India has seen record inflows into its sharemarket over the past 12 months, from both domestic and foreign investors. But markets dipped sharply recently on the news that India’s current prime minister fell short of the majority mark on its own, with the alliance only winning by a thin majority. What’s next for India, and can its growth trajectory be maintained?
Global Cross Asset Specialist Lukasz de Pourbaix sat down with Amit Goel, portfolio manager of the Fidelity Global Emerging Markets Fund and Fidelity India Fund to discuss some of the long-term structural forces supporting the case of India.
Why is the growth story of India so special?
I'm Indian and I grew up in the capital, Delhi, so I have very deep context to this question. I think the best thing India has for it to sustain the kind of growth it has shown in last 20 years and to execute the promise it is showing today, is the human capital. At the end of the day, businesses, governments, and countries are all run by people.
Whilst India is a very diverse country, it is also a very unequal country, comprised of very poor people and very rich people. Despite this disparity in equality, I’ve seen the drive and motivation to grow in life in India that is unparalleled; to invest in education, and to move up in the social hierarchy. That's why so many Indians travel abroad, why you see so many becoming CEOs of some of the largest companies in the world. Most importantly, all these people, whether within India or those who travel abroad, carry that brand image for the country.
This is why I believe the growth story for India is so special. At their foundations Indian companies and their corporate governance teams being comprised of very strong, committed, and educated human capital at a very grassroot level. In essence, the DNA of India shapes it’s unique selling point.
When comparing across different emerging markets, say China, where demographics are poor, India is almost the opposite. Why are India’s demographics so significant?
Demographics are very important because they can determine your long-term growth.
For an ageing society, the social cost increases and the productivity comes down. You must make up for that loss of productivity through other means. However, for a young and growing economy like India, with the median age in the high twenties, the most productive part of the workforce is growing, creating a natural tailwind. Additionally, the social cost of this workforce is lower than what you may see elsewhere.
However, it goes both ways.
Not only is India one of the youngest world economies, but it’s also one of the largest. There are more than 10 million people entering the workforce annually, which makes it difficult to find jobs for everyone, especially knowing the disadvantages faced by the unemployed. The government has implemented building blocks to ensure that this problem will be resolved in the future, but it's not an easy problem to solve.
India is probably adding between four to five million formal jobs each year, resulting in increased investments in infrastructure and manufacturing over the last decade. India has begun to emerge as a kind of major manufacturing hub on a global scale, but it is at a very early stage. I believe the contribution of this hardworking, younger workforce, to add that GDP multiplier, is what is needed to get there.
So undoubtedly, I believe India’s demographics are significant, but execution on the ground to ensure that younger people find employment is equally important. Demographics alone cannot be relied upon.
From a bottom-up perspective in the past decade, what are some of the key trends you have seen and what is the type of consumer that you've observed?
One of the advantages of being on-the-ground in India is keeping abreast and seeing for myself the changes happening. In the past decade, I’ve noticed two key trends happening: infrastructure, and consumer digitisation.
Firstly, investment in infrastructure is very visible. When I visit India, I notice it everywhere. The number of roads, airports, bridges, highways are highest ever India has seen. Some of this infrastructure includes the final completion of long-haul projects such as dedicated freight corridor from north of India to the western coast, allowing you to move freight freely on an exclusive railway line.
Some of these large projects which were either started but became idle or started more recently, are now being completed at a very high pace.
It certainly has not happened over night and government has had been a very big part of it. Both the central and state governments have invested a lot of funding into infrastructure and in fact, public expenditure on infrastructure has doubled over last five years and continues to grow. The government has been able to spend money because they have fixed their own balance sheet, they're spending less money on subsidies, and they're generating more revenues.
The government has taken steps to formalise the economy, so I think at a at a fundamental level, some of these building blocks were important for fixed capital investment in India to happen, because that can drive the next leg of manufacturing. It's a chicken and egg situation. You can't have manufacturing without infrastructure, but you need to find money for it, which I believe this government has supplied.
At a consumer level, I think things are progressing slower than expected. One big trend I’ve seen is that the Indian consumer is digitising very fast, especially in the area of financial services: how they communicate with the government, and how they communicate with their bank has gone up tremendously. What that will translate to is when these consumers get money, they're already digitised.
This will allow them to have more options when they spend money online and I see this accelerating the consumer part of the economy. As a result, we've been working a lot on the fixed asset part of the economy on the infrastructure manufacturing side, which I think creates building blocks for the jobs to be created. It’s certainly a cycle, it can't happen overnight, but it’s very much required if you have a high conviction on India's GDP growth and it’s sustainability for a longer period of time.
Emerging markets have had a fascinating year. There has been a lot of dispersion between markets between returns. If you reflect on 2023, you summarised India as being a bit of a golden child in terms of markets; you saw a lot of capital going to India, compared to China, which was sort of at the other side of the ledger. You saw markets retrace quite aggressively.
Is it as simple as saying that there has been a shift away from China to India? And has that capital followed from a broader investment perspective? What are some of those dynamics that you've observed over the last 12 months?
