Friday, 31 March 2017

Is India Being Overlooked By Investors?

People shouldn’t be discouraged from buying Indian equities because of high valuations and the time it is taking for Prime Minister Modi to push his reforms through, although investors should keep an eye on the supply/demand unbalance in the country, something often overlooked.
India was the darling EM of 2014, following the election of the pro-reform prime minister. During those 12 months, the MSCI India index returned 31.58% while the MSCI Emerging Markets index – dragged down by struggling Brazilian and Russian economies – returned just 3.9%. 
Modi achieved a landslide victory in India’s 2014 general election after promising to implement a series of drastic economic reforms. These included a focus on corporate governance, allowing 50% more foreign investment across varying sectors and deregulating prices of natural gas, kerosene and fertiliser pricing in a bid to encourage the expansion of private production.
However the honeymoon period was short-lived as investors grew impatient for Modi’s economic reforms to push through, and rising commodity prices bolstered stocks based in oil-importing emerging market countries.
In a complete role reversal 2016 was all about Russia and Brazil, the commodity-led emerging markets. After being so unloved the Brazilian and Russian MSCI indices returned 98.29 and 84.67% respectively, while MSCI India produced a comparatively meagre 17.57% return.  India went from being the pre-2014 ‘slum-dog’ to being a firm foreign favourite almost overnight, but then in 2015 it seemed investors became disenchanted almost as quickly.
So are investors right to be pessimistic, or do they simply need to be patient and retain a longer-term investment view?
It is important to remember that India had a dysfunctional political federal system which pre 2014 wasn’t working, and things were never going to be turned around overnight.  The PM always indicated that true economic reform in India would be at least a two-term job, if not three.  Modi is already talking about 2024 even though the next election year is 2019. His vision seems to be that he needs 15 years to pull India up by the scruff of the neck and reform it to deliver growth.  The agenda is not pro-business, but rather to make a real difference to everyday lives through provision of job opportunities and growth. 
There are key issues still to be resolved, perhaps the most important one being the economic unbalance between supply and demand which has grown as a result of homegrown manufacturing.  India has a consumption economic, avoiding the typical development model and moving directly from agrarian to consumption.  In recent years demand exploded due to job growth and rising consumer confidence, and supply levels are still playing catchup.  India’s current working age population should not peak until around 2055, and is growing at the expense of the number of young and elderly dependents. This has further increased spending power and led to a consumption boom.
Because of the huge consumption possibility, inflation has periodically derailed the economic and stock market growth cycle,  hence why many of the population have historically chosen to invest in gold.  Now this is slowly changing.  There are a lot of economic reforms in place, keeping inflation in check.  The country can industrialise and roll out infrastructure, and there are no imported inflation issues linked to overseas commodity consumption.  Inflation is more domestically driven, and the reforms will help address bottlenecks in the system.
So the future seems bright, and yet despite this some investors still object on the basis that India now looks expensive, particularly when compared to Russia or Brazil.  While the market lagged its emerging market peers last year, stronger fundamentals have led to the country to fall back into favour with foreign investors.  Year-to-date, the MSCI India index is already up over 16% while the MSCI AC World index has returned less than 7% per cent in sterling terms. 
Even with high equity prices today, there is good reason to believe that the coming years will see strong continued growth coming from India.  The domestic market is enormous with huge potential.  Many local companies have longer-term time horizons (10-15 years in many cases) for how they want business to develop.  In comparison to the US or UK these time frames might seem like an eternity, but they have the advantage of putting less pressure on management teams and allowing better decisions to be taken which will enable consistent, longer-term growth.

I would expect India to be one of the stand out performers over the coming 5+ years, and would certainly recommend this sector as part of a balanced portfolio for investors.

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