India’s Economic Expansion: Opportunities for EM Bond Investors

India’s exceptional growth has positioned it as a leader in the region. While growth has been largely driven by domestic investment and consumption, we anticipate net exports will join these drivers, reversing the trend of recent years (see chart) – and helping ensure that the country’s robust growth will be broad and continue to fire from all cylinders. India’s growth story is underpinned by a combination of policy reforms, global shifts, and pandemic-induced adaptations that will extend its longevity, in our view.

Several Key Drivers Are Contributing to India’s Growth

GDP Contributions

Source: Macrobond and Pinebridge Investments as of 31 March 2024.

What India has done right

We believe three idiosyncratic factors will continue to drive India’s robust economic expansion.

1) Structural reforms. Over the past decade, structural reforms have played a pivotal role in driving positive change. The government has adopted a disciplined fiscal policy with a focus on infrastructure spending. Notably, India boasts more roads and highways per 1,000 persons than China (at 5.13 km, versus China’s 3.6 km), as the chart shows. India also has more room for further road infrastructure projects than other major emerging market (EM) countries. For instance, Brazil has 9.29 km per 1,000 persons, while Mexico has 6.41 km and Poland has 11.6 km.

India Outstrips China in Roads and Highways Per Capita

Road/highway length per 1,000 persons (km)

Source: Macrobond. India as of year-end 2017, China as of year-end 2021.

Other key reforms include supply-side measures, the Goods and Services Tax (GST), the Production Linked Incentive (PLI) scheme, the Insolvency and Bankruptcy Code, and the Real Estate Regulation Authority. India has also made an impressive climb up the World Bank’s Ease of Doing Business Index, from 133rd in 2010 to 63rd in 2020.

2) China’s slowdown and supply chain shifts. China’s economic slowdown has accelerated the process of supply chain relocation. For instance, Apple started to move part of its assembly lines to India in 2017, and now nearly 14% of its iPhones are produced in India.1

3) Pandemic-driven changes. The Covid pandemic helped position India as a prime destination for multinational corporations (MNCs) that were relocating their back offices as they recognized that remote work was feasible, leading to significantly lower operational costs. Consequently, India’s IT service exports have surged, and according to ANSR, India now hosts more than half the world’s global capability centers (units providing global tech services, research and development, engineering, and IT support).2

Outpacing its peers in medium term, pent-up potential to unleash

Over the next decade, we expect continued annual growth rates of 6.5% or higher in India, and at this pace, the country would double its economy from $3.4 trillion in 2022 to $7.5 trillion by 2032. That growth trajectory would make India the third-largest economy in the world, overtaking Germany3, and would surpass the average for emerging markets and stand out as the fastest among BBB rated countries.

We believe several key factors will contribute to India’s growth story:

An FDI surge. Foreign direct investment (FDI) has been consistent over the past decade and accelerated during the pandemic. Three key sectors, in particular, are beneficiaries of the country’s ongoing FDI boom. First is India’s manufacturing sector, which is still in an early growth stage and is attracting continuous FDI. While India’s share of global goods exports is currently around 2% (versus China’s 14%), we believe India will grow as FDI brings productivity gains and expect continual expansion of the manufacturing sector. Second, the digital sector has received approximately 50% of FDI inflows, and roughly $130 billion (equivalent to 4% of GDP) has been invested in Indian tech start-ups over the past eight years. Lastly, financial services continue to see FDI inflows, and we expect this trend to continue.

A robust ESG agenda. India is committed to building green hydrogen production capacity, targeting at least 5 million metric tonnes. Electric vehicles (EVs) currently account for only 2% of total vehicle sales in India, lagging behind China’s 31% (as of first-quarter 2024), so we see strong potential in this sector. In addition, India’s renewable energy sector is growing rapidly, driven by ambitious government targets and favorable policies. As announced at COP26, the country aims to achieve 500 GW of non-fossil-fuel-based electricity generation capacity by 2030, from 170 GW currently.

Strong consumption potential. India’s young population and low urbanization rate, coupled with growing GDP per capita, signal further consumption potential. Approximately 26% of the population is aged 0-14 years, while 68% fall in the 15-64 age group and only 6% are 65 years and older. Although India’s household consumption expenditure of GDP is already slightly higher than the EM average (at 60% versus 58%), we think given the high birth rate, increasing GDP per capita, and significant urbanization potential (see chart), household consumption of GDP will continue to grow.

