investment insights

India’s promised boom

India’s promised boom
Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

Stéphane Monier

Chief Investment Officer
Lombard Odier Private Bank

Key takeaways

  • India remains one of the world’s fastest-growing major economies. We see growth of 6% in 2023 and annually for the next decade
  • A Western shift in supply chains away from China may benefit India’s economy as it supports domestic production across a range of industries
  • Inflation was lower than the central bank’s target in November and we expect the RBI’s policy rate to peak at 6.5% in 2023
  • While corporate earnings are forecast to rise more than 15% in 2023 and 2024, stock valuations are high. Carry yield and an investment grade rating mean we like short-duration Indian government debt. We see the rupee trading in a range of 80-84 rupees to the USD over the next 12 months.

India’s economy will benefit from a global drive to diversify supply chains, manufacturing investments and technological infrastructure in 2023. With its population set to surpass China’s in 2023 and growth set to outpace rivals for the foreseeable future, the country’s economic ambitions are increasingly attracting long-term investors’ attention.

India’s economy, the world’s fifth largest, likely expanded by 7% in 2022 and maintained its status as one of the fastest growing major economies. Over 2023, we expect growth to slow to 6%, but that modest change is unlikely to be sharp or lasting. The business sector looks better prepared to weather this slowdown with higher profitability, while monetary policy tightening is poised to pause soon. Although the banking sector’s underlying fragility is a risk, our base case is that the cyclical slowdown will be manageable. If so, the market’s focus will be firmly on the country’s long-term prospects.

India’s youthful population will continue to work in its favour. According to the United Nation’s forecasts, India’s population will surpass China’s in April 2023 for perhaps the first time ever. More importantly, the country’s working age population growth will be higher than most of its global peers in the coming decade (see chart 1). The UN’s population forecast points to the addition of nearly 95 million to India’s working population.

If India manages to maintain this pace of growth, it will become the world’s third largest economy by 2033

Further boosting India’s long-term prospect will be its position as an alternative to China amid shifting global geopolitics. As the Western world looks to diversify supply chains away from Chinese production and manufacturing, and China begins to focus on domestic consumption, India is consolidating its role between the two. The push to make India an alternative in global supply chains seems to be bearing fruit. India’s electronic goods exports, for instance, have nearly doubled since 2020 (see chart 2) as firms such as Apple and Samsung accelerate investment into the country’s technology production. Prime Minister Narendra Modi’s cabinet hopes to further this trend with “production linked incentives” worth a total of 32 trillion rupees (USD 39 billion) to industries including carmakers, aviation, chemical, and electronics as well as medical devices and pharmaceuticals.

Considering these tailwinds, we believe that it is reasonable for India to achieve between 6.0% and 6.5% annual growth over the next decade, despite some complications from the pandemic and climate volatility. If the country manages to maintain this pace of growth, it will become the world’s third largest economy by 2033, ahead of Japan and Germany.


Climate challenges, inflation credibility

India’s big unknown is the impact of global climate change. India is still mostly rural and its underdeveloped economy is vulnerable to climate volatility. Additionally, the credibility of its inflation targeting framework depends heavily on food prices that account for nearly 40% of the consumer price basket calculated by the Reserve Bank of India (RBI), the country’s central bank. India’s macroeconomic policy is effectively at the mercy of the annual monsoon. In the medium-term, building infrastructure resilience to climate volatility will be essential to India’s development.

…normalising global demand and stable commodity prices should help... India bring inflation below its 6% threshold

In the near-term, normalising global demand and stabilising commodity prices should help India bring domestic consumer inflation below its 6% threshold. In fact, headline consumer price inflation already rose by a below-target 5.9% in November compared with a year earlier. This supports the RBI’s recent assessment that “the worst of inflation is behind us.” We expect the RBI to implement its final rate hike of 25 basis points in early 2023, and then set the benchmark repo rate at 6.5% for the remainder of the year.


A stable domestic political outlook

The ruling Hindu nationalist Bharatiya Janata Party (BJP) remains in a position to win the next general election that needs to be held by May 2024. Recent state elections supported this outlook. The BJP minimised its losses in the March state assembly election in Uttar Pradesh, despite poor forecasts, and then won its largest ever majority in the prime minister’s home state of Gujarat, where Mr Modi was chief minister for 12 years. We do not expect meaningful negative surprises for the BJP-led parliamentary coalition of the National Democratic Alliance (NDA) in this year’s state assembly elections, especially because the opposition is fractured at both national and local levels.

We also see little scope for infighting within the BJP as Mr Modi seems to be preparing to run for another term, though there is discussion of a challenge from Amit Shah, the current Home Affairs minister, and Yogi Adityanath, Chief Minister of Uttar Pradesh state. Confident in the Modi brand, the BJP may push for reforms to land acquisition and labour laws nationally this year. A lack of majority in parliament’s upper house, however, may constrain the government.


Can India outperform?

Overall, Asian economies may outperform in this period of global weakness. Southern Asia’s economies in particular performed better than other emerging markets in 2022, led by India. As China changes its Covid strategy, North Asian economies become more likely to outperform in 2023.

India’s strong performance means that it is already widely held in investment portfolios. India makes up 15% of the MSCI Emerging Market index, half the weight of China and almost three-times the weight of Brazil. Still, Indian equities are trading around 30% higher than their long-term averages, or 21-times forward earnings, significantly higher than the broader MSCI World index. Consensus expectations point to growth in earnings of more than 15% in both 2023 and 2024. At the sectoral level, India will continue to benefit from its strong industrial focus on digitalisation. However, Indian equities’ valuations remain high for now, and so look less appealing.

Indian equities’ valuations remain high for now, and so look less appealing

With interest rates at 6.25% in December, and one more hike expected early in 2023, India’s government bonds look attractive compared with other emerging sovereign debt in local currency. High carry yield and an investment grade credit rating of ‘BBB-’ from Standard & Poor’s, mean India’s bonds may see rising levels of foreign interest. Inclusion in major bond indexes would boost their attraction further. At this stage, we prefer shorter-duration Indian sovereign debt, while longer-duration bonds may look more attractive later in 2023.

The Indian rupee has depreciated against the US dollar, from around 40 rupees in 2005 to around 80 rupees today. This is largely due to India’s higher inflation rate compared with trade partners. In the months ahead, the rupee is unlikely to benefit directly from China’s reopening economy, since higher commodity prices will keep India’s current account deficit wide. Any external inflows into equities will be countered by the central bank re-building its foreign currency reserves. The RBI will look to prevent any spikes in the dollar-rupee exchange rate, to keep the Indian currency high yielding, with lower volatility than many of its emerging peers. We see the currency trading in a range of 80-84 rupees to the dollar over the next 12 months.

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It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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