Update on India: Time to take another look

India’s stock market has underperformed global markets overall as well as some of its emerging market regional peers so far this year. However, there are signs that perhaps the tide has turned, and investors may be taking another look, according to Franklin Templeton Emerging Markets Equity’s Sukumar Rajah. He shares his latest outlook in light of recent events.

India’s economy has been resilient in the face of recent challenges, including the banking turmoil impacting the United States and Europe. India’s gross domestic product (GDP) is expected to grow 5.9% in 2023, on the back of 6.8% growth in 2022.¹ Contrast that with negative numbers anticipated in parts of Europe this year and growth of only 1.1% seen in the United States—with many forecasters anticipating a recession there as well.

Meanwhile, Indian stocks have recently underperformed—the MSCI India Index declined in the first quarter of 2023, while the MSCI All-Country World Index, a global stock market proxy, was up more than 7%.² In March, investors pulled back from perceived “risk assets” in the wake of the banking turmoil in other parts of the world, but Indian companies—particularly technology companies—faced other challenges.   

The Indian information technology (IT) sector represents a sizable part of India’s stock market and has been growing in recent years. Indian companies have been able to capture a more substantial portion of the global IT spending pie. It used to be a small sector, with a small share, and thus able to grow via gains in market share, even when the pie was shrinking. But as Indian companies in the space have grown in size and importance globally, they are now more exposed to global issues. As such, growth rates for many Indian companies may be lower than in the past, but I think the long-term prospects still look good. That said, as investors, we have to be selective. The risk profiles of companies differ depending on how diversified they are, the type of clientele they are exposed to, etc.

Valuations

Some analysts surmised that the valuations for Indian stocks didn’t make sense in a lower-growth environment, and thus the market needed to correct. Currently, the price-earnings ratio for Indian stocks (based on the MSCI India Index) stands at 24.13, higher than the MSCI Emerging Markets Index, at 12.41, or the MSCI All Country World Index, at 18.30.³

As investors, we discount cash flows based on an appropriate tapering growth rate to compute the intrinsic value of companies. In the IT sector for example, we see reasonable upside potential for some, but not all, so we need to be selective as we invest. Midcap IT companies could see improved prospects if they are more exposed to clients that are growing very fast, but smaller companies tend to come with a higher risk profile.

Where the penetration is high in any sector, earnings growth rates may be challenged as these companies are most exposed to global cyclical issues; IT services being an example. In other areas of the market, generic drugs have been facing such challenges for some time, so some of these companies are moving to specialty products that offer a better opportunity to increase market share. Emerging sectors where India is trying to penetrate global markets also offer opportunities for investors, including financial services support, software as a service, electronics, solar equipment, chemicals and education.

While earnings growth for sectors like IT services might slow down due to some of the above discussed factors, growth is accelerating or being maintained in a variety of sectors due to robust domestic demand and/or growing opportunities to export. I would anticipate mid-teens earnings growth for fiscal year 2024 (year ending March 2024), which is still respectable and probably represents longer-term potential as well.⁴

Economic and market resilience

From a macro perspective, India’s economy has become more resilient, and the current account deficit has declined from prior peak periods. The fiscal situation is better, the risk profile of the economy has improved, and India is in a position to generate foreign exchange earnings. Inflation has also been on the decline, with the March Consumer Price Index coming in at 5.66%, its lowest level in over a year.  India’s Manufacturing Purchasing Managers Index stood at 57.2% in April, a four-month high.

That said, the world has changed, supply chains have changed, and price pressures are likely to continue in the developed world. This might mean that global interest rates might not return to the levels we have seen in the last decade. While this could imply that emerging markets might not be awash in liquidity, markets like India with a sustainable growth story for a variety of companies and sectors might see good upside potential driven by organic growth and resilience.

Overall, I think the market is still very attractive compared with other markets in the region, and I believe the recent underperformance is unlikely to continue. I think India has an opportunity to become even more resilient, and domestic investor net inflows should continue as a result. We are also seeing signs of global investors looking to allocate funds to India on a standalone basis. That should change the market picture materially.

Many investors are not well informed of the changes that India has seen in the last few years and are yet to understand how differentiated the India story is. Few countries can sustain GDP and corporate earnings growth at high levels for decades, and therein lies the unique opportunity India offers.