In a very challenging year for global equity markets, the MSCI India is only down 1.9% year-to-date (ytd) (end Sep’22). MSCI Asia-ex-Japan is down -29% while the S&P500 is down -25%. Likewise, in the forex world, the Indian rupee (INR) is only down -9% ytd vs. the US Dollar (USD), making it among the better-performing currencies this year. The common questions that we always get are: i) why are Indian markets behaving like they are Teflon-coated?; and ii) does above-average valuations suggest that MSCI India is vulnerable to an upcoming selldown? The short answer is that we believe India market will hold up for at least the next six months. That said, we are watchful of its trade deficit, slowing growth and uneven pressures for the consumer. India cannot be insulated from a prolonged global contraction and flight to USD, though so far, a combination of factors have made India earnings (and Indian equity markets) rather resilient vis-à-vis many weakening economies across the world.
In this piece, we explore three key reasons as to why India has held up better relative to its peers.
1.Domestic-driven market. We live in a world where free trade is increasingly restricted, one where conflict has made energy, food and a variety of other commodity inputs scarce. Governments are trying to secure resources domestically. The new status quo is one of restricted traded and disjointed supply chains which make for additional inflation pressures and fading exports engines. In such times, several factors could be advantageous:
i) Having a large, domestic markets with limited global integration.
ii) Having liquid capital markets with a high degree of monetary sovereignty to prevent currency-driven whipsaws.
iii) Domestic access to a wide range of resources to limit inflation. India is one such market with the aforementioned factors.
Inflation insulation. India’s CPI is at 7%, vs. World’s inflation at 9.7%. US CPI is at 8.2%, while EU is at 10.2%. It is a topsy-turvy world where developed economies are the new developing economies. Historically, India has always seen high inflation. In fact, India’s inflation went as high as 12% in the past decade, so while the average consumer is getting pinched, there is no blood on the streets. In fact, consumption, especially discretionary consumption (fast food, shoes, paints, houses, travel, credit card spends, cars) is actually doing very well, reflecting a rather common K-shaped recovery seen in many economies. When one digs further to understand why there are no street protests and civil unrest, we point to two things. First, India has capped energy prices at the pump by forcing government-owned oil companies to bear losses. To add to that, India also does not turn away Russian gas despite western sanctions. Therefore, rising energy prices does not exact such a heavy toll consequent. Second, India is self-sufficient in food. As fertilizer is a priority sector in which the government channels cheap domestic energy and provides subsidies, India is partially insulated from rising food prices.
Figure 1: India CPI Inflation (%) (Consumer Price Index) – Left,
India WPI Inflation (%) (Wholesale Price Index) – Right
Source: Bloomberg, Kotak, Institutional Equities
2. Structural drivers in place, as stars align. The structural reason to be optimistic on India is the potential birth of a middle class. India always has had a young population, a cheap workforce but consumption never quite took off. It took twenty years for India’s GDP per capita to increase by 4.5x, to US$2000 (2020). In the same period (2000-2020), China’s GDP per capita went up by 11x to US$10,500. The difference was the ability to transition the masses from farm jobs to factory jobs. There are real parallels to draw from India now to China in the 1990s. China became the superpower it is today by being the manufacturing factory of the world in the 1990s, leveled up income levels and birthed economic multipliers. So why did India not take the same path of progress? First, intra-State regulations were too difficult to navigate to attract Foreign Direct Investments (FDIs). Second, infrastructure was lacking and logistics reliability was poor. The Modi government has resolved a good part of these deficiencies in the past decade. Goods and Services Tax (GST) has made movement of goods across States easier. Shortage of power infrastructure has been tackled. A new dedicated rail line for freight is now up and running, guaranteeing better predictability of logistics timings. Tax benefits have been rolled out to encourage the shift of manufacturing supply chain to China.
All these alone might not have been enough if we were still living in a trade-friendly world; China could still be the factory in the world. It is difficult to cajole supply chains to shift, once they are laid down. US-China trade wars and Covid lockdowns in China have encouraged MNCs to look for alternative manufacturing locations outside of China. While China remains the center of gravity, where should one base an alternative manufacturing footprint, when ‘just-in-case’ considerations trumps ‘Just-in-time’? The oft-used term is the “China-plus-one” manufacturing strategy; India comes into consideration as it has rectified some of its ills (logistics, bureaucratic regulations). India’s ambitions to grow a manufacturing sector received another boost in 2022, when European-based manufacturers started to look for another alternative manufacturing location outside of Europe. The Russia-Ukraine war meant energy was scarce. EU-based companies turned wary of industrial shutdowns this winter, adding to challenges to supply chains; India’s attraction as an alternative manufacturing hub drew more interest. The new term increasingly mentioned in the investment world is now “Europe-plus-one.”
