India outlook

Marcus Weyerer, CFA, Senior ETF Investment Strategist and Samir Sinha, CFA of the Franklin Templeton Institute discuss the current macroeconomic backdrop and weigh in on topics ranging from the banking sector to domestic consumption, government reforms and central bank policy.

Marcus Weyerer: Thanks Samir for joining us today. India is currently in vogue, with equity markets down since their all-time highs but less significantly compared to many EM and DM peers. However, valuations appear elevated based on last twelve months (LTM) earnings. What’s your big picture view of the country at the moment?

Samir Sinha: Hi Marcus. India’s structural and fundamental story is pretty strong and stands out in the face of recent challenges globally, particularly considering the banking turmoil in the US and Europe. Since bottoming in March, Indian equities have rallied, but have still underperformed the broad EM universe. Growth, inflation, monetary policy, a reform-oriented government and a strong banking sector set the scene for optimism going forward.

Marcus Weyerer: Just to put some numbers of what you just mentioned. Currently expectations for GDP growth in 2023 are 5.9% for India, 1.1% for the US, negative for Europe and China growth 5.2%.¹ The projected compound average growth rate for the next five years is 6.1%, significantly eclipsing that of China.

You mentioned the banking sector already, important for any economy but especially critical to growth in emerging economies. Can you give us the low-down on the situation after the upheaval we’ve seen in Europe and the US during the spring?

Samir Sinha: Indian banks are very well capitalised with capital adequacy ratios well above their regulatory requirements, which tend to be a bit more conservative than Basel III. The banks’ balance sheets generally are also looking very healthy, with buoyant credit growth and non-performing assets remaining low. Also, foreign claims on Indian banks are significantly less than, say in the US or UK. That further limits the country’s exposure to some of the global uncertainties we’re seeing.

Marcus Weyerer: Let’s turn the focus to the outlook and let’s start with the Purchasing Managers' Indexes (PMIs), because when I look at the PMIs in India, I find it impressive how stable they have been since their initial sharp recovery post-covid. They haven’t budged much at all.

Samir Sinha: Indeed, the Indian Manufacturing PMI stood at 58.7 in May, while the Services PMI stood at over 60. Factor activity and domestic consumption have both seen strong increases, and on top of that, input prices have declined which could mean higher operating margins and earnings going forward. Indian companies also tend to have high capacity utilization, encouraging more deployment of capital in order to expand this capacity. Another important factor is the re-shoring away from China to India, which can not only provide diversification of supply chains for Western companies, but also access to the large and growing domestic market. In fact, a government priority is on foreign direct investment, through tax incentives, skills development, and improving the ease of doing business.

Marcus Weyerer: On that last point we are seeing good progress apparently, at least according to the recent Economist Intelligence Unit’s business environment ranking. Year-on-year, India jumped 6 spots, making it one of the biggest improvers and the only major economy able to do so. The progress happened across most parameters. Two that strike me as critical are for example, technological readiness and their policy towards foreign investment, which you mentioned. The government is also driving negotiations for trade deals around the world. How would that affect the manufacturing sector in the country?

Samir Sinha: It’s set to grow in importance and as a share of GDP. We also expect a gradual migration of finished goods up the value chain, so that in terms of gross value added, manufacturing has the potential to contribute significantly more going forward.

Marcus Weyerer: As of today, private consumption is a key driver of the Indian economy, though, and will remain important. How do you assess the domestic market currently?

Samir Sinha: Collectively, urban and rural demand are expected to increase, and by 2030 the retail market size is expected to roughly double vs 2018, when retail spending last peaked and then collapsed during the pandemic. The recovery since then has mostly been urban-led, but rural consumption will be a major focus in the upcoming election cycle as agriculture remains a large proportion of the economy. The government has already initiated programmes to support farmers and local rural communities.

Marcus Weyerer: In that context, let’s have a look at the fiscal and monetary situation. This year so far, government budget targets have mostly been hit, driven by healthy sales tax receipts. FX reserves have grown encouragingly since covid and are close to all-time highs again. Can that continue?

Samir Sinha: We’d expect sales tax collections to improve along with overall domestic demand, and that should help the government in terms fiscal consolidation. The current account deficit has also been declining and is set to narrow further in 2024, potentially driving up FX reserves.² And lastly, India’s external debt position, roughly 20% of GDP, is low compared to developed markets.

Marcus Weyerer: That compares to some 100% of GDP in the US, 170% for Germany, and 130% for Italy.³ The last point I wanted to discuss is the interest rate trajectory, especially against the backdrop of El Niño potentially driving up food prices and the recent Saudi oil production cut. Is there any wiggle room for the central bank, and what does that mean for investors?

Samir Sinha: The RBI has made it clear that getting inflation down to 4% remains an absolute priority. Having said that, the recent rate decision was to hold at 6.5%, in line with market expectations. But if you look under the hood, you’ll see that inflation already hit a two year low in April, and that general trend is consistent with the rest of the world. Global rates may not return to the ultra-low levels of the past decade and India’s fiscal prudence should be rewarded over the medium term as current rates remain elevated. In a nutshell, India’s macroeconomic situation is quite different from a lot of other markets, justifying different valuations. So that gap may well persist or even widen if the macroeconomic gap continues to grow.

Marcus Weyerer: So to sum it up: Indian equities aren’t cheap at the moment, but they aren’t expensive either if you take into account the structural trends that we discussed. A supportive fiscal environment, an expanding manufacturing prowess, and of course a positive set-up for private consumption. More short-term, we’ve seen a rapidly improving business environment, government reforms, healthy credit growth and very strong PMIs, along with equity markets that have just turned positive year-to-date. Samir, thank you for your time today, and speak soon!

Samir Sinha: Thank you.