and strong multinational corporate sentiment leading to increasing share of exports.

Morgan Stanley goes on to state that the decade to come will resemble that of China during the five years around the Global Financial Crisis (GFC), with GDP and Productivity differentials heavily in India’s favour.

Unlike China’s growth story - which was largely fuelled by the benefits of exports having a leading action on domestic consumption - India’s manufacturing exports seem to be led by increasing domestic consumption trends, which is estimated to have a nearly 9.2% Compounded Annual Growth Rate (CAGR) over the next decade. In parallel, credit growth is expected is expected to have a 17% CAGR over the next decade.

Overall, Morgan Stanley declares that “New India” will drive a fifth of global growth for the rest of this decade.

A month prior to this release, Deloitte noted that while India’s GDP trajectory was impacted by restrictions necessitated by the global COVID pandemic in the more immediate term, the growth rate of growth is estimated to continue staying strong under both optimistic and pessimistic scenarios.

One of the main – and often-cited – reasons for a bearish perception on Indian economic growth has been the massive web of regulations originally set up when post-Independence India was conceived as a command economy, with additional layers of regulations built on top to enforce this. Earlier this year, the Indian government did away with a massive 39,000 points of regulatory compliance and 3,400 legal provisions to promote ease of doing business. In late 2021, it had done away with 22,000.

As a result of this as well as the aforementioned tax reforms, Amundi Asset Management (a unit of Credit Agricole) estimated in May that capital expenditure (CapEx) outlays for a vast array of manufacturing indstries - ranging from batteries and food products to pharmaceuticals and semiconductors - will be massive and variegated in the years to come.

While the overall macro outlook by virtually institutional firm is strongly positive, S&P Global Intelligence highlighted a key bottleneck of concern: infrastructure. Despite India's significant infrastructure investments (about 35% of GDP), the government estimates that it requires US$1.5 trillion in infrastructure investments over the next decade. Outdated infrastructure – especially in power and transportation – criss-cross the nation and are the target of substantial expenditure for upgrades. In fact, India's only sovereign wealth fund - the National Investment and Infrastructure Fund (NIIF) – was established in 2015 solely to fund the infrastructure sector. S&P believes that corporate growth and investments can possibly be hampered if this "infrastructure deficit" doesn’t continue to receive attention and remedy. While the S&P report was published in 2016, it’s always a very valid argument for any country’s economic growth.

Equity Market Trends

As of the end of this past week, the Indian stock market’s total market capitalization has been comfortably been breaching all-time highs for some time now.

What’s quite interesting is how tight the relationship of the market has been with respect to the total GDP, both with or without the reserve bank’s assets factored in, over the past decade as well as the current one.

Under the market valuation zone classification method, the Indian stock market is deemed as being fairly valued in both the classical as well as the modified method.

In terms of price performance, this market discipline remains evident. From 2018 till the present, the NIFTY 50 (Large Cap), MidCap 150 and SmallCap 250 indices show nearly identical convictions - with the MidCap inching forward and close to surpassing the performance of the NIFTY 50 benchmark.

In addition, the Price to Book (PB) Ratio for all three indices have been 3-5X range for this year - as compared to the nearly 10-11X for the Nasdaq-100 and 3-4X for the S&P 500.

Arguably, the most striking aspect of the Indian stock market has been its Price to Earnings (PE) Ratio discipline. The benchmark NIFTY 50 has mostly remained in the 20-26X range for most of this current century.

Excepts for dips during the GFC and other key points of the noughties as well as an earnings drop (while stock valuations remained high) during the course of the pandemic causing ratio inflation, the benchmark has displayed a particularly strong tendency for reversion back into this ratio range over the past eight years.

The Story Continues

It should come as no surprise that experienced “India watcher” professional investors have been left awestruck in recent years. Considering the fact that the Indian government is setting such ambitious pathways for rapid industrial growth while also working on developing the world's largest healthcare and housing systems for the underprivileged and also making a massive push for renewable energy generation infrastructure gives many of these veterans the inkling of a notion that an ambitious, intricately-designed and well-balanced paradigm shift is in motion.

On the 23rd of June, during Indian Prime Minister Narendra Modi’s address to a joint session of the U.S. Congress (which received 15 standing ovations and had to be stopped for an applause break 79 times), he said:

“When I first visited the U.S. as a Prime Minister, India was the 10th largest economy in the world. Today, India is the 5th largest economy. And… India will be the 3rd largest economy soon. We’re not only growing bigger but we’re also growing faster. When India grows, the whole world grows.”

It’s entirely logical to consider that nobody has ever aimed to just be at 3rd place. One can wonder if only one decade will be enough for the “New India” story or if there are a few more afterwards. Time shall tell.

For sophisticated investors considering making a play on the Indian market’s trajectory, two newly-changed ETPs provide magnified exposure to the $iShares MSCI India ETF(INDA)$ ETF: $IND3 gives a 3X daily-rebalanced exposure on the upside while $INDS does the same on the downside. Macro-driven plays will prove to be a solid strategy with these products.

For articles on broader economic events that are tangential to tactical market movements, visit asianomics.substack.com. This week has been all about India: a comprehensive macro/market overview (an expanded version of this article), a full breakdown of GE’s landmark deal to transfer technology to and manufacture jet engines in India, and finally India’s quiet participation in the global AI arms race (which was originally prepared for and sent to the South China Morning Post).