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Incredible India? How stock investors can ride the tiger

Anthony Fensom  |  27 Sep 2017Text size  Decrease  Increase  |  
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India's transformation from one of the "fragile five" to an economic powerhouse has started capturing the attention of investors. But can so-called "Incredible India" deliver?

 

The latest economic data has revealed that the path to prosperity is rarely smooth. India's GDP growth slowed to 5.7 per cent in the April-June quarter, well below market expectations for a 6.5 per cent gain, amid slowing manufacturing activity and business investment.

ANZ Research described the underlying growth momentum as "weak" ahead of the implementation of India's new goods and services tax (GST) in July.

"We don't anticipate a revival in investment any time soon amid the twin balance sheet problems of an over-leveraged corporate sector and a stressed banking sector. Further impact will arise from [the] scaling down of capital spending by the state governments to accommodate farm loan waivers," the bank's economists said in a 31 August report.

The Australian bank expects the Reserve Bank of India (RBI) to cut its policy repo rate by 25 basis points in October to boost growth, which it sees slipping to 6.2 per cent in fiscal 2018 compared to its earlier forecast of 7.3 per cent.

Capital Economics sees India's GDP increasing by 6.3 per cent this year, rising to 6.5 per cent for the next two years. However, the International Monetary Fund projects a more bullish expansion, from 7.2 per cent GDP growth in 2017 to 7.7 per cent next year.

Although currently the world's seventh-largest economy, India's per capita GDP for 2016 was estimated at just US$6,600 in purchasing power parity terms, with challenges including corruption, poverty, inadequate infrastructure, border security, and overpopulation in a nation with nearly 1.3 billion citizens.

Just four years ago, India was seen as particularly vulnerable during the "taper tantrum" to rising US interest rates, given the South Asian nation's then large current account and fiscal deficits, high inflation, and increasing capital outflows.

Yet the sweeping election victory in 2014 of Indian Prime Minister Nardenra Modi's Bharatiya Janata Party (BJP), which delivered the first single party majority in 30 years, has seen a raft of economic reforms, boosting investor confidence.

Since Modi's victory, Indian stocks have risen by around 45 per cent, while foreign direct investment inflows have surged, hitting a record high US$60 billion in fiscal 2017.

"India's narrative has changed, as the country has embarked on a path of fiscal consolidation, the current account deficit is at manageable levels, inflation and inflation expectations are running low, and the [RBI] has cut rates by a cumulative 175 basis points since early 2015. Consumption levels and penetration rates of toothpaste, cosmetics, steel, cement, cars, and mortgages are at low levels, even in comparison to other emerging markets," Nikko Asset Management (Nikko AM) portfolio manager, Anuja Munde, said in an August report.

"Combine this with one of the largest and youngest populations in the world, and it is easy to see India as one of the great investment destinations among emerging and developed markets."

Economic reforms

Munde said she had been "pleasantly surprised" by the economic reforms implemented by Modi, who came to power with a burden of massive expectations in the world's largest democracy. She highlighted significant reforms including the new GST, individual identification through the Aadhaar system, and demonetisation.

The GST's introduction has facilitated an overhaul of India's indirect tax regime, which has been plagued with multiple layers of taxes imposed by federal, state, and local authorities. Significantly, the GST is predicted to increase GDP by up to 2 per cent, improving business efficiency, reducing evasion, and broadening the tax base.

"Indian businesses are known to find legislative gaps, but with the GST it's hard to do so. There's a large segment that have never paid taxes ... and once they start paying, that will help lower the fiscal deficit and improve the government's balance sheet, giving it extra funds to spend on productive purposes," Munde said.

The Aadhaar system has been another key reform, giving millions of Indians access to the financial system for the first time, along with direct government benefits. Previously, some 100 million households did not have a bank account, while government subsidies for lower-income groups suffered from misappropriation and corruption.

As of March 2017, more than 1.1 billion Aadhaar numbers had been issued, helping eliminate fake identities and reducing leakages in government benefits, while saving the government an estimated 250 billion Indian rupees ($4.8 billion) a year.

Demonetisation has been another key government weapon in the battle against the shadow economy, making cash-based corruption far more difficult. While it could crimp growth in the short term, Munde sees long-term benefits from a higher GDP, increased tax payments and lower demand for real assets such as gold and real estate, leading to increased financial savings.

Munde suggested further reforms should focus on addressing an over-leveraged corporate and banking sector, along with rationalising public sector enterprises and antiquated labour laws.

Overall though, "the current set of reforms have already started to gain traction. India has improved on most macroeconomic parameters; we are especially impressed with the growth-inflation mix, fiscal prudence, and positive real rates".

Structural growth

Nikko AM considers India to offer Asia's best structural economic growth profile over the medium to longer term, with earnings growth also improving over the next few years.

Munde pointed to both the consumer and financial sectors, with the former benefitting from structural growth in per capita consumption, and the latter from an interest rate tailwind.

The benchmark S&P BSE Sensex Index has risen by more than 20 per cent in 2017, making it one of Asia's best performers--including the Australian bourse, which has virtually stood still this year.

For Australian investors, a range of funds are available that are either focused on Indian stocks or include them among their Asian or emerging market offerings.

These include the India-focused Fidelity India [13314] and India Avenue Equity [41512] funds, while the iShares MSCI BRIC ETF (ASX: IBK) covers India among the BRIC nations. The Nikko AM New Asia Fund [13432] had around 15 per cent of its investments in India as of August 2017, including IndusInd Bank.

With India forecast to become the world's third-largest economy by 2030, diversifying into the emerging powerhouse could prove profitable for years to come.

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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