Reasons for optimism about Indian equities

In our view, global equity investors may do well to consider Indian equities. Despite criticisms that Indian equities trade at higher valuations today than they have historically, we believe that they have the potential to help drive total returns over time.

The longstanding view of India’s investment potential is that the nation presents a long runway for growth. Below, we summarize three recent developments and identify how, in our view, they’re creating a favorable backdrop for security selection by generating an environment that helps investors assign more conviction to companies’ future cash flows (Figure 1). 

Figure 1

Ongoing momentum in economic reform

A key reason India has outperformed over the last 30 years, in our view, is its uninterrupted journey of economic reforms. Over this time, there have been no fewer than seven different governments that have ruled India. These have included political parties of all hues, from communists to full-blown capitalists and everything in between. Importantly, however, economic reforms have not stopped.

• Reform momentum might have been slow at some times and fast at others, but there have been no reversals. In the last nine years in particular, the country has had a very stable government under Prime Minister Modi that has accelerated the pace of reform, increased the role of the private sector in India’s economy, and incentivized manufacturing. This should allow privatization and consolidation to continue across many industries, enhancing corporate profitability.
• It seems very likely to us that Mr. Modi will be come back to power in the 2024 elections for five more years. Such an outcome would give India a stable government under a single party and one leader for 15 continuous years. A third mandate like this would be unparalleled in our world today, but it would ensure policy continuity — providing Indian companies a stable macro backdrop to keep generating shareholder value.  
  

The case for innovation in India

A second reason we believe India will continue to outperform over the next decade and more is the “India digital stack.” This is a unique set of digital public goods India has created. No other country has done anything similar at such scale. We believe this will be a game changer for India. 

• The digital stack helps identify 1.4 billion unique Indians, transfer money to their bank accounts, disburse social security benefits, enable peer-to-peer transfers, authenticate transactions, facilitate lending, store and organize health and education records, and so on. The digital stack has reduced friction — i.e., improved productivity — in the daily lives of millions of Indians.
  
• The digital footprint of these activities is enormous. We believe India’s world-leading, knowledge-based industries can further leverage such data by deploying artificial intelligence and machine-learning algorithms to come up with future use cases.
• On the ground, we see entrepreneurs tapping into the digital stack to create unique use cases that the original designers never dreamed of when they were building it more than a decade ago. Such examples include hyper-local delivery, online ticketing for travel, and other consumer services. 

Confidence in the future brings about a reduction in equity risk premium

Finally, in our view, a significant reason why India has and will continue to sustain its premium over other markets is the reduction in equity risk premium that has happened under the current government. Such a reduction in risk premium allows our team to have more confidence in future cash flows and discount them at lower rates. The contributing factors fall into three main categories:

1. “Loss of capital risk,” or lack thereof – India has avoided inducing any permanent capital loss on foreign equity holders at the hands of the government. In contrast, various other EMs, such as Russia, Turkey, and several sectors in China, have seen a dramatic de-rating because of such permanent capital losses. India has emerged as a relatively “safer haven” and equity investors have opted to allocate more capital to India, essentially saying they expect their capital to be better respected in India. This confidence in the macro framework has contributed to a reduction of India's equity risk premia. Therefore, India’s valuation premium over peers has strengthened.
2. Reduction in political/policy risk – We believe India could offer global investors the most stable government in the world over the next five to 10 years. Based on our experience, this often gets overlooked. With its rock-solid majority, the Modi government, already over the last nine years, has shown a resolve to make many policy decisions that may only pay off in the long term. For example, in 2017, India moved to a common single market with a single sales tax across the country and later cut income tax rates to regional averages. The measures took five years to show any impact, but today, the benefits are clear. Now, there is significantly higher tax compliance and record-high tax collections. The bulging tax kitty has enabled India to incentivize manufacturing, invest heavily in infrastructure, and build physical and digital connectivity across the nation.
3. Deft management of geopolitical risk – Many global supply chains are considering manufacturing in India to offset geopolitical risk as tensions between the US and China remain elevated. Apple is the highest-profile company so far that has shifted a meaningful chunk of its capacity to India. One can imagine the discussions in boardrooms across the Western world — If Apple is moving to India, why aren’t we?

The three factors above have led to falling risk premia in India, which, in turn, could keep its valuation premium high. But the same factors also allow us to have much more conviction on the future cash flows of Indian companies and keep looking for long-term value-creating managements. We believe we’re at a very exciting phase in India today and prudent global equity investors may wish to consider Indian equities for potentially compelling, long-term performance.