How to invest in India’s dazzling economy

India, the world’s third-largest economy, offers some interesting alternatives that are more significant than they may seem. For instance, ‘two-wheeler’ registrations, which include scooters and motorbikes, are finally back to 2019 levels after climbing steadily in the past year, as per Goldman Sachs data. 

This data feeds into a consumer index that also includes domestic air travel and petrol consumption. All of these metrics are pointing to growing consumption and a changing country, in which the number of people in the middle class is soaring and even lower earners have far more access to education, healthcare and finance. 

“At the simplest level, India is both a low-cost manufacturing location and a rapidly developing source of demand. Perhaps more significantly, India is also home to true centres of innovation in a number of fields,” said analysts at investment bank Bernstein last month. 

Tech companies and manufacturers have announced billions in new investments in recent months, with some looking to India as a new factory hub complete with lower political risk than in China. 

This is reflected in the country’s most-tracked index, the BSE Sensex, which includes major banks HDFC (IN:HDFCBANK) and ICICI (IN:ICICIBANK), conglomerate Reliance Industries (IN:RELIANCE), Infosys (IN:INFY) and Tata Consultancy Services (IN:TCS). 

The index is up 20 per cent over the past year, and trades on a forward price/earnings ratio of 23 times. By contrast, a similarly inward-focused index closer to home, Germany’s Dax 30, trades on just under 12 times. However, investors and analysts argue there is more to come from India, especially if the government opens up the country and stock market for more inward investment. 

Conventional economic indicators also point to the country’s growth: the annualised increase in gross domestic product (GDP) since 2014 is 6 per cent. The country also overtook China in terms of population last year. A more important number than the 1.4bn or so people in either country is the average age – India’s is 10 years below China’s, where the mean is 38.

There remains a gulf in the size of the two economies, of course, with India’s GDP less than a quarter of China’s. But there are comparators that make India more attractive for outside investors, not least the lower reliance on government cash for growth and a labour force unhindered by China’s decades of throttled birth rates. 

Hargreaves Lansdown founder Peter Hargreaves is heavily invested in the country, ranking his exposure to India behind only the UK and US within his portfolio. “Last year was extremely good [for returns], but I’m still very keen,” he told Investors’ Chronicle. “I don’t think this is a one-, two- or three-year story; this is a long, long story.” 

Hargreaves waxes lyrical about the entrepreneurial spirit in the country. “Companies are very very keen [to invest there] – Indians have always been great businessmen,” he says, adding that education levels and young population add to the investment case. 

Economists at Barclays put it in drier terms, but mentioned similar attributes in a report last year, noting that the country has “clean balance sheets, private-sector dynamism, a geopolitical backdrop that favours manufacturing capacity build-up, and a young population in an ageing world”.

For UK investors, there are two aspects to this growth story: backing companies that are exposed to India, and investing in Indian companies. The latter is harder than buying into a European or North American stock, however, meaning that funds and investment trusts are the most sensible option.

 

Recent history 

India is the fastest-growing major emerging market. Capital Economics sees growth of over 6 per cent in 2024, ahead of China and rapidly expanding countries such as Indonesia and Taiwan. This is below the 8 per cent seen in the early 2000s, but a sharp rebound from pre-pandemic levels.

While government investment has climbed, expansion is not being carried by a mad rush of stimulus. Economists at Barclays say Prime Minister Narendra Modi’s administration has “prioritised macro stability with a focus on inflation, as opposed to a spend-and-grow approach”. That stability means keeping a lid on fiscal and current account deficits. 

“We are seeing broad-based economic growth, which is funnelling into earnings growth,” says Murali Yerram, portfolio manager on Franklin Templeton’s emerging markets equity team. He also highlights the rising participation of local investors in the market. 

Government spending is critical to this story. But instead of funnelling debt into big projects to hit growth numbers – see China – it is putting new tax money to good use. Modi, now in office for almost a decade, has significantly increased the tax take through bringing in a goods and services tax (GST) that ranges from 5 per cent to 28 per cent. 

This has been in place since 2017, albeit it initially had little overall impact on government coffers because it replaced multiple taxes at the state and federal level. Since 2020, collections have “grown steadily”, according to Bernstein analysts. “We are currently seeing 24 successive months of collections of over 1tn rupees (£9.4bn) and 16 successive months of collections of over 1.4tn rupees,” they said in December. 

Also significant for government coffers and the broader financial system are the Jan Dhan banking reforms, which have seen almost 500mn new bank accounts opened. Over half of the account holders are women, helping boost the proportion of adults with a bank account from 35 per cent in 2011 to almost 77 per cent in 2021.  

For a sense of the scope of government spending, consider Bernstein estimates regarding the daily rate of road construction: they think this has risen from 14km a day in 2012 to 38km in the current financial year, which runs to March 2024. The goal is to hit 60km. Spending has also been targeted at airports and ports – turnaround time at ports has gone from five days in 2011 to two days. That infrastructure growth has got suppliers to the country excited. 

