20 Nov 2023
India is home to 17% of the world's population, but it accounts for only 3% of the world's GDP, presenting huge growth opportunities. As my Equity colleagues noted here, India might well be following China’s exponential growth trajectory.
For fixed income investors, structural complexities around foreign access to India’s local bond market have held back investment and index inclusion. Yet global investor interest in the country’s bonds has grown over recent years. While this is most likely a side effect of index-concentration concerns, Indian fixed income offers a lot more than portfolio diversification potential, in my view. And with Indian local bonds set to begin a phased inclusion into the primary EM local currency benchmark (GBI-EM Global Diversified Index) in June 2024 – in response to investor demand – now is a good time to explore this.
Challenges specific to this complex market necessitate careful analysis, and trips like this – meeting key policymakers, industry experts, political commentators, bankers and analysts – can provide valuable on-the-ground insights.
Mumbai is booming, with the push for government-led infrastructure investment in evidence across the city skyline. Yet the country had a somewhat less chaotic feel than in my previous visits. It was encouraging to see the prevalence of abject poverty significantly reduced, with wireless earbud-wearing road sweepers one anecdote that also pointed to modernisation within society.
Among India’s road users, there’s been a clear upgrading of automobile use, with 4 (rather than 2 and 3) wheelers much more prevalent and a surprising number of luxury brands in circulation, signalling that urban consumption is growing strongly. While I didn’t see much evidence of electric vehicle penetration or the required infrastructure, that’s likely to be a big theme over the next 10-20 years as the country forges its path to net-zero emissions.
India’s macroeconomic outlook remains solid - growth is impressive (currently around 6.5%), and my trip revealed optimism among officials around Q3 figures due to be released later this month. Various meetings also confirmed that credit growth continues to be robust and is likely to remain at strong levels. After suffering two big shocks of demonitisation (2016) and COVID, the Indian economy appears to have repaired itself to a large extent, thanks in no small part to key structural dynamics like the digitisation of the economy.
Inflation is currently running at 5%, with expectations for this to soften – although since my trip, a print of 4.9% was higher than some had hoped. Risks in the short term appear to be tilted to the upside given concerns among local experts on food prices, due to a poor monsoon season and weak rains.
Looking at external balances, the picture remains one of good health – the current account deficit should be well contained at 1.0-1.5%, and weak FDI inflows are seen by the administration largely as a global phenomenon, with rich market valuations also a factor. The overall balance of payments should be in surplus, allowing for reserve accumulation to continue. I came away with the impression that there is a strong desire to rebuild reserves towards the previous highs of c.US$640 billion versus c.US$585 billion currently. I don’t foresee much change in policy rates over the near term, with cuts unlikely until there is confidence in the 4% inflation target being met sustainably.
India’s fiscal balance is expected to hit the 5.9% target this year thanks to strong tax collections; expect to see some politically motivated fiscal measures at the next budget in February 2024 ahead of the April elections, but this is unlikely to derail the fiscal consolidation path too meaningfully, with the deficit set to fall to 4.5% in two years’ time.
While Prime Minister Modi has faced international criticism over his role in stoking division between segments of society, from an economic perspective, the governing body has enjoyed a very long honeymoon period. There is little doubt Modi will remain in power at the next general election in April 2024 to serve a third term, even if his party, the BJP, is unable to win an outright majority. Unemployment and inflation still need to be tackled over the next two-to-three years. It’s still too early to have serious discussions around who will be Modi’s successor as this does not seem to be a consideration with the BJP at present. The two potential successors touted currently are Amit Shah (Home Minister, largely seen as Modi’s right-hand man) and Yogi Adityanath (Chief Minister of Uttar Pradesh) – but there is time for more names to be considered in the future.
A top-down view suggests valuations are fairly lofty at present; we believe FX opportunities to be limited until policymakers allow more volatility in the currency. On the local rates side, two rate cuts are being priced into the market at time of writing, which we feel leaves room for a hawkish surprise to the market. That said, our corporate credit and equity colleagues see some exciting opportunities from a bottom-up perspective, especially in the green energy sector. Look out for more on this from my colleague Victoria Harling after her visit later this month.
Over the medium term, index inclusion will lead to further inflows into the economy, however we do not expect a meaningful impact on Indian asset prices given the size of the bond market and the fact that the central bank (and other local financial institutions) would be willing sellers. Similarly, we expect the currency impact to be limited as we believe the central bank will likely intervene if the rupee rallies.
Longer term, India represents an important market for fixed income investors. The positive growth outlook and structural dynamics are two important factors that could propel the EM Investment case on a long-term basis and shape the global economy in the coming years.
General risks. The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets are subject to change and may not necessarily be achieved, losses may be made. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.