BRIC by BRIC: India
India fared well in the global slowdown. Last year, GDP grew by 5.6%1, well ahead of anything seen in the developed world. The stockmarket rewarded this show of strength with an impressive 81% return over the year2. What does India have that other markets don’t? And does it have what it takes to become the great world power that the BRICs acronym suggests?
FROM ZERO TO HERO
India has come a long way in a short time. It was only 1991 when it had to go cap in hand to the World Bank and the International Monetary Fund because a balance of payments crisis threatened the rupee and almost bankrupted the country. The reforms put in place then, in return for international help, have led to financial stability, deregulation and an entrepreneurial culture that has created a seemingly unstoppable competitive dynamic, with impressive consequences for the fortunes of the country.
For much of the past decade, India has ranked among the fastest growing economies in the world and has been propelled to become the fourth-largest economy in the world. GDP is forecast to expand by 7.7% this year1. To put that in context, it is estimated the eurozone will muster just a 1.0% expansion, with the US expected to grow by 2.7%1.
To flourish in this way, an economy needs some advantages. A strong legal system gives investors faith that they will receive a fair deal – physical and intellectual property rights will be respected. Pro-business governments provide the building blocks to growth. But more than that,
there are three key advantages underpinning the future growth of India:
-Favourable demographics -A skilled workforce -An expanding middle class
India’s 1.1 billion people are young. About 30% of them are under 15. Almost 65% are in the 15-64 years old bracket3. The end result is that the dependency ratio for India is low compared to other countries. Europe especially must face up to its ageing population, Japan likewise. Even the ‘one child’ policy in China risks its future potential – China must get rich before it gets old if it is to keep up its current pace of development.
India, meanwhile, enjoys the vast majority of its population either in, or soon to enter, the age where they will be most productive and consume most. A study in 2007 estimated that, according to demographic trends, over 100 million people will enter the Indian labour force by 20204. With more people in the economy working to support fewer older people, that bodes well for discretionary consumer spending – giving an important boost to domestic demand.
A SKILLED WORKFORCE
The other population advantage is that it is highly skilled in comparison to other emerging markets.
With fluency in English being one of the most common of those skills, this explains why so many companies have outsourced functions to India. There has been a successful reallocation of resources from low-productivity agriculture to high productivity industry and services. India’s large number of scientists, engineers, lawyers and financial managers are helping high value industries succeed and are attracting foreign investment into the country.
Foreign investors are attracted by the simple fact that it is generally cheaper to employ a skilled worker in India than it is to employ a similarly qualified person in the west.
Industry is increasingly becoming an important growth driver for the economy. More than 25% of GDP now comes from industry, while a mighty 58% is generated in the services sector5. But a quarter of services are directly linked to industry, in sectors such as trade, transport, electricity and construction. Agriculture may employ more than half of the population but it accounts for just a little over 15% of GDP5.
AN EXPANDING MIDDLE CLASS
National productivity has improved significantly already but, although India is the fourth-largest economy, GDP per capita is still just $31,005. On that measure, India ranks a lowly 164th in the world. However, better educational standards have improved the incomes of the average Indian.
A middle class has emerged in India that is set to boost – and alter – consumption patterns within the country.
If you assume that Indian consumption patterns will mirror those in the west as Indians become wealthier, the potential for consumer goods companies is huge. Few Indians have what richer countries would consider essentials: a car, TV, a PC, a mobile phone etc. Demand for consumer durables should therefore rise significantly as aspirations are more readily met as affordability increases. Innovations such as the Tata Nano car are already bringing goods that were previously beyond the reach of the average Indian worker to a much broader spectrum of buyers.
The first hypermarkets and discount stores only opened in 2001 but the emergence of an urbanised middle class has seen the Indian retail sector transformed. Organised retail still has only a 10% market share – but it was just 3% of the market five years ago6. There is still much more growth to come. Buying into companies serving the growing retail demands of the Indian population is a simple way to tap into India’s economic development.