When it comes to capital markets, I think you can't correlate India to China that directly, because it is not driven by the same amount of capital and same the people. Yes, there is a group of investors who would have taken money out of China and put that to work in India. But I think there are two different forces working here.
Within China, I think it is the exodus of foreign capital. I think foreign investors were overweight China with that geopolitical view and short-term fundamentals being weak. There has been a massive exodus of long-term capital out of China from foreign shareholders and that has caused, along with weak fundamentals, short-term markets being very weak and valuations landing where they are.
At the same time for India, I agree, there has been a pick-up in foreign capital but I think there is a sea of money coming into Indian equity markets from local investors. We have seen this major shift, where the number of demat accounts* and the number of equity trading accounts for retail investors have gone to a level which is four or five times what it was five years ago and that has moved Indian markets.
So, if you think about retail ownership in the Indian market today, it is at its highest in history. Foreign ownership is not, it is more or less average compared to historical levels. In fact, in India, stock market companies are still owned by first or second generations compared to previously when half of companies were owned by families and promoters, and the other half by retail institutional investors. The foreign promoter ownership has gone to around 38 per cent, the lowest they have been historically. I think that has also created a lot of wealth at the upper strata of the society, because equity markets have almost gone three times since the lows experience during Covid.
A big phenomenon that has happened in India is the emergence of retail investor. We saw this happen in China 5-10 years back, and it is still a retail investor dominated market. But that's not the incremental change in China, the incremental change in China is exodus of foreign capital. The big incremental change in India is the emergence of retail local investors.
So arguably, it’s been a very hot market driven by retail investors, which has seen momentum in that market carry the price on and on. For a professional investor, they’re looking to invest in stocks that go up, but they’re also looking for quality and stock prices. It’s positive to hear that India is offering this at present. So with that, where do you see the opportunities but also, the challenges?
When it comes to markets being expensive or cheap, I think there can be a very easy definition if you look from a top-down perspective. India is trading at about 20 times price-to-earnings (POE) one year forward, which is 25 per cent higher than what they have traded historically. So, it is expensive.
At the same time, China is trading at nine times POE, or around 12 times POE in the long-term. So, it too is cheap. As bottom-up investor, I go a layer deeper than just looking at these figures. When looking at the Indian market, there are parts which are very frothy, in my opinion, trading at 100% premium to what they should be, and there are parts of market which are very reasonable where you can still own in an optically active valuation.
I categorise the market into those different buckets since, as I mentioned, India is going through this Capex cycle investment in infrastructure (a lot of investment is going into power capacity) and because India became power deficit last year. Stocks in infrastructure, real estate, and industrials have gone up significantly in the last 12 months. Some of the utilities companies which are regulated businesses with low ROE and long-term lower growth are now trading like consumer businesses.
At the same time, a large pocket of the market including private sector banks, which are going through a name compression cycle in last six to nine months, used to trade in line to or premium to market. I believe these are better businesses as a whole as they tend to have a higher ROE, higher growth, and they trading at a decent discount to markets.
Within the consumer sector, sentiment is weak; many companies are still expensive, but some of the consumer distribution sectors, which have not participated in this growth and the stocks have not gone up, remain expensive. However, you can still own them given the long-term growth in some of the consumer discretionary categories, which I believe will happen if India continues to grow.
There are pockets of the market we are focused more on now including the private sector banks and some consumer names. Then there are there companies in sectors like chemicals which we like because it's a global theme, where business is coming back to India.
And how do you view the outcome of the recent elections? Modi’s government was very supportive of growth and fiscal spending has followed. Do you think the recent outcome has the potential to derail India’s growth trajectory?
Many investors are disappointed that Modi’s BJP party will need the support of its allies to form a government. The BJP’s allies will hence have greater bargaining power, potentially including in the cabinet, a say in the reform process and other policy decisions.
It means that the new government will have to be more collaborative and make decisions after building a consensus. It could lead the new government to focus on more inclusive growth versus a massive K-shaped recovery that we saw in last 2-3 years, where middle/upper-middle class consumption did well while rural/lower income segment consumption was stagnating. This could also mean that the government may have to balance long term reforms with short term fiscal prudence. However, I still don't see a change in long term fiscal consolidation and growth in India, which are the two important drivers of economic and market performance.
Overall, we should see some consolidation in near-term, away from some of the exuberance we saw in sectors like state-owned enterprises, utilities, infrastructure plays, small caps, etc., while sectors such as consumer and financials should see positive moves.
I firmly believe that this does not break the India story where growth drivers are structural and long term in nature given its strong demographics and domestic-focused consumption trends. India is a place where one can invest with a very long-term view because it has a more sustainable and high base rate growth for GDP and corporate earnings. Also, being a democracy, policy changes are not sudden but largely evolutionary. We do not expect any major changes and continue to focus on high-quality sustainable growth companies available at reasonable valuation with a 5-7-year investment horizon.
*A demat account is an Indian term for a dematerialised account that holds financial securities (equity or debt) digitally and to trade shares in the share market.
