Do you like sports? I am by no means an expert, but it feels that recently, emerging market countries are doing much better in sports than in addressing their economic difficulties. While it's great to see Argentina and South Africa doing well in football and rugby World Cup tournaments respectively, I fear that investors might need more goals to be scored in the economic arena in order to bring portfolio flows into these emerging market countries. Yet India seems to be one of the countries to buck the trend. Despite its recent loss in the Cricket World Cup, the country has done surprisingly well when it comes to coping with the economic and geopolitical uncertainties of today's world. We are constructive on Indian hard currency corporate debt and have a neutral stance on local currency debt, primarily driven by valuations.
In the last two years, 50% of global GDP growth came from emerging markets (“EM”). China accounted for none of that gain, while India was the single largest contributor, with GDP growth of 16%. Together with Indonesia, Mexico, Brazil and Poland, these five countries accounted for half of the total EM GDP growth during this period. I visited India a few weeks ago to explore the risks and opportunities in one of the world’s strongest growth economies.
What is the secret behind India’s success?
Following my recent visit to the country, I would attribute this to six key reasons:
First is demographics. India is the world’s most populous country, representing one-sixth of the total world population. While the rest of the world is experiencing labour shortages, India benefits from strong demographic dividends. With 70% of the population working and labour costs lower than China, India has offered solutions to countries facing recent work shortages by increasing its manufacturing to ease the supply chain or bridge the labour gap.
Second is the neighbourhood i.e. its proximity to the Middle East. The flight from Mumbai to Abu Dhabi is shorter than the one from Mumbai to Delhi, making India an attractive market to target in the eyes of its Middle Eastern neighbours. This, along with improved relationships with countries such as Saudi Arabia, UAE, Egypt and Israel, to name a few, has turned India into a new power in the Middle East.
Third is China’s decline, which has become India’s geopolitical dividend. India has benefited from the increased geopolitical tensions between China and the West by offering an alternative investment destination. China is moving from being more of a structural to a tactical allocation for investors’ portfolio flows, and direct investments are settling across the border, with businesses and manufacturing facilities relocating to India. International brands are increasing their presence, including in the retail sector, with Apple opening its first store in Mumbai earlier this year, and others set to follow. On the geopolitical front India has managed to successfully navigate and largely preserve its neutrality amidst global conflicts and maintain relative political stability, with presidential elections next year being viewed as a non-event.
Fourth is India’s focus on infrastructure. This investment has grown at a very fast pace, with the government tripling annual budget expenditure in the infrastructure sector in the last four years to 3% of GDP1,2. Indeed, the number of highways has doubled in the last 10 years, whilst the railway and shipping networks have also been beneficiaries of higher investment levels. Today, India’s projected investment in infrastructure as a percentage of GDP remains the fourth largest in the world after China, Indonesia and Australia. The U.S. pales in comparison, with only 1.5% of GDP investment in infrastructure, representing a 0.7% investment gap. India also enjoys a funding advantage, with 100% of its fiscal deficit being locally funded.
Fifth is India’s progress on the renewable energy front. India has the largest solar plant in the world (Bhadla Solar Park) and is on track to achieve COP27 targets3,4. With 8-9% annualised growth in electricity demand, the government is asking for a move towards a new hybrid model from its renewable energy producers, delivering both wind and solar energy to ensure uninterrupted energy supply. India’s non-fossil fuel capacity now accounts for 43% of the country’s total electricity capacity5. India is a good example of a country that has been able to decouple its economic growth from greenhouse gas emissions, with the latter dropping by 33% since 2009.
Last but not least is the country’s focus on improving regulations in the local asset management industry and facilitating foreigners’ access to India’s financial markets. Having experienced a number of crises in the past – the latest being in the Non-Bank Financial Institutions (NBFC) sector with the collapse of Infrastructure Leasing & Financial Services (IL&FS) in 2018 – Indian regulators are learning from their mistakes. Today the top 10-15 NBFCs are treated and regulated almost like banks, while transparency rules imposed by the regulator, Securities and Exchange Board of India (SEBI), on domestic asset managers are even more demanding than in the West. For example, I was surprised to learn that local asset managers are required to record every meeting they have from 9am until 5pm. More encouragingly, there is also a working group focusing on establishing a set of regulations to ease foreign access to the domestic market, ahead of India joining the government bond index, which is expected next year.
With so many tailwinds, what would prevent India from attracting even more capital? One of the challenges is current equity valuations. India is the second most expensive equity market in the world after the U.S. Despite only a modest increase in the policy rate in the global context (the central bank has raised the policy rate by 2.5% to 6.5%) corporates cite rate hikes as one of the key risks to their growth targets. Leverage levels are manageable on an aggregate basis, with public debt-to-GDP around 80% and private debt-to-GDP at 50%. However, in some sectors such as renewables, leverage levels are elevated amongst certain issuers, which could be a challenge when it comes to meeting future growth targets. Another challenge is structural inflation. The central bank has a flexible inflation-targeting regime, with growth being an important consideration, given a continued focus on reducing the poverty rate in the country. While the current inflation rate at sub 5% is well under control, the appetite to use a more hawkish monetary policy going forward might be limited, should the inflationary trend change. In 2022, China exports to the U.S. accounted for USD536 billion compared to India’s USD85 billion. If China’s decline in imports is more structural in nature, goods’ inflation could come under further pressure. For example, with the U.S. government blocking more than 1,000 shipments of solar energy components from China earlier this year, the demand for solar panels from India is likely to increase further. This has already translated into a 40% rise in model cost for solar panels this year, with further rises likely going forward. If this theme is more structural in nature, the pressure to keep the rates higher for longer across global central banks will affect not only India, but also other EM countries. From a bottom-up perspective, we also see select large scale businesses being challenged in India, namely the conglomerate Adani, given overinflated equity valuations, and mining giant Vedanta, given its overleverage. That said, we don’t see contagion risk to the domestic banking sector or asset management industry, given limited exposure to both names.
While these issues require monitoring, it's difficult to imagine a country that has done a better job than India in addressing structural and cyclical challenges over the last few years and, moreover, coming out stronger, despite additional strains surrounding Covid and heightened geopolitical risks. While India’s fixed income market is fairly valued at the moment, we would view any dislocations as an opportunity to add risk, given the constructive fundamental backdrop. As investors, we would also like to see more “elephants in the room” like India that could translate into future investment opportunities.
When the South African rugby team won the World Cup this year, the team said that it was a ‘vehicle for inspiration for the country’ and ‘showed what the country can look like’. Perhaps now is the time for EM leaders to also deliver reasons for optimism on the economic outlook and equally show a vision for what their economies can look like going forward.