- Indian equities are currently at an all-time high, as its economy bucks a global slowdown trend and brushes off pressures from higher rates, with the Reserve Bank of India choosing to pause rate hikes.
India is also emerging as a strong alternative to China, a major factor that is set to open doors for economic growth in areas such as manufacturing, assembly of goods and exports, which is set to be bolstered by the country’s burgeoning working population.
While India has a lot going for it, we see some challenges within. These include having twin deficits – fiscal and current account deficits that have the potential to destabilise its currency, low literacy rates which hinder labour productivity growth, and corporate governance/corruption issues.
Despite a constructive outlook, valuations for Indian equities are currently stretched. We see a limited upside potential of 7% over the next 2 years and maintain our 2.0 Stars “Not Attractive” rating on India. For investors who wish to seek exposure to Indian equities, we advocate investing via a regular savings plan.
As global powerhouses from China to Germany contend with slowing growth, the stakes are rising to find another country equipped to propel the global economy. India has emerged as a contender, with demographics especially on their side. Half of India’s population are under the age of 30, while China’s citizens are ageing rapidly with its population even shrinking in 2022 for the first time. Not to mention, one of the biggest structural drivers for India will come from its position as a key beneficiary of the relocation of supply-chains away from China.
Indian equities have delivered strong returns supported
by a stronger economy, but inflation is slowing creeping up
Indian equities are currently at an all-time high (Figure 1). The Sensex Index has gained 12.0% in INR terms year-to-date (as of 20 July 2023), as the Indian economy bucks a global slowdown trend and brushes off pressures from higher rates.
Figure 1: Sensex Index is at an all-time high
India's inflation outlook is relatively benign, with the headline CPI seemingly trending downwards. The slowdown in inflation in recent months have put it back in the 2-6% target band, and the Reserve Bank of India (RBI) is expected to try and anchor inflation close to the 4% mid-point of that band (Figure 2). With the slowdown in inflation from its highs, RBI has kept its accommodative stance, holding the repo rate at 6.5% for a second review in a row on 8 June 2023, after hiking 250 basis points since May 2022.
Figure 2: India inflation remains within the RBI inflation target range
However in June, India’s headline CPI rose, snapping four months of easing due to surging prices of vegetables, as inflation increased to 4.81% yoy after hitting a 25 month low in May. Such seasonal food spikes are not uncommon in India given that 50% of the summer crop depends on favourable rainfall during the monsoon season.
Going forward, India could experience below-normal rainfall, and severe droughts given the effects of El Nino, affecting crop performance and possibly fueling broader food price inflation. Though from past experiences, these price surges tend to correct themselves within a few months, but should it persist, the RBI would likely turn more hawkish.
Looking at the purchasing managers index (PMI) data for both Manufacturing and Services, it continues to remain in healthy expansionary territory, suggesting the resiliency of the Indian economy. In fact, the PMI has remained above the crucial 50-mark for two consecutive years now, with the latest data revealing a reading of 57.8 in June, a slight decrease from May's figure of 58.7 (Figure 3). Overall, India’s economy has been showing broad-based strength, with GDP expected to grow strongly (Figure 4).
Figure 3: India PMI data shows continued expansion in both Manufacturing and Services
Figure 4: India GDP figures and estimates
India benefits from secular growth opportunities
A key growth driver for India is its demographic. This is where India has a distinct advantage over other Asian economies. In fact, India has overtaken China as the world’s most populous country according to UN population estimates, with the Indian market being characterised by a large and young population, with half of the population being under the age of 30. This is promising as a higher working-age population increases labour supply, which is a key input into economic growth.
Moreover, the Indian middle class is rapidly expanding according to the World Economic Forum, nearly 80% of households in 2030 will be middle-income, increasing from roughly 50% in 2019, bringing with them increasing purchasing power that will fuel consumption.
Of late, one of the biggest structural drivers for India will come from its position as a key beneficiary of the relocation of supply-chains away from China. This is arisen mainly due to ongoing US-China tensions, and is set to open the doors for economic growth in areas including manufacturing, assembly of goods and exports.
Apple, for instance, has been shifting production away from China after the country's strict COVID-related restrictions disrupted the manufacturing of new iPhones and other devices in the country and also to avoid a big hit to its business from tensions between Beijing and Washington. India will be one of the biggest beneficiaries of this. In fact, India's trade minister has said that Apple, which begun iPhone assembly in the country in 2017 through Wistron Corp and later Foxconn, wants India to account for up to 25% of its production from about 5-7% currently.
More recently, Micron Technology announced that they will be investing up to USD 825 million in a new chip assembly and test facility in India. The US chip maker became the most high-profile name to commit investment in India to build a chip packaging plant shortly after the Chinese government barred it from national projects over alleged national security risks.
If we look at reforms, the reform momentum has also been fairly consistent over the last few years, with changes such as a reduction in corporate tax rates that were implemented in 2019 that was welcomed by investors.
Table 1: List of major reforms and secular domestic tailwinds
|
Reforms and secular domestic tailwinds |
|
|
Demographic dividend |
|
|
Growing middle class |
|
|
Supply-chain diversification |
|
|
Production-linked incentive scheme |
|
|
Reduced corporate tax |
|
|
Strong CAPEX push |
|
|
Source: Reuters, Bloomberg, iFAST Compilations |
|
India has huge potential, but watch out for key factors holding it back
While India’s economy clearly has a lot going for it, we note that it comes along with some challenges which may impede its further growth.
