India: Where China was 10 Years Ago, Not all Emerging Markets are the Same?

Between 2005 and 2010, economic growth in the BRIC nations – deemed the world’s most important emerging markets – averaged approximately 7.5%, considerably higher than the 5% growth averaged by the world as a whole, and the 3% achieved by OECD countries.  The BRIC countries leveraged a number of factors, including favourable demographics, growing factory output (in the case of China and India), vast national resources (in the case of Brazil and Russia) and a rapidly growing middle class, and as a result were widely expected to lead the shift in global economic power towards the developing world away from the developed G7 countries.  Over the past 18 months, however, China’s GDP growth has slowed to a six year low, Russia’s economy looks to be slipping into a recession, and Brazil’s growth has been hit by the on-going downturn in global commodity prices, leading investors to revisit the notion that emerging markets will be the engines of future global economic growth.  India, alone among the BRIC countries appears to have bucked the trend, having continued to perform well and emerging as an increasingly attractive investment destination.  Given India’s current favourable macroeconomic positioning, growth potential, and the focus of its leadership, the country has avoided the challenges currently faced by emerging markets and has emerged as a high potential investment destination for large pools of capital.

Key Challenges Facing Investors in Emerging Markets Today

Emerging markets today are characterised by a number of structural issues that make it difficult for international investors to deploy large sums of capital into these regions today. The key challenges include:

  • Currency Uncertainty. Over the past 12-18 months, a combination of the powerful rally in US equities, decelerating growth in emerging markets and rising geopolitical risks have driven a shift in international asset allocation towards Western markets perceived as safe havens in times of uncertainty.  The ensuing capital flight from emerging markets has driven significant currency uncertainty in a number of economies including China, Brazil, South Africa, Indonesia and Russia.
  • High Dependency on Commodities. Many major emerging market economies are heavily dependent on the export of commodities such as oil, precious and industrial metals and food grains.  China’s economic acceleration in the 2000s fuelled unprecedented demand for these commodities, and in turn drove economic growth in a number of these supplier economies. The slowdown in China’s economic growth over the last 18 months, however, has caused a slowdown in this demand, adversely impacting economic growth in commodity-driven emerging market economies.
  • Rising Debt Levels. Since the onset of the global financial crisis in 2007, global leverage has increased rather than decreased as was hoped and this has particularly been the case in emerging economies like China and Malaysia, where leverage levels increased by 83% and 49% respectively between 2007 and 2014.  While debt has proven to be an effective tool to fund economic growth, especially in emerging market economies, the recent economic slowdown in these countries has accelerated the need for them to deleverage their economies.
  • Investment Liquidity. While private investors deployed in excess of US$2tn worth of capital into emerging market economies between 2009 and 2015 , many have struggled to realise returns on these investments. This can be attributed in large part to illiquidity in emerging economies across both public markets – the median free float is 35%, as against 80% in developed markets – and private markets where the ratio of private equity exits to investments remains low.  
  • Asset Price Fluctuations. A combination of the various challenges highlighted above has contributed to significant fluctuations in asset prices in emerging market. In the last year alone, emerging market equity and debt market indices fluctuated by 28% and 8% respectively and these fluctuations made it difficult for investors to time asset allocation and disposals in these markets.

Given these risks, managers of large pools of capital have become increasingly wary of placing long-term bets in emerging markets, shifting their asset allocations towards mature markets with significantly lower returns expectations. Importantly though, unlike all other emerging markets and the BRIC countries within that category, India’s position vis-à-vis these risk factors has steadily improved, driven by a number of structural advantages and developments with longer-term implications.  These appear to be transforming the country’s risk profile, while at the same time continuing to deliver high economic growth, and positioning the country for potentially high risk-adjusted investor returns.  The table below benchmarks India’s performance against major emerging markets along key metrics.

India’s increasing stability and attractiveness is further supported by a number of political, social and economic macro-shifts underway both domestically and internationally, examined later in this paper.

