Banks stand to win big in India and Indonesia's dash for growth

Ask almost any bankers in the west when was their best year and few would answer “2009”. But on a recent visit to HDFC, one of India’s largest private sector banks, we couldn’t help but reach the opposite conclusion for what’s happened in the east.

An impressive 92 per cent of transactions at HDFC are digital, management told us. And any one of their 93 million customers can apply for a personal loan within 10 seconds. Such numbers would have been unimaginable just 15 years ago. But thanks to the Aadhaar biometric identification system, launched in the spring of 2009, India has undergone supercharged digitisation. Between 2014 and 2019, India’s digital economy grew 2.4 times faster than its national economy.From Mumbai’s financial district to the villages of rural India, it’s not unusual for the Indian consumer to pay for everything from groceries to luxuries on their mobile phone. South across the Bay of Bengal, economic progress has picked up in Indonesia too. The country made its mark on global commodity markets through nickel mining, crucial for the energy transition.

Today, growth-focused policymakers are working to keep more of the metal’s downstream profits onshore by developing the country’s industrial sector and investing trillions of dollars in infrastructure that will help knit together the world’s largest archipelago. Executives at one of the country’s biggest banks were uncharacteristically upbeat when we sat down with them earlier this year, visibly buoyed by the country’s growth momentum. Outperformers It’s clear from our observations on the ground, together with the headline figures, that India and Indonesia are two of the brightest spots in the world economy today. While global growth is expected to be around 3 per cent this year and next, both Asian countries have projections for between 5 and 6 per cent.2 Their labour forces are young - demographic dividends that far outshine China and Japan, the largest economies in the neighbourhood. In India, about five million workers enter the workforce each year. 


Profiting from this growth is less straightforward. Investor optimism for India has recently cooled as a result of rapidly rising valuations in its equity market. At 27 times price-to-earnings, MSCI India is more expensive than emerging markets (15 times) and global equities (19 times). Indonesia faces no such problem, but the benchmark is hamstrung by a handful of industrial conglomerates and pockets of poor corporate governance that no longer represent the new economy. In both cases, buying the index would involve holding illiquid stocks vulnerable to volatility driven by speculative traders. However, all companies - big and small - require financing. This in part explains why bank stocks generally correlate with inflation-adjusted GDP growth in emerging markets (see chart). In the decade before the pandemic, shares in Indonesian banks performed particularly well, producing a total return of 172 per cent. Chart embed:


Credit where credit’s due

India and Indonesia’s debt levels have also been a boon for their banks. Compared with Japan’s debt-to-GDP ratio (over 400 per cent) and China’s (over 300 per cent), India (182 per cent) and Indonesia (77 per cent) have more capacity to borrow, which means more room for financial services to grow. The countries are less indebted across all categories - public, household, and corporate debt - than China or Japan, and they are below the averages for both developed and emerging markets. 


Credit growth is generally expected to outpace GDP growth as capital expenditure picks up, and this will benefit corporate banking. Growth in consumer banking should have more room to run too. As of 2021 only half of Indonesians over the age of 15 have payment accounts or own a credit card. More Indians have an account (78 per cent) but far fewer have access to credit cards (5 per cent). Compare that with Japan, a developed economy, which scores 98 per cent on the former and 70 per cent on the latter. 


Banking the unbanked goes beyond credit cards, of course. Demand for financial products such as mortgages, or services like wealth management is likely to rocket as middle classes expand and more people become credit-worthy. Given the size of India’s and Indonesia’s populations, these trends should continue in the banks’ favour for years to come. Just a snapshot of HDFC’s client base in India tells the story: the bank is acquiring 11 to 12 million new accounts every year, without having to make any changes to their business model or strategy. In the financial year of 2024/25, we expect earnings per share (EPS) among the banks on our radar to grow around 10 per cent in India.

Not all created equal

The benefits are unlikely to be felt across the whole sector, however. In India, there is a quality dichotomy drawn along ownership lines. Privately held banks spend 65 per cent on growing their business and the rest on employees’ compensation. At state banks it’s the other way round. State-owned financial institutions are also subject to the risk of ‘national service’ where lenders are expected to compress margins to support economic growth. Private sector businesses, which increasingly bear the brunt of growth and job creation, also tend to bank with privately-owned lenders. As such, these banks enjoy better fees and lower cost of credit compared with their state-owned competitors.

More than 80 per cent of Indonesia’s deposits are held in less than 2 per cent of the country’s bank accounts, which are in turn concentrated among the ‘big four’ banks.3 Business mix matters too. Bank Rakyat Indonesia (BRI), for example, has succeeded in capturing a uniquely large client base in the country: micro enterprises. The bank’s bread-and-butter micro lending serves almost 37 million of these types of businesses - over half of the total addressable market of 67 million.4 

Of course, the BRI - much like the economies of India and Indonesia - is not immune from cyclical challenges just because they have structural advantages. Food inflation and tighter monetary policy have hit the BRI’s clientele, with non-performing loans piling up. Changing business strategies can also undermine medium-term growth potential. Margins at HDFC have been squeezed of late because of its decision to merge with its parent company, for example. Bottom-up selection remains critical. Rising tides do not lift all boats.

Importantly, none of these short-term challenges are the consequence of exuberance, in sharp contrast with US and European banks in the 2000s (if anything, the 2008 global financial crisis and the 90s Asian financial crisis have led to more prudent regulation). Banks in India and Indonesia are beefing up their loan book because businesses in their home markets are racing to expand. As long as this story continues, these banks deserve the attention of - if not, a prominent place in - global investors’ asset allocation.


1: ‘India@100: Realizing the potential of a US$26 trillion economy’ by EY. Calculated in US dollar terms.
2: Projections in ‘World Economy Outlook Update January 2024’ by the International Monetary Fund (IMF).
3: LPS - the Deposit Insurance Agency, as of December 2021.
4: 1Q 2024 Financial Update Presentation by Bank Rakyat Indonesia.