Indian Equities: The Rewards of Resilience

• As one of the fastest-growing economies globally, India is set to capitalize on positive GDP projections by the International Monetary Fund (IMF) and the Asian Development Bank (ADB) due to its rising capacity utilization, given healthy consumption supported by robust credit growth.

• With solid foundations in place and structural changes in progress, India is experiencing improving banking sector health, accelerating credit growth for large non-banking financial companies (NBFCs), and rising household credit relative to GDP – all of which should provide a tailwind for domestic companies.

• Given the combination of India's economic differentiators, investors can access a host of potential opportunities for equities exposure, including India as an outsourcing hub, as well as various aspects of the acceleration of the digital economy.

Emerging markets (EMs) have increasingly stood out for their resilience at the precise time that rising interest rates, inflation, and volatility are creating a drag on growth in developed markets. This reflects the gradual evolution and diversification of EM economies over the past decade – away from their traditional drivers of manufacturing, commodities, and low-cost exports and toward domestic consumption, technology, and services.

India is one of the biggest beneficiaries of this shift. The country’s growth trajectory is the envy of large economies around the world: For example, in its World Economic Outlook in April, the IMF projected India’s GDP to grow 5.9% and 6.3% in 2023 and 2024, respectively.1

These outcomes look achievable given rising capacity utilization due to healthy consumption, supported by robust credit growth. Even during Covid, India’s domestic economy grew 5.6% annualized in nominal terms in US dollars, from US$2.85 trillion in December 2019 to US$3.35 trillion by the end of last year.

The global researchers are equally positive about India’s prospects. In its recent Asian Development Outlook, Asian Development Bank (ADB) forecasts faster growth in investment in fiscal 2024 in India, thanks to supportive government policies and a sound macroeconomic backdrop, along with lower non-performing loans in banks and significant corporate deleveraging that will enhance lending.2

With these foundations in place and structural changes in progress, opportunities are likely to arise from India’s positioning as an outsourcing hub, as well as from the steep acceleration of its digital economy.

Building on sound fundamentals

Against an uncertain global economic backdrop, India stands tall today with its sound and robust macroeconomic fundamentals. The economy has come a long way from the era of “taper tantrums,” when it was featured as one of the “fragile five” nations, to now being a flagbearer of resilience amid global turmoil. India’s markets and economy have seen multiple cycles and weathered more storms than they likely anticipated, some unprecedented.

Among India’s sound fundamental indicators, today credit growth for banks is accelerating at a pace never seen before. Credit growth is at a whopping 15% year-over-year as of March 2023, compared with 6.8% in September 2021. This has been supported by a robust financial structure in India. Indian banks are already seeing improved financials, and now better profitability will enable them to lend more to companies and individuals. In turn, this should aid capital formation and investments in the bid to boost economic growth.

Asset quality and capital adequacy have been improving over the last few quarters, even after the withdrawal of Covid-related relief measures. Large NBFCs have also reported an increase in their assets under management (AUM), based on strong demand for retail loans and higher working capital requirements. Further, the Reserve Bank of India (RBI) has addressed regulatory gaps relating to areas such as digital lending and climate finance.

At the same time, a relatively low level of credit penetration within Indian households (compared with other countries) offers another promising sign. As urbanization increases, and data on personal finances becomes more organized with increasing bank accessibility, household credit-to-GDP ratios should rise. This will likely provide a tailwind for consumer-focused companies.

Meanwhile, the ADB’s April 2023 outlook also pinpointed improving labor market conditions and consumer confidence as factors expected to fuel private consumption.3

Honing in on India’s hotspots

A key string to India’s economic bow has been its role in the global value chain. In recent years, it has demonstrated its strength as one of the largest exporters globally of IT and business process outsourcing, with these services accounting for US$157 billion in 2021-2022.4

Today, with international businesses keen to adopt technology at a global scale, India is well-placed to become a technology and innovation hub. Already, global corporations are leveraging Indian technology talent through their capability centers, which employ around 5 million people.5

This aligns with the growth in the country’s digital economy – which, in absolute US dollar terms, was 15.6% from 2014 to 2019, 2.4 times faster than the growth of the overall Indian economy.

Investment in digital infrastructure has been a critical driver, reinforced by the government’s Digital India program. This aims to establish better connectivity between citizens and the government via e-services and to deliver government services in a cost-effective and transparent manner. With this level of support, India has the potential to gain a significant competitive advantage globally.

The overall approach to digitization fueling this investment opportunity is also unique compared with the rest of the world. Rather than create platforms akin to global household names, such as Apple, Google, Facebook, and Twitter, India developed open protocols where each individual can openly communicate and all data is freely available.

One such example is Aadhaar, a 12-digit individual identification number which serves as a proof of identity and address for residents. This has helped millions of citizens to open a bank account with ease.

UPI, an instant real-time payment system, is another beneficiary of the open protocol system. The interface facilitates inter-bank, peer-to-peer, and person-to-merchant transactions. This also reflects the government’s commitment to expand digital transactions in the domestic economy, and thereby enhances the quality and strength of the financial sector.

Advances in digital payments are also spurring the growth of fintech firms in India. According to a mid-2022 report by PhonePe and Boston Consulting Group, for instance, the digital payment market will more than triple by 2026, from US$3 trillion to US$10 trillion.6

Looking beyond the benchmark

Ultimately, there is no shortage of interest in investing in India. The AUM of the domestic mutual fund industry has grown fivefold in a span of 10 years, while institutional equity flows have been strong onshore and stable from foreign accounts.

There is certainly scope to grow these allocations. For example, data from MSCI shows that while India’s GDP weighting within EM countries has been in the double-digits since the early 2000s, India is highly underrepresented in terms of its weighting in the MSCI EM Index – at a mere 8%. India’s representation in the index has not increased proportionately with the consistent growth in its GDP weighting.

In addition, not all Indian stocks – including some of the largest ones – are included in major benchmark indices.

Further, with exposure typically skewed toward the largest and most liquid stocks, the niche players that most likely form the bedrock of India’s long-term economic prosperity seem to have been side-lined. As a result, many investors have missed the opportunity to allocate to India over recent years.

It’s not too late to change this. To boost their local equity exposure, investors should look to selectively tap into those sectors with good long-term growth opportunities.