Political Conviction Driving Strategic Bets

The general consensus, amongst both democracies and autocracies, has been to welcome the return of India. The reasons for this are many and include the increasing perception of the need for a counter-weight to emerge on the political and economic front to China. Politics has moved faster than economics in placing a bet on the rise of India. Three factors seem to be driving this bet:

  1. India Central to Asia Pivot. Asia is a critical growth region in the world today. It is home to 60% of the global population, represents 34% of global GDP, 34% of global market capitalisation and 40% of global trade. More importantly, Asia generates nearly half of all global GDP growth, with the region expected to account for 55% of global economic growth by 2050. “Both sides recognised India’s strategic and economic importance in the Asia-Pacific region, and welcomed growing engagement and increased cooperation with India on a range of security issues, particularly counter-terrorism, maritime security, countering transnational crime and cyber policy.”
    US – Australia Joint Statement, Oct-2015
    This economic shift has also been accompanied by a political one, with the Western world paying increasing importance to China’s growing influence in South Asia, and geopolitical developments in the Korean Peninsula and South China Sea. There is a growing recognition that the US needs to be a counterweight to China in the East to balance China in the West. Given the size of its economy and its established democratic traditions, India is viewed by the US and many industrialised Western economies as an important ally that can help them protect both their economic and security-related interests in the region.
  2. Growing Strategic Partnership between India and the US. This global pivot to Asia, and India in particular, is perhaps best exemplified by the growing strategic relationship between the US and India. In the last 18 months, Prime Minister Modi has visited the United States twice, while President Obama also travelled to India earlier this year.“We are both open societies which value education and enterprise. Our relationship with the United States is defined by the natural synergy of our democracies and easy identification amongst our people.”
    Sushma Swaraj, Indian External Affairs Minister, Sept-2015
    These visits have also been complemented by a series of meetings between Indian and US diplomats and business leaders, and over the course of these various interactions, both countries have pledged to cooperate on nuclear energy, work towards promoting political stability in Asia, strengthen defence and security ties and improve bilateral trade, with India potentially joining the US’s twelve country Trans-Pacific Partnership (TPP), estimated to have the potential to generate in excess of US$14bn in economic benefits by 2025 through increased trade.
  3. Growing Focus on Strengthening Military Capabilities. India’s growing economic influence has been accompanied by the rapid build out of its military capabilities. The country imported US$21bn worth of arms last year, the highest in the world, and ranks 8th in global military spending with a defence budget of US$38bn. India’s military strategy has also involved elevated strategic dialogue and activity with a number of its allies. “India’s military clout is growing fast. For the past five years, India has been the world’s largest importer of weapons… Today it is the world’s 7th largest military spender… By 2020 it will have overtaken Japan, France and Britain to come in 4th.”
    The Economist, Mar-2013
    It has conducted joint military exercises with the US, Japan and the UK, expressed a willingness to revive the Quadrilateral Security Dialogue between the US, India, Japan and Australia, and, as part of its “Look East Policy”, has stepped up its engagement with a number of East Asian and ASEAN countries. With instability in Pakistan and Afghanistan in West Asia, and China exerting greater influence in East Asia and seeking to expand its reach through its Silk Road initiative , India’s military diplomacy is expected to play an increasingly important role in its global outreach.

Positive Social Factors Driving Stability

India also has a deeply ingrained social fabric, which helps foster long-term stability.  This has been a double-edged sword allowing politicians over the decades to count on a free pass for not delivering on prosperity and in contrast also promoting the kind of stability among developing nations which is necessary to enable prosperity to grow.  With an effective government, a number of positive social factors stand to support India’s rise in prosperity.   

  1. High Degree of Personal and Political Freedom for its Level of Development.  Indian citizens have enjoyed universal suffrage since their independence and India is one of the only countries to have deeply institutionalised democracy before it reached a sufficiently high level of income.  As a result, a relatively high level of personal freedom – including to vote, of movement, of information – has become deeply institutionalised at every social level.  India has maintained this level of freedom interrupted only by a brief period of martial law in 1975-1977 (which ended with free elections that overthrew the ruling government).  This level of freedom ensures a base level of stability with peaceful transfers of power and against revolutionary political upheavals.
  2. Strong Demographics.  India has a uniquely attractive population age profile and growth, which is estimated to rise to 1.7bn by 2050, which stands in sharp contrast to every other sizable economy or economic region in the world including the US, Europe, Japan, China and Russia which are rapidly ageing and whose workforces already have or will very soon start declining.  This can be partially attributed to India’s social diversity: it has regions in the south which have an older demographic profile and are richer while many of the more populous states in northern and central India are younger and poorer.  Population control measures, although attempted, have been largely unsuccessful and fertility rates have been closely linked to income levels.  As a result, India’s age profile is not just well-poised for growth but also well-balanced in a manner which will prevent a sharp demographic ‘cliff’ like the one China now faces as a result of its one-child policy.  India must of course get this workforce well employed to reap the full benefits.  
  3. Socio, Cultural and Political Norms Which Reinforce Peace.  India is famously the birthplace of the concept of political non-violence and civil disobedience which helped it, under the leadership of Mahatma Gandhi, secure independence from British rule.  Since independence, India’s constitution has provided the framework for representative government at central, state and local levels and thereby ensured all sections of society have mechanisms to be heard.  India’s long-standing and well-chronicled diversity in terms of languages, ethnicities, religions, political philosophies, castes and other lines can at times result in disagreements which boil up to the surface, and this has at times been cynically fomented and used by politicians to stoke divisions, but universal franchise has ensured that these disagreements are managed through the legal and political process, and the scope for any kind of violent revolution is therefore contained. 
  4. Outside of the Headlines, A Long History of Religious Harmony.  Although the news cycle tends to highlight the instances of religiously-driven violence in India by extremists wings of all religions, India has a long history of peaceful co-existence between Hindus, Muslims, Christians, Sikhs other religions and atheists that goes back long before its independence.  During British rule, there is a history of Hindu-Muslim cooperation to help achieve independence.  Since independence, India has stayed true to the secular fabric of its constitution and despite the overwhelming majority Hindu population, other religious minorities have been accommodated in the political process.  Efforts by extremist elements across religions to polarise the dialogue, although they tend to attract headlines, have therefore proven ineffective over the long-term.

