Can India become the new emerging markets powerhouse?

It’s not easy trying to find something to buy in today’s battered financial markets. While stocks are down a lot, with the S&P 500 down 17 percent year-to-date, there are plenty of investors who think they may need to drop further.

Fund managers seem finally convinced that the US Federal Reserve, the world’s most powerful central bank, is serious about maintaining high interest rateseven if it means pushing the US and much of the rest of the world into recession.

“Hardly anything has been saved since the beginning of August,” writes Max Kettner, chief multi-asset strategist at HSBC, summing up the situation in a note this week that shows developed markets, emerging markets, investment-grade bonds and high-yield (or junk) are all tanking together.

So is it time to buy? Not yet, in Kettner’s opinion. And it would be a bold retail investor who would jump in today feet first. But that doesn’t mean we can’t take a look at the most bombed corners of the asset pool.

Consider emerging markets (MS), for example. Long outcasts, they have been particularly hard hit in recent months, as foreign investors dumped emerging-market stocks and bonds for five straight months through July, according to the Institute of International Finance. That’s the longest streak of exits since IIF records began in 2005.

Could emerging market asset prices have fallen enough for investors to take a slightly more selective exposure to emerging markets as part of a broad portfolio? Maybe.

One focus of attention is India, widely reported to have overtaken the UK as the world’s fifth largest economy last week, and the fastest growing of the world’s major economies. Gross domestic product growth will be more than 8 percent this year and remain close to 7 percent for the next five years, according to the IMF. That’s a good 2 percentage points more than China, the former emerging-market powerhouse.

The country’s local currency government bonds enjoyed a small rally in August after the Financial Times reported that they may soon be included in a major global benchmark index, which would automatically boost investment by asset managers trying to mirror the index in their funds.

Despite India’s heavy hit from Covid-19, its stock market held up better during the pandemic than many of its peers. Had he bought Indian shares three years ago, they would have risen 47.5% today, compared with a 20% gain for advanced economy stocks in the benchmark MSCI index, a loss of more than 5% in emerging markets. as a whole. and losses of nearly 18 percent in China and 30 percent in Brazil.

Glen Finegan, Senior Portfolio Manager at Skerryvore Asset Management, believes that India’s economy is entering a new phase, led by its recent transition from a highly regulated business environment to a more liberalized one, and fueled by a young population that will soon it will give the country the largest labor force in the world, even larger than China’s.

“It seems that the economy has passed a tipping point, where growth is self-sustaining to some extent,” he says. “There are a lot of tailwinds.”

That may sound surprising to those who remember the government’s chaotic early response to Covid-19, when millions of migrant city dwellers were told to return to their villages, spreading the coronavirus across the country and damaging the economy.

Before that, in November 2016, the government scored a supreme own goal in the form of demonetization, when it withdrew more than 80 percent of cash in circulation overnight in a bid to shrink the informal economy and increase its collection. of taxes, just to cause economic disruption. This was exacerbated by renovations to the property that, while seen as positive in the long run, caused pain in the short term.

But other policy changes have been more favorable. Hiren Dasani, India equity portfolio manager at Goldman Sachs Asset Management, points to a corporate tax cut in 2019, followed by reform of labor laws, making it easier for companies to hire and fire, and a new approach to privatization, in which the government is willing to sell controlling shares rather than just minority stakes. “There is a very strong cyclical recovery taking place after Covid,” she says.

This is being driven by three main factors, in his opinion. In the first place is the real estate sector, which is making a comeback after bottoming out. In second place is private consumption, which has been much stronger than expected. And third is private equity investment. This is increasing after years of stagnation during which many companies reduced their borrowing, while private sector banks have cleaned up their balance sheets, reduced non-performing loans and become increasingly willing to lend.

The results are already visible in Indian stock prices, trading at multiples of more than 18 times expected one-year earnings, compared with a recent historical average of 16. Dasani says earnings are picking up and could lead to profit. 10 to 12 percent per annum in rupee terms, even if valuations regress to historical level.

For foreign investors, who must convert rupee earnings into their own currency, there is great concern. The rupee has lost about 7 percent of its dollar value this year, wiping much of that return out of equities.

It is little consolation that this year’s devaluation was largely not driven by Indian weakness, but by dollar gains, fueled by rising US interest rates with the Fed determined to follow. Going forward, other currencies are vulnerable.

Shilan Shah, senior India economist at Capital Economics, says India is far from immune, but it is less exposed than many emerging market peers. “The economy is internally driven.” While public debt has risen sharply in recent years, to around 85 percent of GDP, the fact that it is locally owned and denominated in local currency gives India greater security than many other emerging markets.

Finegan at Skerryvore says many mainstream consumer stocks have appreciated heavily in India’s recent rally, making them less attractive, although there are still opportunities. A rise in share prices since mid-June has sent the Bombay Stock Exchange’s Sensex index up 17 percent, erasing all previous losses this year.

Among his picks is Crisil, a local rating agency well positioned to benefit from the expansion of India’s capital markets. He also likes the drugmaker Cipla.

Finegan says Cipla and others exemplify the growing sophistication of India’s economy. Just as the country’s IT industry has progressed from low-cost back-office operations to globally competitive business service providers, its pharmaceutical industry has moved from manufacturing generic drugs to joining the global drug development chain.

Finegan says that one way foreign retail investors can gain exposure to India is to buy dedicated Indian equity funds, but avoid any that invest in state-owned companies.

Dzmitry Lipski, head of fund research at Interactive Investor, suggests buying Asian or broader emerging market funds that may adjust their exposure to India. He gives the examples of the Pacific Assets Trust, with a 46 per cent allocation to India, or the Mobius Investment Trust, with a 16 per cent allocation. He adds that the iShares MSCI India ETF, which tracks an index of large and mid-sized companies, is an easy option for passive investors.

For retail investors looking for a gateway to India, there are a few routes available. Anyone looking for short-term gains may be toying with the Fed and the global outlook. But for those prepared to expect any immediate market instability, India offers a bit of economic hope at a time when there isn’t much around.

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