1) Growth momentum could be subdued by twin deficits
India economy runs a twin deficit, which refer to fiscal and current account deficits. While fiscal deficits can boost a sluggish economy via government's capital spending on infrastructure, long-term deficits can negatively impact economic growth and stability by increasing the cost of borrowing.
Table 2: India’s Union Budget figures
|
INR (billions) |
2021/22 |
2022/23 |
2023/24 |
|
Receipts: |
|||
|
Revenue receipts |
21,699 |
23,484 |
26,323 |
|
Capital receipts |
394 |
835 |
840 |
|
Total receipts |
22,093 |
24,319 |
27,163 |
|
Expenditures: |
|||
|
Revenue expenditure |
-32,009 |
-34,590 |
-35,021 |
|
Capital expenditure |
-5,929 |
-7,502 |
-10,010 |
|
Total expenditure |
-37,938 |
-41,872 |
-45,031 |
|
Fiscal deficit |
-15,845 |
-17,533 |
-17,868 |
|
% GDP |
-6.7% |
-6.4% |
-5.9% |
|
Source: Ministry of Finance India Data as of Feb 2023 |
|||
Meanwhile, a current account deficit also means more money is going out of a country for imports, investments, and services, than the money coming into the country. India historically has a chronic current account deficit (Figure 5), and moving ahead, a high commodity bill may likely widen the current account deficit, given our expectations that commodity prices will remain higher for longer.
Related article — Commodities are down but not out. Here’s why the bull market is far from over.
This will put a downward pressure on the rupee as the demand for dollars from importers increases. Moreover, the Indian Rupee is traditionally one of the more energy-sensitive currencies, given its high reliance on imported energy. A weaker rupee will further accentuate the risk of imported inflation.
Figure 5: India’s current account deficit
Figure 6: Indian rupee depreciation against the dollar
2) Low literacy rates hinders labour productivity growth
Another factor holding India back is that of low literacy rates, which impacts productivity growth. India’s literacy remains at 74%, with almost 26% of India’s population lacking any formal education, and this pales in comparison to global literacy rates of 86.3%. Women account for a large share of the illiterate in India, and this contributes to the reality that just 19% of women participate in the workforce. There are many socio-cultural factors behind this trend of low participation of women, making the dynamics of the labour market in India challenging.
Closing the gap between men and women could expand India’s GDP by more than 30% by 2050, according to estimates by Bloomberg Economics. Given the low literacy rates in India, there is a need to expand access to education, and focus on human capital and productivity growth in the long-run. India would also have to find a niche in order to move higher up the value chain of manufacturing, and the failure to do so would hold back India’s economic growth.
3) Corporate governance and corruption are issues to watch out for
The recent Adani scandal highlights many corporate governance issues, and caused a storm within the Indian equity market as Adani Group’s companies sold off dramatically, dragging Indian equity indices, such as the Sensex Index and the Nifty 50 Index along with it. While India’s equity markets subsequently recovered, investor confidence was likely shaken. Moreover, while corporate governance issues affect countries globally, what is different about the Adani case was that it was highly political given the close ties between Adani and Prime Minister Narendra Modi. More of such incidents would severely reduce investor confidence in India’s equity markets and political system.
Growth potential of Indian equities hindered by steep valuations
Indian equities are expensive relative to its peers (Figure 7), and are currently trading above its average historical forward PE (Figure 8). Applying our designated fair PE ratio of 19.0X for the Sensex Index, we project a limited upside potential of about 7.0% by 2025. Thus, in spite of a rather constructive macroeconomic outlook, we believe much of the positives has been baked into equity prices.
Figure 7: Indian equities are more expensive relative to Asia ex-Japan equities
Figure 8: Sensex index forward PE over the years
All in all, the road for India to become a global powerhouse is not without challenges. While we acknowledge the strong secular growth opportunities in India, which is an attractive trait amongst emerging markets, we are hesitant to pay a big premium for it. We continue to maintain Indian equities’ Star Rating at 2.0 Stars “Not Attractive”. Nevertheless, investors who wish to seek exposure to Indian equities can opt to do so via a regular savings plan, aligning their investment horizon with the nation’s long-term economic potential.
Related article: Is this EM powerhouse cheap to enter after the recent rout?
Related article — India: Downgrading one of the best-performing equity market of 2021
Table 3: Earnings growth for Indian equities
|
India (Sensex Index) |
FY22 |
FY23E |
FY24E |
FY25E |
|
PE ratio (X) |
24.4 |
23.9 |
20.7 |
17.8 |
|
Projected earnings growth (YoY %) |
30.3% |
12.0% |
15.4% |
16.0% |
|
Projected Earnings Per Share (EPS) |
2,528 |
2,831 |
3,267 |
3,790 |
|
Target price (19.0X Fair PE ratio) |
- |
- |
- |
72,010 |
|
Potential upside (%) |
- |
- |
- |
6.7% |
|
Source: Bloomberg Finance L.P., iFAST estimates. Data as of 20 July 2023 |
||||
Table 4: Recommended products
|
ETF |
Unit Trusts |
|
|
India |
iShares MSCI India ETF (BATS:INDA) |
|
Figure 9: Earnings forecast and price performance of the Sensex Index
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