Economic Drivers of India’s Attractiveness for International Investment

It is clear that the Modi government has started to rewrite the India story.  The process will no doubt take some time to translate fully into reality.  The question for investors is whether to wait for the story to be evident to all, and therefore priced into assets, or to act now.  The case for economic action is being made through a number of key drivers. 

  1. India on J-Curve in Growth.  Following the election of a new Bharatiya Janata Party (“BJP”) government in 2014, an ambitious structural reform agenda has helped improve investor and business sentiment, with GDP growth accelerating to 7.2% in 2014, from a low point of less than 5% in 2012.  In contrast, China’s on-going efforts to rebalance its economy have resulted in GDP growth decelerating from 11% in 2010 to 7% in 2014, with speculation that the number is closer to 4% already. With the economies of India and China at intersecting paths, and India’s position across a number of key indicators including GDP per capita, exports, infrastructure investment and R&D spend similar to that of China in the early 2000s, one can expect India to leverage its favourable demographic profile, technology-led services sectors and foreign investment inflows to embark on an equally ambitious growth trajectory over the next 10 – 15 years.  Mr Modi has set the bar high and the government has announced the target to double-digit growth .
  2. Growing Global Integration and FDI. India’s growing trade and investment links within Asia and with the rest of the world are playing an increasingly critical role in its economic growth story. Within the Asia-Pacific region, the country has begun to position itself as an alternative investment and trading destination for Japan and Australia, and its current bilateral trade figure of US$127bn in the region could as much as double to US$250bn over the next decade. India has also historically established strong trade links with the US and Europe and these provide the basis of now securing a higher trade volume. With several industrial and services sectors in India developing to become globally competitive, and with its large low-cost base of educated, trained and English-speaking workers, India has potential to secure competitive advantages in both manufacturing and services, as well as a large domestic market, all of which are beginning to drive foreign multinationals to look at India as a global production and sourcing hub for manufacturing and services. In the last 12-15 months, Prime Minister Modi’s state visits to Japan, the United States, Canada, Brazil and Australia helped raise India’s profile, attracting investment commitments in excess of US$170bn in 2014, and resulted in India leapfrogging China as the world’s most attractive foreign direct investment (FDI) destination by US$3bn in the first half of 2015 . While there is a risk that on-the-ground execution challenges could result in these commitments not translating into actual projects, the government’s focus on making it easier to do business in India – as evidenced by the country’s recent jump in the World Bank’s Doing Business Rankings – would suggest that it is committed to mitigating these risks. India’s linkages with the rest of the world are expected to continue to increase going forward, and the foreign investment and trade benefits that arise as a result of this will be significant drivers of productivity and economic growth in the short and medium-term.
  3. Favourable Currency Dynamics. The rupee stands at one of the lowest levels vs. the dollar and major currencies since its inception. It has appreciated by 6% from its post-Global Financial Crisis low but is still down c.40% to the dollar from its 2008 level. High fiscal deficits, interest and inflation rates, and the withdrawal of large amounts of foreign investment from the country in 2008, 2011 and 2013 drove the currency down. India is now faring well on each of these metrics as a combination of aggressive monetary and fiscal policy initiatives over the last year have helped reduce both the fiscal deficit and inflation to five-year lows, with FDI inflows at an all-time high (as highlighted above). Therefore, with the cycle appearing to turn, investors that deploy capital in India today could reap the benefits of the rupee remaining stable or appreciating over the next few years. As highlighted earlier, there is of course a risk that the onset of a major global event (e.g. Greece’s exit from the Eurozone) could result in investors choosing to allocate a greater portion of their assets to “safer” Western markets, and this could adversely impact the Indian rupee. However, it is also important to note that between January and September 2015, while the currencies of other emerging economies including Brazil, Russia, South Africa and Indonesia fluctuated 11-41%, the Indian rupee remained relatively stable, fluctuating by only 4%. This relative stability, along with strong underlying macroeconomic fundamentals should help contribute to creating a currency environment that is conducive to foreign investors.
  4. New Government Pursuing Aggressive Reform Mandate. The 2014 General Election saw the Narendra Modi-led BJP government voted into power with 52% of the total seats and a mandate for development from India’s growing middle class. This signalled an end to more than three decades of coalition politics, which saw national parties ignoring or compromising on much needed economic measures in order to appease smaller coalition partners. Buoyed by this victory, the new government, has in its first 12-18 months in office, pursued an aggressive policy agenda that is focused on unlocking previous regulatory bottlenecks, increasing FDI limits in key sectors, increasing financial inclusion across the country and reforming India’s complex taxation system. And while the nature of the country’s democracy, with almost 2,000 national and regional political parties contesting elections across 29 states mean that some reforms may take longer to pass than others, the new government’s clear intent to pursue economic development should encourage international investors to increase their exposure to the country. “The stable outlook over the next 24 months reflects our view that the new government has both the willingness and capacity to implement reforms necessary to restore some of India’s growth potential, consolidate its fiscal accounts and permit the Reserve Bank of India to carry out effective monetary policy.”
    S&P, Sept-2015
    Clearly, this is the beginning of a long journey of change in a country that is more like a continent. Most of the factors highlighted above are functions of the unique structural makeup of the Indian economy and are likely to be long-term drivers of economic growth. The country today appears to be in a unique position where its growth trajectory is increasingly diverging from that of other emerging market economies, but its asset prices and market valuations are still much lower than those of developed economies – India’s price to earnings to real GDP growth ratio is 58% lower than that of the US – while moving to a much more stable macro-economic regime reducing risks associated with emerging markets. Investors should look to take advantage of this divergence by deploying capital in India today at lower, emerging market valuations, while enjoying the benefits of operating in an investment environment that offers a considerably more attractive risk-reward ratio.