BHP (BHP) boss Mike Henry talked up India demand at the company’s 2023 results presentation, while Rio Tinto (RIO) has also floated the country as a growing source of iron ore demand that could balance out a weaker China. “Economic development in India and Asean [will help provide] the backbone for increasing future commodity demand,” said Rio economics and markets head Vivek Thulpule last month, putting growth in the region alongside decarbonisation and supply chain security as “pivotal forces” impacting metals demand. 

But India is a different proposition to China, which buys coking coal and iron ore in huge quantities. India mines its own iron ore but needs coking coal. Bank of Montreal forecasts that Indian imports will rise from 68mn tonnes last year to 80mn tonnes by 2026. 

 

Outlook 

There is one major question this year – the election. Modi is running for a third time and is very likely to be re-elected in the vote, which runs from April to May. Franklin Templeton’s Yerram predicts there will be a slowdown in government spending in future even with Modi still in office. This is partly down to the annual tax take not climbing as much as it has in recent years.

But the OECD says growth would continue as “fiscal consolidation… will increase financial space for the private sector”. And any drop in spending will be from a high level: Yerram notes government capital spending is forecast to reach over $100bn (£78.5bn) for the first time this year. 

He also points to corporate balance strength supporting greater spending. “The top 100 companies in India have generated free cash flow of $30bn to $40bn in each of the last three years,” he says.  “We are expecting GDP growth to be strong, which means demand is going to be strong. So they’re going to increase capacity as well.” 

Where that private spending is going is also notable: Bernstein says of the 4.6tn rupees-worth of projects in the next four years, 37 per cent will go to semiconductors, 20 per cent to solar cell manufacturing and 10 per cent each to automotive and lithium-ion batteries. 

The equity outlook is reflective of that spending. “Market performance (represented by the Nifty 50 Index) over the past two years has been positive, but it has lagged cumulative earnings growth of 31 per cent,” Franklin Templeton said last month. “We believe 2024 could witness a re-rating of the market if there is increased acceptance among foreign investors that India’s growth is structural as opposed to cyclical.” 

Economists at Barclays, meanwhile, say the election could prove a “turning point”.

“The more proactive push to increase manufacturing, with friend-shoring, clean corporate and financial balance sheets, better control over inflation, a sophisticated digital footprint and a large infrastructure build-out, should provide an additional stimulus to the economy.”

 

The middle class

As a young, growing country, there is plenty to like about India’s long-term prospects. But demographics alone cannot make a place investable. Nigeria has long been held up as a country with a young population ripe for added investment, but returns have not emerged. By contrast, elderly Japan had a very good 2023. 

The combination of a growing population with growing wealth is what makes India compelling for outside companies. Consumer goods manufacturer Haleon (HLN) is seeing double-digit growth from India and 2 per cent growth from developed markets, as one example. 

The huge build-out of the domestic air travel sector shows the world is already looking to feed rising middle class demand. Air India and challenger airline IndiGo have 750 planes coming from Airbus and Boeing in the next decade. IndiGo’s 500-aircraft deal with Airbus was the largest purchase on record. 

Some of this spending power can be tracked back to government reforms: the boss of Mercedes India, Santosh Iyer, told the BBC last month that bringing more earnings into the light has had reverberations across the economy. For him, it means more people have access to financing for luxury car leases or purchases. “Post GST, and demonetisation, a lot of money is now declared as income, which also means consumers are able to apply for loans,” he said. “There was a bit of resistance in the past and now that’s not the case.” 

Beyond buying more Western luxury goods – which Indians are doing at greater clip than ever before – India, via companies such as Infosys and Tata, is selling its tech expertise to the rest of the world. Call centres this is not. “Its strong services sector accounts for almost half of total exports,” say analysts at Bernstein. “Its strength in the IT sector can shape the world in the AI transition.” 

That call centre industry is still important, but broad levels of tech expertise (the highest number of engineering graduates globally) combined with cheap data and workers means innovation. This is what Hargreaves likes about the country. “India has some fantastic tech companies,” he said. “The people of India are becoming digitised.” 

 

China 2.0? 

Massive infrastructure expansion, a booming middle class and growing local high-tech manufacturing all sound familiar. The India/China comparisons have come thick and fast in recent years, particularly after India took the population crown in 2023. India’s GDP per capita is where China’s was 20 years ago as growth began to accelerate, and the government has similarly shown it will do business with just about anyone. Russian oil imports remained high last year, making up one-third of demand in the country. 

But there are differences, not least because much of China’s growth came from higher levels of government cash and cheap exports. Even with its own tax-fuelled spending, India’s total investment is around 30 per cent of GDP. The figure for China has hit 45 per cent at times this century. 

“India may not match the pace of China during its capex spree, but given the more sustainable cycle, capex is likely to last longer,” say Bernstein analysts. They also point out that India has closer ties and trade relationships with Europe and North America, meaning reverse engineering tech from major players, as China has been forced to do lately, is not on the cards. 

