By Kim Catechis, Investment Strategist, Franklin Templeton Institute
The world’s fifth largest economy appears to be facing an unprecedented window of opportunity. International investors are asking: Is this the new China?
India is great, there is a new one the population and the government has implemented various “business-friendly” reforms. But it is still classified as a “low-income country” by the World Bank. The investment case for India rests on the assumption that it will make the move to “upper middle income” relatively easily, implying doubling its gross domestic product (‘GDP’) per capita to over US$4,466.1
Such a move would be remarkable and underlines the potential that India’s exciting technology, software and communications sectors present. The growth of the middle class has predictable positive impacts on all aspects of the consumer, housing and related sectors.
To implement these changes and to unlock this potential, we believe India needs to put in place a combination of long-term oriented policies to address structural constraints and execute short-term, pragmatic infrastructure investments. The main principle should be to establish the conditions to support growth, with a unified approach, covering employment, education, investment in infrastructure and climate change insulation.
Trade is a major potential driver of economic growth and employment. According to the World Trade Organization (‘WTO’), which India joined in 1995, the average import tariff applied by the most favored nation (‘MFN’) was 18.1% in 2022, the fourth highest in the Organization World Trade Organization (‘WTO’), after Sudan (21%), Tunisia (19%) and Algeria (18.9%).2 For reference, the European Union is at 5.1% and the United States is at 3.3%. For agricultural imports, India’s equivalent tariff is 39.6%. The pace of development can be further accelerated and expanded in more sectors by joining free trade agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which include waiving domestic protection but provide market access in 11 countries representing 15.6% of world GDP. In our view, there is a window of opportunity for India to turbocharge its economic development and enable it to meaningfully integrate with the global trading system and “punch its geopolitical weight” in Asia and the world.
India’s young demographics are usually presented as positive, but the reality is more complex. Having lots of young people is definitely good, but they need to be healthy enough to work and educated enough to learn the right skills for the job market. India does not need millions of Ph.D.s, but a pool of relatively well-educated young people because they are more easily employable. Given the trend towards automation and artificial intelligence (it), the growth of the “knowledge” economy drives the demand for skilled workers. A young and well-educated workforce will attract investment in high-margin manufacturing areas, providing a positive boost to economic growth.
The country’s climate change vulnerabilities and their potential impact on the social fabric are not particularly well known. India uses over 90% of its fresh water in agriculture. 3 This is clearly inefficient, because the global average is 70%, but millions of farmers still depend on monsoon rains, which have become less regular as heat waves have become more frequent over the past 20 years. Meanwhile, the Indus, Brahmaputra and Ganges river basins are among the most water-stressed river basins in the world, according to a European Commission study.4 This is due to a combination of lower volumes of seasonal meltwater from the Hindu Kush Himalayan region due to the negative impact of climate change, population growth in Pakistan, India and Bangladesh straining existing water resources and the threat of diversion of water from China. .
Valuations of the Indian stock market suggest that investors have high confidence in the likelihood of earnings growth, but also reflect bearishness, as company controllers/promoters tend to hold roughly 50% ownership in public companies. Despite this, middle-income households have only 10% of assets in mutual funds or capital market investments, implying a potential wave of domestic investors in the future.5 Another important factor is that some sectors in India, such as fast-moving consumer goods companies, offer margins that are significantly wider than global averages. Meanwhile, the development of the domestic fixed income market bodes well for deeper funding availability for both government and corporates.
Typically, international investors are attracted to fast-growing economies on the premise that these markets hold more promise for equity investors. However, experience suggests that it is unusual for capital returns to match nominal GDP growth over time. In the chart below, while Chinese GDP growth averaged 8.65% per year over the past 30 years, the average total stock market return has been +0.7%. In contrast, India has had GDP growth of 6.5% per annum, yet the capital market has delivered an average total return of 9.4% over the same period.6
GDP vs. Stock Market Returns over 30 years
India remains an interesting place to invest, but in a more defined range of opportunities than in the past. For asset owners, we believe that India is not the new China. It is potentially a new India.
WHAT ARE THE RISKS?
All investments involve risks, including the possible loss of principal.
Equity securities are subject to price fluctuations and potential loss of principal.
International investments are subject to particular risks, including currency fluctuations and social, economic and political uncertainties, which may increase volatility. These risks are magnified in emerging markets. Investments in companies in a particular country or region may experience greater volatility than those that are more geographically diverse.
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1. Source: World Bank, Country classifications by income level for 2024. 30 June 2023.
2. World Trade Organization, (‘WTO’) World Tariff Profiles 2023. Data as of 2022.
3. Source: Food and Agriculture Organization of the United Nations (FAO) Aquastat Database.
4. Source: “An innovative approach to hydro-political risk assessment: a clear, data-based spatial indicator for hydro-political issues-2018”, F. Farinosi, C. Giupponi, A. Reynaud, G. Ceccherini, C. Carmona-Moreno, A. De Roo, D. Gonzalez-Sanchez, G. Bidoglio. European Commission. As of June 2020.
5. Source: CRISISL. “The Big Change in Funding.” December 2022.
6. Past performance is not an indication or guarantee of future results.
Editor’s note: The bullet points for this article were selected by Alpha’s research editors.