India – A long term structural growth story

One of the most obvious reasons to invest in India is the size of its economy and its rate of growth. Today, India is essentially in the position China was in 15 years ago – still developing and growing fast. India’s economy is also incredibly diverse, with a huge number of companies across industries and sectors to discover new opportunities. This universe is getting broader with online and digital businesses starting to get listed.

Strong growth prospects

We maintain a very positive view on India’s long term structural growth prospects. This is because the country has strong demographics - its 1.4bn population which is only behind China, but younger (median age of 28 years) and growing more rapidly. India is expected to add 200mn people to its workforce between 2020 and 2050. As these extra hands join the workforce they will contribute to GDP growth as well as add to the country’s consumer base.

Also, India has one of the lowest penetration of goods and services such as automobiles, white goods, electronic devices and services such as mortgages, credit cards and online travel. This is expected to correct with rise in income levels and increasing affluence. Growing urbanization, education and infrastructure development is expected to add to this trend by enhancing growth prospects and increasing efficiencies.

Note that at about US$2,000, India’s per capita GDP is where China was 15 years ago. While it may chart its own course going forward, it has all the ingredients that can help it closer to the path China has shown. As GDP per capita increases from US$2,000 to US$5,000 in the next few years, the country can experience the ‘S-curve’ effect that is known to boost demand for goods and services.

Focus on manufacturing

One of the keys areas where India has lagged China is manufacturing. Driven by favourable policies, development of special economic zones, strong investments in infrastructure, among others, China paved way for a very strong manufacturing base that could employ its large population and contribute the country’s GDP. What followed was that China literally became the factory of the world and was able to fruitfully employ its large population and earn valuable foreign exchange to further invest in its infrastructure.

Meanwhile, India’s manufacturing sector stagnated with archaic infrastructure and inefficient policies. While India’s skilled labour got employment in its burgeoning services sector, the unskilled remained underemployed and poor.

This is now changing with India focusing more and more on manufacturing. This is also happening at a time when companies are increasingly looking to diversify their manufacturing to cut costs (with the rise in labour costs in China) and to de-risk themselves in the wake of growing geopolitical concerns.

We think the Indian government’s recent package of reforms can be a game-changer if executed well.

  1. Implementation of a unified goods and services tax (GST) is improving efficiencies and formalising the economy and increasing the country’s tax base.
  2. The 10 percentage-point cut in India’s corporate tax rates in 2019 has brought these in line with other countries in the region, improving the competitiveness on India’s manufacturing sector.
  3. The consolidation of 29 archaic labour laws into 4 new codes is expected to simplify rules and make them more flexible for the employer.
  4. The new version of its “Make in India” has shifted focus from high end manufacturing to import substitution, which seems more achievable.
  5. The government has extended production-linked incentives for domestic manufacturing in areas such as mobile phones, active pharmaceutical ingredients (APIs), auto & components, semiconductors, food processing, telecom & networking equipment, textiles, specialized steel, white goods, electronics, solar cells, medical devices. In addition, there are tax incentives, and protectionist increases in import duties/bans in areas where local manufacturing can easily substitute imports.
  6. The plan is to create 100 million manufacturing jobs and increase the manufacturing sector’s contribution to GDP to 25% by 2025 from the current 15-16%.
  7. The government is also looking to double infrastructure spending in the next five years versus the previous five years.

Given its track record, the country may be slower in implementing some of these initiatives, but we believe that even a slower progress will be beneficial for the economic as a whole in medium to long term.

Increasing diversification of the listed space

Indian equities enjoy a premium versus other markets in the region due to its higher and more consistent return on equity profile, given the presence of a large number of high-quality, growth companies. While volatility is there, just like in any equity market, Indian equities have been able to generate 10-15% returns in USD terms over a period of 15-20 years due to this sustainable high quality returns the market offers.

This is also the reason why India’s shareholding data suggests that foreign holdings in Indian companies have remained steady across cycles at around 20-22% over the last 10-15 years.

Despite having the oldest stock exchange in Asia and having one of the largest number of listed companies in the region, one concern about India equity market has been that it is dominated by a few large companies. Also, there was no representation of the new economy sectors, such as digital and online businesses, on its stock exchanges.

All this is now changing rapidly as more domestic companies in these internet sectors are growing fast and gaining critical mass. This year, we have seen the IPOs of online food delivery company Zomato, while many others such as digital finance app Paytm, cosmetics brand and retailer Nykaa, ecommerce logistics firm Delhivery, and insurance marketplace Policybazaar as in the queue.

What this means is that the Indian equity market will continue to broaden and provide more invest options leading to an increase in alpha generation potential. A recent estimate by Bernstein suggests that these consumer tech businesses will grow from zero percent currently to about 19 percent of the total market cap of NSE 500 index by 2030.