Implications for Investors

As highlighted in previous Sign of the Times , India is more akin to a continent than a country, and investors do well to deploy money in the country not simply on the basis of headline economic statistics but by recognizing the differences.  Investors looking to participate in the country’s growth story should seek to adopt a strategic approach to capital deployment with a number of potentially attractive strategies emerging:

  1. Country Wide Investment Strategy.  With India set to embark on a growth trajectory that could mirror China’s over the next decade, and its economy in a relatively healthy position, there is clearly a case to pursue a country-level investment strategy, just as some savvy investors did in the early days of China’s rise.  As mentioned earlier, India’s equity market, despite its headline valuation looking expensive, is actually attractive relative to both the US and China once weighted for earnings and GDP growth.  Investors looking for stable and high returns on their investments should look to take advantage of the fact that Indian markets are priced relatively well priced versus developed markets and place large bets in India’s equity markets.
  2. Regional Focused Investment Strategy.  In July’s Sign of the Times, we analysed and grouped India’s states across a wide range of metrics including economic growth, inflation, demographics, urbanisation, literacy, debt-levels and human development indicators.  Based on their desired risk-reward requirements and minimum investment size, investors can look to participate in India by choosing to invest in any one of these state clusters.  For example, India’s I-5 states – Maharashtra, Delhi, Haryana, Tamil Nadu and Gujarat – are city centric states that account for nearly 40% of the country’s GDP and 60% of its companies.  These states are attractive to both liquid investors looking for stable returns from large publicly traded stocks, and FDI looking to invest in scaled companies delivering high growth.
  3. Sector-Theme Focused Investment Strategy.  International investors could also define their capital allocation strategy in India based on their interest in broad sector themes such as (a) labour-intensive industries such as heavy and light machinery, pharmaceuticals and chemicals, (b) low-cost outsourced manufacturing sectors like textiles, clothing and steel and (c) innovation-driven industries including consumer electronics, internet services, aerospace and robotics.  India’s economic diversity means there is potential for high growth and investment returns across each of these themes, and investors looking to play this strategy also enjoy the added benefit of tapping into opportunities across different state clusters.  For example, investing in innovation-driven industries would expose technology-focused venture and growth capital investors to a combination of scaled IT services companies located in the I-5 states like Delhi and Maharashtra and emerging internet and digital-focused companies in the “Old Economy” states of Karnataka and Andhra Pradesh. 
  4. Big Ticket Investment Strategy.  India has scaled capital needs across a number of infrastructure and financial services related sectors.  With the financing gap in these sectors expected to exceed US$1.5tn over the next 5 years, the government is playing an increasingly active role in soliciting private sector investment.  This provides international investors that are looking to deploy large sums of capital – US$100m or more per transaction – with a number of investment opportunities, as they could either make direct investments, partner with the government to invest in public sector organisations or invest via scaled private funds.  Given the government’s focus on improving productivity in public sector banks, a potential opportunity for investors could be to contribute US$250-500m each towards the creation of a National Banking Fund that looks to take up sizeable investment positions in these state-owned banks. 
