Head of FX Strategy
Summary: India’s strong growth potential, along with the rising headwinds for the Chinese economy, has generated stronger investor interest but allocations from foreign investors are so far limited. We believe India’s strong demographics, large consumer base, a push to attract manufacturing and a powerful digital landscape could be some of the key cornerstones of the economic transition that could demand a dedicated strategic allocation in foreign portfolios.
India is now the fastest growing economy in the world, and the world’s fifth largest economy and likely to become the third largest in the next five years after overtaking Germany and Japan. Investors have however taken a generalist approach to India so far by including it in the “emerging market” allocation bucket. This has translated into large returns being missed by long-term investors.
Given the large and growing size of the Indian economy and the opportunities it provides for investments, there is a clear case for a dedicated mandate to India in foreign portfolios. We discuss below the key cornerstones of the Indian macro story that positions it to be strategically attractive in the long run.
India’s population has recently passed a long-awaited inflection point, overtaking China as the world’s most populous country. By midyear, the UN projects, there will be 1.428bn people in India, about 3mn more than in China.
India not just has the population momentum but also a growing working age population with the numbers skewing towards the younger population, with over half the population being under 30 years old. This is at a stark contrast to other, more developed, Asian countries that are seeing declines in working age population because of ageing population.
But the question around whether this population growth will be a dividend for India or a disaster is often raised, given the challenges around harnessing the skills of the young population. Steady investments in health and education will be needed to ensure that the young and rising population contributes to economic growth, instead of becoming a burden. Efforts are also needed to increase the participation of females in India’s labor force.
India needs to focus on investments in agriculture, so more and more population can move from farm jobs to urban jobs and increasing investments in infrastructure to enable faster urbanisation. This will help India to avoid the middle-income trap. Reforms on manufacturing and digitisation, as discussed below, suggest India’s population can come to its advantage in the years to come if steps like these continue.
Domestic consumption is a key pillar of India’s economy and a key contributor to GDP growth. The increasing population continues to signal tailwinds for consumer demand of goods and services, and with the expected increase in per capita income levels, the outlook for consumption is only getting better. Even with the lowest income per capita among the emerging markets, there are still about 70 million households (~300 million people) in the upper middle and high income brackets which still suggests a large consumer market.
A private researcher on India’s consumer economy, ICE360, estimates that total number of households in India can rise from 293mn in 2018 to 386mn in 2030, with more than 50% of the households (~200mn households, more than 700mn people) in the upper middle and high income segments. With that kind of size and scale, it is not difficult to expect that many global businesses will be looking to set up manufacturing in India, primarily to serve the domestic market.
Apple’s decision to manufacture iPhone 14 in India is partially a result of the US-China tensions but also serves to cater the growing domestic market. Apple is a huge test case for India, and if it is able to deliver the promised number of handsets, that will be enough of a push for many other global manufacturers to overcome the risks of a difficult business environment which has been a key obstacle for many years. India is also making its business environment competitive to attract more foreign investments. India has risen to the 52nd spot in EIU’s global business environment rankings, up from the 62nd spot five years ago and now ranks above China.
The deglobalization trend has ramped up since the Trump era, followed by the pandemic and Russian war. But ideally, self-sufficiency is still a stretched concept so even as the happy marriage between the West and the East comes to an end, there will be new alliances formed. That, precisely, was the theme of our Q2 quarterly outlook, The Fragmentation Game, and this game brings a lot of potential opportunities for Asia and particularly India.
As companies try to diversify their supply chains and move their production out of China – be it for geopolitical reasons or the high labor costs (as shown in the chart below) – they will be looking for places that offer cheap labor, manufacturing scale and domestic demand. India realizes that opportunity and has launched ambitious programs to attract global manufacturing, which includes corporate tax cuts, investment incentives and infrastructure spending. The government’s latest scheme to offer production linked incentives (PLI) to attract manufacturers is intended to offer $25bn in incentives over the next five years and generate an incremental output for $400bn with about 6 million additional jobs. The share of manufacturing in India’s GDP could increase from 15.6% currently to 21% by 2031, and, in the process, double India’s export market share.
India’s digital landscape has seen a vast turnaround in the last decade. A growing broadband penetration, with over 50% of the population now having access to internet, along with low data charges has helped deepen the push for technology. The initiative on India Stack, a comprehensive set of APIs that allows governments, businesses, startups and developers to utilize a unique digital infrastructure to offer identity, payment, healthcare and other services. This digital infrastructure is interoperable and “stacked” together — meaning that private companies can build apps integrated with state services to provide consumers with seamless access to everything from welfare payments to loan applications.
The scale and interconnectivity of India’s digital infrastructure is unmatched and provides scope to increase the formalization in the economy as well as deepen the financial inclusion. It also aims to improve business efficiency and create more jobs. A great example of that was CoWIN – a software application that helped mass rollout of COVID vaccines in India. By the end of December 2021, the platform had reached 900 million registered users and helped administer 130 million doses of the COVID-19 vaccine.
While it is still difficult to say that India can be the next China, but there is still a lot of room for India to grow economically and that itself commands a dedicated mandate for India in global portfolios. Investors follow the growth potential and had developed dedicated mandates to invest in China since the economy opened up its capital markets. Now, China is not just seeing slowing growth, but also increasing regulatory risk and geopolitical risk. So while China can still be a tactical play (due to the reopening demand) or a selective play (sectors like energy transition, chip technology), India is more of a structural play and deserves a dedicated mandate. As India’s economy transforms, it will be increasingly relevant for foreign investors in a similar way as China has been in the last several years.
The IMF expects India to see real GDP growth of 5.9% in 2023 and averaging more than 6% in the next five years. With inflation at 4-5%, that will translate into nominal growth of 10-11%. If India’s potential growth translates into corporate earnings and stock market returns, then an active investor can expect returns of ~15% in the medium-term.
In addition, adding India exposure brings diversification benefits to foreign portfolios, given its low level of correlations with broader global indices as shown in the table below.
The Saxo platform provides a range of ETFs to get exposure to the India growth story. In addition, our India Growth equity theme basket includes a list of stocks that are publicly listed in US or UK exchanges.
Investing in emerging market always brings risks and India has plenty. Some of these include a prolonged global recession, weak domestic reform progress, adverse geopolitical developments, lack of skilled labor, energy shortages and commodity volatility. Foreign investors have also often expressed concerns about weak corporate governance, and these risks were once again highlighted recently by the Adani crisis. But generally, this risk in investments can be minimized if one focuses on identifying companies with an independent board of directors, shareholder committees, accounting, and audit oversight and transparency into business practices. Lately, a lot of investors have also been concerned with India’s growing political and religious extremism which is eroding the country’s secular identity, but this has minimal implications on market returns. In essence, investing in India is a game of patience as the economy’s transformation journey is likely to be long-winded with bumps in the road.
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