BUILDING A NEW INDIA
A consequence of rapid economic development is invariably the growth in urbanisation that takes place at the same time. Goldman Sachs estimate that a further 140 million rural dwellers will move to the city by 20207. With the migration of the population to the cities comes new demand for housing and infrastructure. The process of building that is already apparent to anyone visiting the country.
Much of the economic stimulus applied last year was directed towards this. New roads are being laid. The utility infrastructure is being upgraded (or put in place for the first time). Slums are being cleared and replaced with new housing. As we just discussed, shopping malls have arrived.
Real-estate plays and construction companies will be the obvious beneficiaries as the young and better-off population looks to improve its living standards and quality of life.
THE RISKS FROM HOME AND ABROAD
It all sounds like the perfect investment story. And yet India’s stockmarket is still prone to bouts of high volatility. The reason for this lies in its correlation to the markets of the rest of the world.
Today, the greatest risk investors face in India is not that its economic advance may be derailed but instead, that a weaker economic picture in the west may see risk appetite wane, with a consequent slowdown in capital flows to India. As successful as it may be, India still relies heavily upon foreign investment flows to fund its balance sheet.
If the west enters a second down-wave, it is likely that we will again see assets repatriated, taking capital away from India’s economy. That capital is needed to fund a sizeable deficit. The stimulus required to see India through the economic downturn came at a cost. The fiscal deficit is forecast to be almost 10% of GDP this year8, including spending in all the local states as well as central government expenditure. In the context of a fast-growing economy like India, that is less of a threat than it is to the debt-burdened economies of the west, but it is nonetheless undesirable over the longer term and India’s government must take steps to balance its budget.
PUTTING A VALUE ON INDIA’S GROWTH POTENTIAL
After the surge in India’s stockmarket last year, it is obviously not as cheap as it once was.
Nevertheless, the market is still trading around the level typically seen around mid-way through the economic cycle. The market is aware of the risk from the west and so may be volatile in the months ahead as greater clarity about the state of the western economies emerges.
Meanwhile, earnings are improving. Earnings growth was dented by the global slowdown but is turning around and is forecast to return to more normal levels. In the years preceding the crisis, earnings growth averaged over 20% per annum9.
It is, however, worth bearing in mind that history shows that the market multiple tends to decline when interest rates rise. Interest rates, like in so many other parts of the world, are likely to increase sometime in the not-too-distant future. Inflationary pressures are building in the Indian economy and the Reserve Bank of India is likely to be forced into action to combat these. The last time that the RBI changed its monetary stance to raise rates was 2004. Then, like today, the growth environment was very strong and the multiple decline was short lived. Investors may be justified in assuming a similar outcome this year.
An investment in India is not without risk. However, with risk comes reward and the long-term structural drivers of India’s growth look very rewarding indeed. Other emerging markets may be driven by similar investment themes but few of these alternatives can back up their claims with the demographic advantages that India brings to the table.
Change is taking place among the people of India and investors can still buy into this story at the early stages of development and at still attractive valuations, when the longer term perspective is considered.
India has come a long way already but there is much further to go. The elephant is picking up its pace again. It’s on the verge of breaking into a run. When that happens, you might not see it for dust.
This is a guest post from Tom Stevenson, Investment Director at Fidelity International. It is the fourth in a series of articles in a BRIC by BRIC mini-series, produced exclusively for BrilliantWithMoney and Informed Choice.
Past performance is not a guide to what might happen in the future. Please note the value of investments can go down as well as up so you may get less than you invested. Investments in small and emerging markets can be more volatile than other developed markets and changes in currency exchange rates may affect the value of an investment. The ideas and conclusions in Tom Stevenson’s article are his own and do not necessarily reflect the views of Fidelity’s portfolio managers. They are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.
1. IMF World Economic Outlook Update, January 2010
2. Datastream, 31 December 2009
3. CIA World Factbook
4. Goldman Sachs, January 2007
5. CIA World Factbook
6. CLSA, June 2009
7. Goldman Sachs, January 2007
8. Financial Times, 2 March 2010
9. CLSA, February 2010