Is this the most attractive investment destination of the next decade?

This article first appeared in Livewire markets on 13 July 2023

Intrigue and mystery no more, this region is growing exponentially – and in many different ways.

When putting together the ‘Where in the world should you invest?’ series, there was one region that I was most intrigued to explore - India. It's seemingly a massive area of opportunity but also largely unknown, and perhaps a little misunderstood, by many investors.

Ask people which economy they think will be the ‘next China’, and the answer invariably comes back as ‘India’. That’s largely because India is expected to grow between 6-6.5% in FY24 and in the range of 5-7% for the next decade (according to the IMF). And whilst those numbers are reminiscent of China’s during its halcyon growth period, there are nuances that investors should be aware of when it comes to India’s investment story.

In this wire, with help from Nitin Mathur from Fidelity, we aim to unpack why India is poised to be the most attractive investment destination of the next decade and how you can gain access.

India

• A population of 1.4 billion people (17.7% of the world’s population) growing at a 1.1% annual rate - recently overtook China as the most populous country.
• One of the world’s youngest populations, with more than half of the population under the age of 25 and more than 65% under the age of 35.
• The government of India aims to achieve a GDP of $5 trillion by FY 2025.
• Home to the fifth biggest market cap, by country, behind the US, China, Japan and Hong Kong, with US$3.31 trillion.
• 800 million internet users.
• In 2022 alone, India processed 74 billion digital transactions worth US$111.6 billion, surpassing the combined volume of the US, the UK, Germany, and France.
• By the end of this year, India is projected to have 1.36 billion unique IDs and 10 million GST-registered companies

What are the main characteristics of the investment region?

A key aspect is India's very young - and growing – population, which creates a very structural kind of growth.

India has recently overtaken China as the most populous country. Its 1.4 billion population has a median age of 28 years, and it is going to add 200 million people to its workforce between 2020 and 2050, according to UN estimates.

A lot of goods and services sold in the country have a very low penetration level. The country is underbanked, for example. There are low levels of penetration in mortgages, which is around 11% of GDP in India, versus 32% in China, and 52% in the US. And only 3% of Indian households have credit cards, versus 22% in China, and 70% in the US.

In many consumer segments such as air conditioners, and vehicles, the penetration level is very low. So, as the GDP per capita of the country expands from the current US$2,500 level to around US$5,000 level in future, there's going to be a lot of demand for products including cars, consumer electronics, mortgages, and credit cards. 

India sold 7 million air conditioners last year in a very hot country, compared to China, which sold a hundred million air conditioners. So you can see the kind of difference.

And as income levels grow, the S-curve effect will kick in and we'll see a sustainable, high growth rate there. So all these characteristics lead you to a structural growth of around 5-6% in GDP, which I think would be a very positive thing in the low-growth world that we are living in.

Why do you like the region as an investment destination?

A lot of it is to do with structural growth, so any company in India is able to tap into this growth. 

The key reason why India can be a very attractive destination is the fact that it has some very high-quality companies. We are bottom-up investors and we find a lot of very high-quality companies. 

Obviously, there'll be bad apples everywhere but, on average, the management quality and the corporate governance standards that we see in the market are quite high.

Some of the private sector banks that we own in our funds, they are among the best - not just in India but around emerging markets - with very high returns on equity (ROE) over cycles. That's why Indian companies have been a very significant part of the quality-focused portfolios that we have at Fidelity.

Where India has lagged is that they're not able to make enough investments in infrastructure, which is why the manufacturing sector has lagged. So services have become 55% of GDP, while manufacturing is still languishing around 15%, which means that we are able to employ a lot of skilled labour. But in the unskilled segment, there's a high level of unemployment.

This is changing into something we like. The government is doubling its infrastructure spending compared to the last five years and into the next five years. And they're giving incentives to build new manufacturing facilities in certain areas under its production-linked incentive scheme. And that is happening at a time when supply chains are looking to shift out of China.

It's a very interesting period where, if India is able to increase the infrastructure spending and have the right infrastructure, it should be able to attract a lot of this production that is moving out of China.

What are the major risks to the region?

One of the key risks is always the execution risk. 

When we are talking about attracting these investments, how much is the government able to commit to infrastructure spending? What is important to know is that the direction is right, and even if they are able to do half of what they are trying to do, it's still going to add a lot of value to the economy.

The oil price is always a risk. India is one of the largest importers of oil in the world. Given the current geopolitical environment that we are living in, although at the moment oil prices have been very well contained, it is something that we will always be looking out for. 

Plus, there are elections in India, the general elections next year. These will place some kind of pressure on the government to increase welfare spending because of the fact that, if there's a change in dispensation or the current government gets a lower number of seats in the parliament, there can be a slow-down in decision-making.

These things are more medium-term risks. India is still the largest democracy in the world. The power transitions have always been very smooth. And in the end, what we are looking at is the direction of policy reforms. 

Whatever government comes in, we know that there might be short-term ups and downs, but the general direction of the government policies is positive.

What is the one thing that potential investors need to know before investing?

Investors should be very mindful that India is a stockpicker's market. 

If you look at the overall valuation of India, it has always been higher compared to some of the other markets in the region. 

The price-to-earnings ratio of India at the moment is around 21x. If you look at emerging markets, next year it'll be somewhere around 12x. The price-to-book ratio is also higher. Not just to compare it with other countries, but also, on price-to-earnings it's slightly higher than average. 

What it hides is that there is a very large disparity among the stocks within the country. 

So you can find very good quality stocks which still do not have high valuations. It is very important to look under the hood and see where the investment opportunities are when you're investing in India.

What is one stock in your portfolio that best represents the region?

HDFC Bank (NYSE: HDB). This is the largest private-sector bank in the country. It benefits from the structural growth which is happening. 

As more and more people use mortgages, loans and credit cards, this structural growth will benefit the bank. 

It's a very high-quality bank and a very strong franchise, with a very strong brand, technology, and consumer focus. Because of that, they are able to take market share from the less efficient government-owned banks.

Government-owned banks are around 77% of the system now. Over time, their share both on the deposit side as well as on the loan side is reducing and private sector banks are taking market share. HDFC Bank, being the most efficient and well-done bank, has been taking a lot of that market share from these banks.

If you look at the banking sector in the last 15-20 years, as a system, the return on equity of the system actually fluctuated between 15-16% positive to negative 2-3%. If you look at the public sector banks, the fluctuation was much more - from 15-16% positive to 15-16% negative. But if you look at HDFC Bank, it has always had that 15-20% range of return on equity over this whole 20-year cycle.

We think it is one of the best banks in the emerging market space.