Elections, growth and valuations: Your five minute guide to Indian equities

Next week (June 4th) will see the results of the Indian elections announced – with current prime minister Narendra Modi widely expected to stay in power for a third term.

With a process lasting more than six weeks, and with more than 970 million registered voters, elections in the country are dubbed “the world’s largest democracy”. To put this into context, the entire population of Europe is 741m.

Latest expectations from brokerage IIFL Securities indicate that Modi’s Bharatiya Janata Party (BJP) will win around 320 seats (up from 303 in the 2019 election) with a few more going to its allies (543 Lower House seats are divided up, with a 272-seat majority needed)*.

Modi’s policies have transformed India in the past decade. The numbers speak for themselves – at a time when growth has been challenging across the globe, GDP in India stood at 7.8% in 2023 and is projected to grow by 6.8% and 6.5% in 2024 and 2025 respectively**. Investors in Indian equities have seen returns to the tune of 216% since 2014, compare that to Chinese equities (the biggest player in the emerging markets space) where returns stood at just 63%***.

The International Monetary fund has predicted India is poised to overhaul the old economies of both Japan and Germany by 2027 to become the world’s third largest economy** – it replaced the UK as the fifth largest in 2022.

Many changes made, but far more to come post election

Modi has already made a series of policy changes covering banking, manufacturing, inflation management and an increased focus on physical and digital infrastructure, all of which have boosted the long-term growth potential of the economy.

But far more is expected to boost India’s long-term prospects. Ashoka India Equity Investment Trust portfolio product specialist and macroeconomist Dipojjal Saha cites the infrastructure story as a key element, citing the compound annual growth rate on capital expenditure standing at circa 20% since Modi came to power****.

He says: “90% of India’s railways are now electrified, compared to 30-40% previously. The number of airports has doubled, while the turnaround time at ports has improved rapidly. Previously, some 20m rural homes had access to tap water, now almost all of them have access.”

The second area bearing fruit is manufacturing, with India having already made strides in both the defence and technology space. The “Make In India” (MII) initiative has successfully lowered India’s reliance on imported goods. India’s government has cut corporate taxes for new manufacturing production and launched Production Linked Incentive (PLI) schemes across multiple sectors.

Goldman Sachs India Equity Portfolio manager Hiren Dasani says: “Progress has been made since MII was first introduced in areas like electronics given fast-growing domestic demand. Capex intensive industries—such as electric vehicles and semiconductors—may have to rely on global corporations as they develop due to a lack of raw materials domestically. Mobile phone supply chains have been shifting from China to Vietnam and India.”

The balance of pros and cons is still incredibly one-sided

The truth is that if you were to do a pros and cons for investing in India it would be heavily lopsided in favour of the former. Strong demographics, growth, few geopolitical concerns, strong corporate governance, and the growing online economy all come to mind. The trouble is, the investment world has spotted the trend, which brings us to the one negative – valuations. Indian equities historically trade at a 40% premium to other emerging markets but in April 2024 it was closer to 70-80%****.

Let’s take a look at a few reasons why India is likely to continue growing from here

1. Stability of governance and reforms

2024 is a year for democracy like no other. Elections will take place in a record 50 countries around the world, with more than 2 billion people heading to the polls to make their voices heard. Changes in governments can herald both welcome and unwelcome switch ups for citizens and investors. India is one of the most stable democracy’s in the developing world and the expected win for Modi should see a continuation of his pro-business stance and infrastructure spending.

Reform initiatives such as corporate tax reduction, the PLI scheme (Modi’s main industrial policy to boost manufacturing) and the infrastructure push are improving corporate efficiency. In addition, the country has stated ambitious renewable energy targets. Notable changes in Modi’s first two terms included the 2016 Goods and Services Tax implementation and the 2016 Insolvency and Bankruptcy Code – further opening the economy to foreign investors.

Professional investor? Read what 2024’s year of the election means for investors

2. Favourable demographics

Demographics are a long-term tailwind for India, with 50% of the population comprised of Millennials and Gen Z’s by 2030) and a growing middle class (the percentage of high and upper middle-income households in India is expected to rise from 26% in 2021 to 45% in 2030). In fact around one million people join the Indian workforce each month^.

3. Digital transformation

The rise of the digital economy should also bolster corporate returns. The digital economy is already responsible for 22% of India’s output. The roll out of 5G networks is a further catalyst, with the digital economy expected to expand six-fold to $1 trillion by 2030^^.

4. Taking advantage of China’s uncertainty

The move by many companies to a ‘China plus one’ manufacturing capacity, will support many EMs in the region, including India. For example, Apple products are now assembled in India, as the government demands to have manufacturing facilities in their country of sale – it is estimated to account for 50% of its manufacture by 2027^^^.

5. Valuation (yes valuations!) – are not as bad as many believe

While India is expensive versus other emerging markets – there are reasons. The growth has been justified given the likes of urbanisation, attractive demographics, and the rise of digitisation. By contrast, the likes of China and Korea do face demographic and corporate governance challenges.

But when you compare Indian equity valuations versus their own history it is a different story.

Dipojjal Saha says: “Valuations for the last 10 years in India have been 20.7x, it is currently around a P/E of 19.7x, so they are not stretched. It has also seen the highest earnings growth amongst its peers.”

Alquity India Subcontinent manager Mike Sell says while India’s P/E has re-rated over the past decade, due to Modi’s reforms, they are not stretched^^^^. He says: “India has a high P/E because of strong earnings growth over a number of years. The earning per share stand at 17%, giving it a price/earnings-to-growth (PEG) ratio of 1.3x. On a PEG basis India, is cheaper than the likes of Korea, Japan, Mexico and the UK.

“Countries like Korea, Taiwan and Thailand may have a lower PEG, but they are cyclical, not structural stories. India has multi-years of growth, not pockets of opportunity.”

Conclusion and funds to consider

India’s growth in the past decade has been phenomenal, but investors must remember the base this growth started from. With a population of over 1.4 billion people – consumption, infrastructure, urbanisation and digital expansion are still in the early stages – paving the way for a multi-decade growth story.

Beyond those funds already mentioned, investors may want to consider the UTI India Dynamic Equity fund, a multi-cap portfolio based on quality, growth and valuations. Those who may prefer exposure as part of a wider emerging markets portfolio may want to consider the likes of the GQG Partners Emerging Markets Equity or FSSA Global Emerging Markets Focus fund, which have 31% and 23% invested in the country respectively^^^^.

*Source: Businesstoday, 28 May 2024

**Source: IMF World Economic Outlook

***Source: FE Analytics, total returns in pounds sterling, from 28 May 2014 to 28 May 2024

****Source: Ashoka India Equity Investment Trust, April 2024

^ Source: Goldman Sachs, 10 April 2024

^^Source: Pictet Asset Management, September 2023

^^^Source: TechWire Asia, 20 January 2023

^^^^Source: fund factsheet, 30 April 2024