  5. Thematic Investment Strategy.  Over the next decade, the Indian economy is expected to be driven by a number of demographic, economic and government policy-led themes.  These include increased mobile and internet participation, improvements in the delivery of healthcare and related services, greater financial inclusion, and the government’s attempts to revive its infrastructure and manufacturing sectors.  Investors that are bullish on India and are looking to be long-term participants in the country’s growth story can build diversified investment strategies around one or more of these themes.  Large pension funds that are looking for consistent, high single digit returns could, for example, help bridge the estimated US$1tn gap in the infrastructure sector by investing in existing or upcoming projects across the roads, power and ports sectors, funding projects with both equity and debt, investing in sectors related to the build out or joining consortia to build and operate projects themselves
  6. Cross-Border and Outbound Strategy. Indian companies operating across a range of sectors have scaled in the domestic market and are increasingly looking to overseas markets for new customers as well as for technology and industry know-how. These outbound investments are being driven by Indian companies in sectors in which they have established strong competitive advantages, and now have ambitions to emerge as global leaders.  These ambitions are also influenced by the fact that despite their scale, Indian companies find their profitability margins being eroded due to over competitiveness in local end markets.  Profitability at a gross margin level is approximately 10% higher in Western developed markets than in Indian markets, and there is a significant opportunity for Indian companies to enter into these profitable markets, while leveraging their lower operating cost structures.   Private equity investors could partner with Indian companies in either the pharmaceuticals or automobile components sectors, help them tap into lower-cost international debt markets and acquire peer companies in higher margin Western markets like North America and Europe.  


India has been through a number of development phases during the past 20 years that have fundamentally transformed the country: from the breakaway from the Hindu rate of growth during the initial reform period in the 1990s, a continuing upswing until the global financial crisis and a subsequent slowdown driven by insufficient follow through on structural reforms, the lack of which have held back India’s potential until recently.  With strong macro-drivers and a roadmap of structural reforms in place now, the country is making up for lost time with accelerating growth.  Importantly, the country’s development has reached the stage of development where it can benefit from previously underutilised structural advantages, including its legal system, democratic institutions, and English speaking population, all of which set it apart from the other BRIC and emerging markets.  With these additional factors in place, India’s position as an investment destination is no longer similar to other emerging markets.  It stands where China was about a decade ago with the potential to deliver a value trajectory along similar lines.  Timing of course as always remains everything.  A market in which GDP is rising faster than asset prices cannot be sustained indefinitely and prices over the long-term term will surely rise above economic growth, reducing the returns potential to investors.  However, at this point India looks to represent a unique opportunity for international investors that are in a position to allocate capital in timely fashion, allowing them to reap the benefit of low prices and high growth for the next three to four years.  An investor’s dream is to turn back the clock and place the bet at the right point, politicians have placed that bet, investors will have to decide if they should too. 


2 Source: Financial Times

3 Refers to the 21st Century Maritime Silk Road Economic Belt, a US$40bn strategic initiative by China to promote economic cooperation and maritime connectivity between Asia, Africa and the Middle East

4 Source: Andy Xie, Former Chief-Economist for Asia Pacific, Morgan Stanley, Jul-15

5 Source: Arun Jaitley, Minister for Finance, May-2015

6 Source: Financial Times

7 Please refer to GPC’s July Sign of the Times, “India’s Hidden Economy: The India Within India”