By James Thom
The world’s largest democracy is growing by leaps and bounds compared to most developed countries, which hardly move the needle these days. India should continue outpacing the rest of the world for the foreseeable future thanks to ambitious government reforms aimed at stoking consumer demand, production and foreign investments. All the while, India stands to benefit from the so-called “demographic dividend.” It’s expected to be the world’s youngest country by 2020 with nearly two-thirds of its 1.3 billion people of working age and in their prime spending years.
In the long term, India’s market potential looks attractive for investors. While valuations are expensive right now, which might deter short-term investors and investors looking for lower cost assets, today’s expensive stocks may be irrelevant in the future because of India’s significant opportunity for growth.
World’s fastest growing country
India reigns supreme as the fastest-growing G20 country with an economic growth of around 7.5 percent annually since 2014. Consulting group PwC forecasts real GDP growth of 7.3 percent this year, followed by 7 percent expansion in 2018 and an average of 6.5 percent annual growth between 2019 and 2023. By contrast, China’s growth is seen slowing to 6.5 percent this year and 6.1 percent in 2018. Growth estimates for the People’s Republic range from 5 percent to 7 percent for 2019 to 2023.
Ambitious government reforms
India’s government is on the brink of enacting the most epic post-independence tax reforms that will unify the entire country into a single market. The nationwide goods and services tax (GST) — an effort 10 years in the making — is set to go into effect July 1. It will potentially lower prices for consumers while reducing bureaucratic bottlenecks for businesses. It is music to the ears of most industries and will reportedly juice economic growth by one to two percentage points.
The GST aims to replace more than a dozen levies dividing the country and turn India into a one-nation, one-tax common market. It will support business growth as it simplifies India’s Byzantine tax system — a tangled mess of local, state and national laws. Manufacturing costs should come down as a result and in turn make Indian exports more competitive. Taxes on commodities are expected to fall, lowering prices on end products.
Large youthful population driving innovation, productivity and growth
Most developed countries face an aging population past their prime working and spending years. India is the polar opposite. India is set to become the world’s youngest country by 2020 with 64 percent of its population in the working age group; the average age will be 29. With 1 million people entering the labor force every month, India abounds with young human capital essential to driving innovation, productivity and consumer spending over the long term.
Demographic trends favor a growing labor force through 2040 given the young population and low labor participation rates for women. Furthermore, some 70 percent of India’s population still lives in rural areas. The potential increase in productivity that goes hand-in-hand with urbanization is enormous.
Apple has long outsourced tech support and software development to India. It will soon produce iPhones there as well. The world’s largest tech company is positioning itself to grow its thin slice of the country’s fast-growing smartphone market and ease the sting of China’s rising labor costs. Wistron, a contract manufacturer, is set to kick off iPhone SE production in April in the city of Bengaluru in Karnataka state.
India’s manufacturing output grew at the fastest rate in five months in March as new orders accelerated. The Nikkei Manufacturing Purchasing Managers' Index climbed to 52.5 in March from 50.7 in February improving for a third month straight, according to IHS Markit. The new orders index climbed to a five-month high of 53.6 in March from 51.3 the previous month. Readings above 50 draw the line between growth and shrinkage.
First quarter global leader
First quarter 2017 marked dramatic turnaround for India’s stock market after in a dismal fourth quarter. India Region Funds tracked by Lipper Inc returned an eye-popping 20 percent in the first three months of the year as stocks scaled new all-time highs. India’s performance dwarfed World Equity Funds which gained 9 percent in first quarter.
Investors cheered the Bharatiya Janata Party’s (BJP) victory in critical state elections in mid-March. The win boosts the odds the BJP — to which Indian Prime Minister Narendra Modi belongs — will continue its reform agenda and attract foreign investors. Modi, secured in power until at least 2019, will likely double down on his plans to improve infrastructure.
India Funds also outpaced all other regions long term. Through March 30 of this year, they gained 26 percent, 15 percent and 10 percent over the past one, three and five years annualized. By contrast, World Equity Funds added 13 percent, 2 percent and 6 percent over the same periods. The India Fund (IFN) surged 20 percent in first quarter. It returned 40 percent in the trailing year, 24 percent annualized the past three years and 17 percent annualized over five years.
Foreign inflows into India’s equity market topped $6.6 billion in the first quarter of 2017, offsetting the sell-off in fourth quarter 2016, according to Jefferies. Foreign inflows into rupee-denominated government and corporate bonds rose by $5.5 billion — most of which came in March. Local sovereign bond yields are among the highest in Asia. India’s 10-year government notes yield nearly 7 percent — about 4 percent more than their U.S. counterparts. Against this backdrop, the rupee appreciated 4.7 percent against the U.S. dollar in the first quarter. It logged its best Q1 performance since 1975 and its largest quarterly gain since third quarter of 2012.
The outlook for India’s stock market remains positive on expectations of continued government-led economic reforms, lower interest rates and corporate earnings growth. Earnings growth is likely to improve over the next two or three years considering the low base, stable commodity prices and a resurgence of consumer demand. Indian households are increasingly saving money in stock-based investments like mutual funds owing to weak outlooks on hard assets like real estate and gold.
James Thom is Senior Investment Manager, The India Fund, Aberdeen Asset Management