If India manages to attract a manufacturing sector, it is not unreasonable to expect a similar trajectory of China’s 1990-2020 GDP per-capita trend, taking place in India.
Figure 2: Historically, India has not been an exports powerhouse
India’s share of world exports is just 1.7% vs its higher 2.9% contribution to world GDP. Pandemic saw Indian exports outperform global export growth
Source: BofA Global Research, DGFT, Bloomberg
Figure 3: India Merchandise exports (US$bn)
Long term, govt’s merchandise exports target of US$1 tn is quite ambitious: Implies 15% CAGR growth till FY28 vs 9% CAGR current 5-yr run rate
Source: BofA Global Research, DGFT, Bloomberg
3. Banking sector standing at the threshold of a capex cycle, all cleaned up. System credit growth data, banks’ guidance and third-party loan sourcing data, all point to momentum in business activities. Credit demand is very strong and broad-based. It is not driven just by infrastructure building, consumption or property demand. System credit growth has moved up to ~16%, from the 7-10% growth levels during pandemic. The demand drivers are varied. The capex cycle merely explains a small part of the loan growth. The bigger drivers are personal loans, non-banking financial company (NBFC) and micro, small & medium enterprises (MSME) loans. It reflects a broadening of financial penetration down the consumer strata. It reflects both the increased appetite for credit (rising average loan quantum) and a greater willingness to lend by the financial institutions. You may ask – why so?
(A) Greater appetite to borrow. Anecdotes from the ground suggest a few factors weigh in. 1) “You-only-live-once” (YOLO) attitude. India had two waves of rather severe Covid. Being able to survive through Covid changed the attitude that lifestyle upgrade is more important to savings. Also, people spent a lot of time at home during Covid, spurring the want to upgrade. Demand for bigger homes and home upgrades have all picked up. Consumption of more aspirational class of products have also noticeably grown; 2) A younger workforce is getting added to the workforce as a few trends converge. One is the IT boom driving up the salaried workforce among the young. Another is the digitalisation of India resulting in all sorts of logistics, startups, trading-related jobs.
(B) Greater willingness to lend. The last six years saw the Indian banking sector navigate various crises. There was demonetisation in 2016, followed by GST, the NBFC crisis, and Covid. Lenders initially did not have the confidence to lend, but with the outlook looking better now and borrowers having survived through the challenges, the willingness to lend has clearly improved. Lenders also tell us that the increased availability of data (credit bureau, personal data tracking, business cashflow tracking, GST) also adds the confidence to lend.
Figure 4: Bank loan growth contribution by sector; a return of large corporate leveraging up, and lending NBFCs could propel growth higher, personal loans retained its momentum
Source: RBI, Nomura research
Valuations & Risks. The relative outperformance of India vis-à-vis global equity markets this year, reflects the above factors. A strong rally since June, reflects growing expectations of peaking inflation, a correction in commodity prices and decent earnings visibility in India. Headline valuations look rich but implies clarity of some growth in CY23. It reflects investors’ mindset that, in a world of extreme skewness and fat tails, clarity is more valuable than the ability to deliver short-term outperformance. India’s EPS growth is not driven by commodity prices, nor exports. It is driven by its own domestic consumption element, while plausibly having an added bonus of the addition of some element of export earnings further out. On valuations, forward CY23 PER of 16x look reasonable against a trading band of 11-19x PER. Investors are paying up for the greater visibility of earnings growth, in a world of earnings risk. Key risks to India would be:
i) High, sustained global energy prices.
ii) Persistent balance of payments deficit and trade deficits.
iii) An inability to get the India consumer on the road of rising GDP per capita – the road that China embarked on since the 1990s.
Figure 5: Key indicators of the Rift-50 index
Nifty-50 Index P/E, P/B (Left), EV/EBITDA and earnings yields (Right)
Source: Bloomberg, Kotak Institutional Equities estimates
Figure 6: Valuation summary of global indices, calendar year-ends, 2021-23E
(a) Data for India is as per KIE estimates
(b) 2021 coloumn refers FY2022 for India. For other countries, numbers are CY basis.
Source: Bloomberg, Kotak Institutional Equites
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