Could India become the best-performing stock market of the next ten years?

The domestic structural shift of household savings into equities could drive a sustainable long-term rise in India’s stock market.

13D Research
13D Research

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The following article was originally published in “What I Learned This Week” on June 22, 2017. To learn more about 13D’s investment research, please visit our website.

In recent years, India has emerged as the world’s fastest-growing major economy. In our view, Modi’s reforms remain under-appreciated, and are a platform for accelerating economic and social growth. Modi’s recent state- election victories provide a strong mandate for further reforms. India’s expanding middle class, with rising discretionary spending, is also increasing domestic consumption. In addition to lowering the cost of doing business, the country’s expanding digital infrastructure is helping companies reach citizens in remote areas where physical infrastructure is inadequate. Finally, the domestic structural shift of household savings into equities could drive a sustainable long-term rise in India’s stock market.

India will still have to overcome challenges, including revamping its education system, creating jobs for millions of young Indians, resolving the nation’s bad loan issue, and reviving private sector investment. However, we believe that India is on the cusp of an economic and social revolution, which could result in domestic equities outperforming the rest of the world.

Demographic factors positioning India for accelerating growth are:

ƒIndia’s estimated domestic consumption growth of 12 percent y-o-y through 2025 is forecast at more than double the global average of 5 percent — poised to triple to $4 trillion by 2025 (See WILTW April 20, 2017). Rapid urbanization and expansion of India’s middle class is leading to higher disposable income. McKinsey estimates that India adds three times the population of Los Angeles to its urban populace every year. By 2025, 69 cities in India will each contain over 1 million people, while 49 large cities will account for over three-fourths of India’s economic growth.

Nearly 120 new cities in India are expected to match the current household income level of its major metropolitan areas by 2025. Economic output for several Indian cities will be close to that of middle- income nations (see chart).

India will have the largest middle class globally by 2027. Currently, only 5% (27 million) of the 519 million strong workforce is classified as “urban middle,” earning more than $11,000 per year. The chart below illustrates how India’s expanding middle class is driving growth in disposable income.

Cisco estimates that 829 million Indian citizens will use the internet by 2021 — rising nearly two-fold from 428 million at the end of last year. Internet penetration is rising faster in rural India than in urban centers, and the internet economy of India is expected to reach $250 billion by 2020 — double the current level.

India is rapidly emerging as a global innovation hub. More than one- third of the global top-1,000 companies by R&D expenditure have centers in India, and over half of Fortune 500 companies employ more than 10% of their global workforce in India. Additionally, nearly 28% of domiciled companies from Japan, the European Union and Asia Pacific have research centers in India. “Global customers looking for IT solutions came to India for cost savings, stayed for the quality, but will now continue the journey for innovation,” summarizes R. Chandrasekaran, Chairman of Industrial Body, NASSCOM.

Indian nationals represent only 6% of Silicon Valley’s population, but have founded 15% or more of its new startups. Indians also outrank other immigrant groups in the number of companies founded in: biosciences (35%); computers and communications (28%); innovation/manufacturing services (29%); semiconductors (32%); software (33%); environmental (39%); and defense/aerospace (29%).

However, a reverse brain drain could take hold, as Indian executives abroad realize superior opportunities at home. It is estimated that 80,000 Indians returned home for work in the past two years, including over 1,000 scientists of the 30 million total working offshore.

Modi’s recent key state-election victories following the currency ban highlight people’s trust in his development agenda. The victories position Modi well for the next general election in 2019, along with rising political capital in the Upper House of Parliament where he lacks a majority to carry out the politically-tough reforms.

Modi’s major policy initiatives already underway include:

ƒThe national biometric identity card. The government has completed the enrollment of nearly every citizen under the biometric identity card (AADHAAR) program. This database is being used to develop a national digital infrastructure platform called “India Stack” (See WILTW January 05, 2017). Last week, the government mandated the linking of bank accounts with AADHAAR, as well as for transactions of over 50,000 rupees. Biometric identity is now also mandated for income-tax-return filings. These steps will make it hard to carry out cash transactions and hide “black money.”

Delivery of social benefits directly to bank accounts linked with AADHAAR is saving money lost to middlemen. Currently, benefits for a total of 220 social programs are being transferred through this route with a target reach of 534 — including 300 cash programs. The government has already saved nearly 500 billion rupees ($7.8 billion) in three years from total transfers of 1.6 trillion rupees ($24.9 billion).

ƒThe implementation of the nationwide uniform “goods and services tax” will decrease paperwork and reduce compliance hurdles. Every transaction is required to be reported online using the government’s GST network — improving transparency and eliminating tax evasion (See WILTW August 11, 2016). The new tax code will levy goods at the point of consumption rather than production — eliminating 17 state, interstate and federal duties. It is certainly an enormous task to bring millions of businesses onto the new platform — however, the government is rolling it out on July 01, 2017.

Other reforms with potential for a long-term positive impact on the economy, include: 1) a bankruptcy law to protect lenders against willful defaulters; 2) demolishing the foreign investment promotion board (FIPB) to reduce excessive regulation; and 3) easing 87 foreign direct investment (FDI) rules across 21 sectors. FDI for the last three financial years totaled $114.4 billion—a 40% increase from $81.84 billion in the prior three fiscal years.

A structural shift of household savings into equities is helping propel Indian stock markets. A Morgan Stanley analysis concludes that domestic equity savings are on-track to rise by $525 billion over the next decade. The government is also taking steps to increase public-equity exposure.

For the first-time ever, India’s domestic investment outpaced foreign fund flow into equities for the twelve-months-ending May 2017. Equity mutual funds received $32 billion in the last three years versus a $31 billion inflow in the preceding 15 years.

Consistent investing through Systematic Investment Plans (SIPs) is ensuring regular inflows. Now, mutual funds receive over 42 billion rupees ($653.5 million) monthly through SIPs—nearly 50% of the total inflow into equity funds. This fund flow has remained consistent during recent periods of increased market volatility and sell-offs.

The domestic investor ecosystem is also reducing India’s reliance on foreign fund flows. Deutsche Bank estimates that Indians invested a record $31 billion in Indian equities during the last three years — exceeding the $21 billion invested by foreigners over the same period.

This article was originally published in “What I Learned This Week” on June 22, 2017. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.

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