Compared to a year and a half ago when the Indian economy was just beginning to reopen after a devastating delta variant surge, the Indian stock market is flat in dollar terms. And yet its weight in the MSCI Emerging Markets Index has climbed past Taiwan and South Korea to second place, with almost all of the gain at the expense of the index’s largest component: China.
Shares in the world’s second-largest economy have fallen by two-fifths since June 2021, thanks to Beijing’s isolationist Covid-19 policies, turbulence in the property sector and a tough anti-trust campaign against the country’s valuable tech companies. If China has sunk into an excess of pessimism, the opposite is true for India. Thanks to pent-up urban demand in the wake of the pandemic, stocks have held up reasonably well despite the Federal Reserve’s aggressive monetary tightening.
As a result, China’s share of the MSCI EM has fallen to 28% from 35% in May 2021, while India’s share has risen from 10% to 15%.
Will the current reopening of the Chinese economy put an end to India’s outperformance? That will be a question for global investors in 2023.
If other countries’ experiences are any guide, the shift from zero infections to community breakthroughs will be messy and potentially deadly for China’s elderly, only 40% of whom receive booster shots. However, a pivotal transition could help lift consumer and business sentiment from near record lows, wake the housing market from its slumber and accelerate auto sales. That could also prompt analysts to raise their forecast of 4% earnings growth over the next 12 months. Before the pandemic, those expectations were 17%.
In India, the pain of Covid-19 – and the gains from reopening – are both in the rear-view mirror. The economy is now losing momentum, although the market continues to foam. While some caution is baked into the estimates due to high inflation (affecting local consumer company margins) and a global slowdown (affecting software exporters), the consensus expectation is for earnings to rise 18% over the next 12 months will. Optimism is highest for banks. They benefit from higher business volumes as well as superior prices: Rising commodity prices have boosted demand for working capital loans, while rising interest rates have supported interest margins.
The case for a rotation away from Indian to Chinese stocks is already growing. BNP Paribas recently downgraded India from overweight to neutral, removing the country’s consumer staples stocks from its model portfolio and reducing exposure to software exporters. “Our tactical caution on India stems from the market’s sky-high relative valuations and the possibility of fund switches to North Asia as China reopens,” said Manishi Raychaudhuri, head of Asia research at BNP. Consensus opinion on India’s consumer-oriented stocks is likely to be overly optimistic, while the federal government’s budget — the last before the 2024 elections — could add additional volatility, he adds.
In the longer term, India is attempting to bolster its investment appeal by positioning itself as an alternative to China. With President Xi Jinping’s policies widening the divide with the West, Prime Minister Narendra Modi is proposing his country as a destination for multinationals to reduce their overexposure to Chinese supply chains.
There’s no guarantee the venture, backed by $24 billion in subsidies for manufacturers, will work. As Arvind Subramanian, economic adviser to the Modi government until 2018, and Josh Felman, a former International Monetary Fund representative in New Delhi, noted in a recent foreign affairs article: “India faces three major obstacles in its quest to ‘the Next’ to become China;’ Investment risks are too great, domestic policies too strong and macroeconomic imbalances too large.”
Other countries may also have a claim. Vietnam, which is more open to trade than India, is on track to oust the UK from this year’s list of the US’s top seven commodity trading partners. The Southeast Asian manufacturing powerhouse wasn’t even in the top 15 as of 2019. No matter how inviting New Delhi’s policies are on paper, there’s no certainty at all that they’ll be implemented impartially and not tweaked for the benefit of national champions – “the giant Indian conglomerates that the government has favored,” Subramanian and Felman said.
The firms controlled by Gautam Adani, India’s wealthiest businessman, alone have accounted for a third of the 33% rise in local currency since 2021 in the BSE 500, a broad index of the country’s largest companies. Throw in rival Mukesh Ambani’s telecoms-to-petrochemicals empire, and half of the profits are promised by the two richest tycoons.
So far, however, increasing wealth concentration seems to have worked well for local investors – they are neither too skeptical of their country’s fate nor too critical of its direction. That’s because their prosperity is also coupled to the same train of pro-capitalist politics. Four years ago, India’s largest firms generated combined pre-tax income of 7 trillion rupees ($85 billion), almost a third of which went to the treasury. Meanwhile, pre-tax profit has risen to Rs. 13 trillion, but the state’s share has fallen to about a quarter. The relative importance of indirect taxes – including on petroleum products – has increased.
It’s not a great outcome for India’s poor, who are hurt more than the rich by consumption taxes, especially in an inflationary environment. But to the extent that corporate tax burdens are light, the stock market is unlikely to question the lack of significant purchasing power beyond a tiny wealthy class. India’s wage-driven economy has become a for-profit enterprise and domestic investors seem to agree. In five years, India’s managed investments — life insurance, mutual funds, retirement accounts, hedge funds and portfolio services — have grown from 41% to 57% of gross domestic product, according to Crisil, a subsidiary of S&P Global Inc. As returns reach more smaller cities and towns, the need $1.6 trillion industry may not take long to catch up with $2 trillion in bank deposits.
With over $187 billion in net outflows, global investors’ retreat from China this year was far more brutal than the $17 billion they pulled out of India. With the reopening of China, they will inevitably invest more money in the People’s Republic. While some of these funds are at India’s expense, it is important to remember that a rapidly expanding pool of local institutional liquidity is undermining the influence of foreign fund managers. As long as India Inc. delivers decent earnings growth, foreigners will not be able to ignore a country where an increasingly muscular domestic investment class has come to worship profits.
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