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India’s general election – with results due on 4 June – stands as the largest electoral event in history, with around 969 million eligible voters.
If, as widely anticipated by investors, current Prime Minister Narendra Modi secures a third term, this would translate to a 15-year continuous mandate, and likely be viewed as a positive outcome for the Indian equity market, which has been one of the best-performing equity markets on a global basis for the last 10, 20 and 30 years.1
However, a full-scale win for Modi is not necessarily a foregone conclusion. An adverse outcome for the Modi administration could create uncertainty, slowing government spending and compromising investor confidence. Yet for now, enthusiasm for Indian equities remains high, raising questions about valuations.
That said, we believe the macro case for India has only grown more compelling, supported by powerful demographic trends, increasing urbanisation, rising wealth, export growth, geopolitical tailwinds and a supportive policy regime. We believe these forces are coming together to drive a new corporate profit cycle in India, which we think is likely to continue for the next five to six years. This is coinciding with the end of the deleveraging cycle that has been playing out since 2015, meaning companies are likely to be in far stronger financial positions than they were a few years ago.
These developments could be supportive for the existing investment opportunity set in India, but that may not be the end of the story. In our view, the investable landscape in India is also in the process of transforming, as the drivers of India’s economy evolve. Service sector contribution to GDP has been rising since the 1970s, driven by higher value-added sectors such as finance, real estate and professional services.2 We believe that an increasing number of internet, media and e-commerce businesses — sectors that have historically been underrepresented in India’s listed equity market — are likely to come to market over the next two to three years. Given that these industries currently make up less than 1% of the MSCI India Index, compared to around 35% of the MSCI China Index,3 we think companies starting to list in public markets in these sectors will provide a fertile new investment area for India equity investors.
Geopolitics is also playing a key role in India’s economic inflection. In response to ongoing political tensions between the US and China, many companies across a range of industries are seeking to diversify their supply chains away from a sole reliance on China. Apple is the highest-profile company so far that has shifted a meaningful chunk of its capacity to India, but US/China tensions are structural and unlikely to diminish. Companies looking to offset geopolitical risk may view India as an attractive alternative for years to come.
Of course, India’s growth potential has not been ignored by other market participants. Investor enthusiasm for Indian equities means that valuations are on average higher than other emerging markets, with some industries more impacted than others. Yet we believe outperformance potential remains.
Firstly, the fact that India has consistently traded at higher valuations than emerging markets means we can look back to assess whether higher valuations have affected performance. Over time, India has consistently outperformed emerging markets while consistently trading at higher valuations, as Figure 1 shows. In our view, active management of India exposure allows portfolios to avoid parts of the market where valuations are stretched and focus instead on mispriced opportunities.
Secondly, we don't think the opportunity in India is yet fully priced in across many sectors. One area where we see opportunities is within the real estate sector. If we compare Hong Kong and India, Hong Kong has a population of around 7 million compared to India's 1.4 billion.4 However, the market cap of India’s real estate sector is only about a quarter of the size of Hong Kong's. We think opportunities within this sector are underappreciated. Demand for real estate is strong and housing affordability is at a two-and-a-half decade high.
More broadly, given where valuations are, we think it's important to carry out deep research, examining the outperformance case for specific companies — firms well-positioned relative to key Indian growth drivers. This could include beneficiaries of the boom in construction and real estate demand, the beneficiaries of middle-class spending growth and beneficiaries of the manufacturing boom.
As with any emerging market — and indeed with any developed market — governance matters. Governance standards can vary widely between corporates; focusing investments in companies with strong track records of shareholder value creation is key.
Of course, there are risks to monitor. While investors appear to expect a Modi win, markets could be surprised if the margin of victory were to be lower than anticipated. A further heightening of political polarisation could reduce the attractiveness of India as an investor destination while any spike in geopolitical turbulence could drive up commodity prices and inflation generally, slowing India's development efforts. Longer-term India also still faces structural challenges in areas such as education and infrastructure. However, we believe that India's growth cycle is resilient, and long-term-oriented stock pickers that can balance valuation concerns with growth convictions could see outperformance.
1Wellington Management calculations, based on data from MSCI and S&P, May 2024. | 2CEIC Data Company Limited, Wellington Management, 2023. | 3MSCI, 30 April 2024. | 4United Nations, Department of Economic and Social Affairs, Population Division (2022). World Population Prospects 2022, Online Edition.
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