India’s Urban Population Has Ample Room to Grow

Urbanization Rate, %

Source: Macrobond and Pinebridge Investments as of year-end 2022.

Favorable demographics. India benefits from a young, largely English-speaking labor force. The median age of the population is just 28.2 years, compared to 39 years in China (see table). However, challenges remain. Although the government has been working to transform the education system – through policies including the National Education Policy (NEP) 2020, Sarva Shiksha Abhiyan (SSA), and Rashtriya Madhyamik Shiksha Abhiyan (RMSA) – further improvements are necessary, with more than 50% of Indian students still dropping out before secondary school.

India vs. China on Demographics, Labor Structure, and Other Key Metrics

Source: Macrobond as of year-end 2023 and World Bank Labor force participation rate table: https://genderdata.worldbank.org/en/indicator/sl-tlf-acti-zs?estimate=National

More reforms are needed

Notable outcomes of India’s reform agenda include its inclusion in the Global EM Bond Index (GBI EM Index) in late 2023 and the Bloomberg EM Local Currency Index in early 2024 – both promising steps toward opening India’s financial markets to global investors, leading to further investment.

However, despite significant wins, India still faces several challenges. While the nation has implemented a number of essential reforms, we will closely watch the progress of reforms in the areas noted below, as any significant delays would slow India’s growth momentum over the medium term.

Labor laws. India’s labor laws are often criticized for being restrictive and complex, potentially discouraging investment in the manufacturing sector. Simplifying these laws and introducing greater flexibility could attract more manufacturing business and stimulate job growth.

Education and skills development. Upskilling India’s workforce is crucial. This involves providing basic education and job training to prepare workers for roles in advanced manufacturing.

Ease of doing business. Improving the business environment in India is essential for boosting manufacturing. Streamlining bureaucratic processes, enhancing transparency, and reinforcing the rule of law can all contribute to this goal.

Environmental regulations. As global manufacturing trends shift toward sustainability, India must ensure that its environmental regulations promote ecofriendly practices without burdening manufacturers excessively.

Rating upgrade prospects

Given the improvement we expect in India’s macro fundamental picture, we anticipate that rating agencies will upgrade India’s credit rating from BBB- to BBB within the next two to three years. when and if this is achieved, we would expect India to continue its fiscal consolidation efforts: The FY2024-2025 budget arrived at 4.9%, which was short of the 5-5.1% expectation (versus 5.6% in FY2023-2024). The fiscal deficit is expected to gradually consolidate to below 4% in the next few years, which would reduce the government’s debt burden. In the meantime, substantial private sector investment and economic diversification are leading to higher value-added manufacturing and digital services, which in turn may lead to higher GDP per capita.

India’s secular growth story presents compelling opportunities for bond investors across both local and hard currency markets. Despite the initial surprise regarding the narrow margin of the Modi-led party’s win, we believe an NDA-led coalition government signals broad policy continuity.

Local currency market. We maintain a positive outlook on Indian government bonds (IGBs), which offer attractive yields with manageable currency risk as inflation trends downward. India’s inflation is sensitive to shifts in the weather and food prices, and we think headline inflation will converge to the central bank’s implicit inflation target of 4% in the first half of 2025. Although we saw a dovish hold in June’s monetary policy meeting, with a vote of four to two (with two voting for a rate cut), the RBI is expected to remain on hold until inflation eases into its target or the Federal Reserve starts its easing cycle, whichever comes first.

Hard currency market. While investment grade credit spreads have largely priced in India’s positive rating trajectory, we see selective opportunities in the higher-yielding segment. These include select corporates in the renewable energy, infrastructure, and technology, media, and telecommunications (TMT) sectors, which are well-positioned to benefit from the country’s robust economic expansion.

We continue to encourage a focus on careful bottom-up issuer selection and risk management to opportunistically tap into the most compelling assets as they emerge. We favor an approach that filters broader trends through the lens of targeted on-the-ground analysis of companies and sectors in India, with the aim of maximizing risk-adjusted return potential for investors.