Investors have marked this difference as well. GQG Partners runs an emerging markets fund [GQG Emerging Markets Equity Fund (IE00BDGV0K75)] that is heavily exposed to India. “Only a decade ago, India was labelled as one of the ‘fragile five’ emerging market economies, while China was seen as the globe’s growth engine,” said GQG chief investment officer Rajin Jain last year. “However, we are finally seeing the contrast between the two nations play out in real time and, in our view, it is quite striking.” 

He added that India’s debt/GDP ratio, at less than half that of China’s, and the higher return on equity (ROE) for Indian companies underline the country’s “higher quality” in business terms.  

But China is a richer country, and will remain so for some time. The so-called demographic dividend is also worth considering. Barclays economists said last year one challenge for India “remains around utilising the labour force in the next decade.”. The labour force participation rate is around 51 per cent, compared with China’s 76 per cent. Additionally, it is still a heavily male workforce. Female participation has “consistently fallen” for 20 years, Barclays said, and a turnaround could push economic growth higher. 

 

The three Cs  

Risks for investors include conglomerates, corruption and climate change. The illiberal tendencies of Modi’s government will also rule the country out for some investors. 

The conglomerate risk is largely linked to the huge variety of businesses within these companies, and the management of them. 

There are two conglomerates in the top 10 of the Nifty 50 index, meaning funds or ETFs are likely to have some exposure. Yerram says valuing and running these conglomerates is “very difficult”, adding: “the current valuations are definitely on the higher side”.

The structure of the Adani Group came under scrutiny in early 2023 after short-seller Hindenburg Research alleged secretive corporate structures were used to mask ownership stakes in various Adani companies held by Gautam Adani and those close to him.  Adani has denied the claims and earlier this month celebrated a court decision putting a short deadline on various investigations by India’s regulator. 

Reliance Industries, an even larger conglomerate, is also controlled by one man who last year put his three children on the board. This kind of family arrangement is common in Europe and North America in private businesses, but rare for listed companies. 

The other side of the coin is that Reliance’s Jio mobile phone network has 450mn customers – more than Vodafone’s 300mn globally – and Adani owns infrastructure that should become more important as energy demand rises and the middle class grows. Yerram says the push into green energy by Reliance is also important for India as a whole. 

Reliance could build as much as a third of the country’s solar capacity target of 280 megawatts (MW) by 2030. “Reliance is building a fully integrated end-to-end renewables energy ecosystem for customers through solar, batteries and hydrogen,” Bernstein analysts said. “No other energy company is investing across the entire new energy value chain, but if Reliance can pull this off, the value creation and earnings potential will be substantial.” Bernstein has a buy rating on Reliance and says its new energy business could bring in $13bn in sales by 2030, from nothing at all currently. The company posted $119bn in total sales in FY2023. 

Climate change is a huge risk for India. It is still a highly agrarian society and already sees regular periods of extreme heat and drought. “The fight against environmental degradation and climate change requires huge investments and behavioural changes,” the OECD notes. 

Alongside China, India remains a significant user of coal power plants. The shift to renewables has started, but it will be decades before coal is phased out. Last year was forecast to be a record in terms of consumption, as per the International Energy Agency (IEA), and this demand is set to keep climbing at least for a few more years. On top of the climate impact, the cost of coal power is set to keep climbing as mining slows down. New capacity is still being built to hit electricity needs as well.  

Corruption, like climate change, is another big issue. Modi has made cutting corruption a goal, and digitisation of the economy has helped. Bernstein reckons “there hasn’t been much development in changing the image” of India on this front, however, nine years into Modi’s government. 

The country has scored around 40 on Transparency International’s corruption perception index for a decade. This is ahead of Argentina and Brazil on 38 (the higher the number, the lower the corruption) but behind the likes of Senegal and South Africa. 

 

Buying in

For investors willing to wear these risks, the question is how to gain access to the country.  

Aside from dedicated funds, UK-listed companies are exposed to India to varying degrees, but we would steer clear of those pitching a single project or plan in India as the path to high returns. 

The country has changed since the Indian arm of Capricorn Energy, then Cairn Energy, was effectively expropriated in 2014, kicking off a lengthy legal battle, but a smoother landscape does not always mean investment success. Saeitta (SED), an Aim-listed electric motor manufacturer, successfully opened a joint venture unit on the outskirts of Delhi last year but has seen its share price crash. Still, this is more a junior stock issue than an India issue, and its potential market for light electric vehicle motors in the country is enormous. 

The happy medium is perhaps what tech giants are doing: shifting manufacturing capacity to India, as a hedge on US/China relations getting worse. Hunting (HTG) has done the same, opening a piping finishing plant a few hours away from Mumbai last year, in a 49-per-cent-owned joint venture. 

Hunting chief executive Jim Johnson says the company was able to benefit from the “Make In India” plan set up by Modi in 2014 to boost local energy output, reducing its dependence on China in the process. “We’ve already had some significant business [there],” he says. “It’s going to be a home run for us in the next couple of years.” Or hitting a six, in more India-friendly terms.