Investing in India – all about the micro
In April this year, the International Monetary Fund’s World Economic Outlook showed that India is set to overtake China as the fastest growing major emerging market, with a forecast of 7.5% GDP growth in 2015 to China’s 6.8%.
The impression of renewed momentum in the economy after several disappointing years is reawakening interest from many international investors. Foreign institutions put almost US$6 billion into Indian stocks in the first three months of 2015, compared to around US$16 billion in the entire of the previous year.
Yet this upbeat narrative is misleading in many ways. There are compelling reasons to invest in India, but recent developments in the economy are not among them. While the vision that Modi has for India is positive, expectations have run far ahead of execution. India continues to suffer from economic and political barriers to progress.
But focusing on macroeconomics is to misunderstand the main drivers of equity returns in India. Successful investing in this market is not about anticipating twists and turns in the economy, but about finding quality companies that can thrive regardless of what comes. It’s all about the micro rather than the macro.
A challenging environment
Macroeconomics in India have never been comforting. Inflation is often high, with CPI averaging around 8% per year over the last three years and reaching double-digit levels on a number of occasions in the past according to the IMF.
The Indian rupee has edged lower in recent years, with the S&P Indian Rupee Index—which replicates the performance of the rupee versus the U.S. dollar—down approximately 11% as of June 2015, since its peak in July 2011. The twin deficits—a persistent, large budget deficit and current account deficit—are frequent cause for concern. It’s no surprise that when markets began worrying about the impact of the end of the US Federal Reserve’s quantitative easing programme on emerging markets, India was classed as one of Morgan Stanley’s “fragile five” that seemed especially vulnerable.
Inconsistent and excessive regulation adds to the problems. India’s economy is held back by a tangle of overcomplicated, poorly implemented laws, a legacy of its history as a “planned economy” for much of the time between independence and the 1990s. One recent example of inconsistent regulation is the Minimum Alternative Tax (MAT)—a form of corporate taxation hitherto not traditionally applied to foreign investment funds in India. Many funds are now fielding demands from Indian tax authorities to pay retrospective MAT charges. These demands, currently being challenged by large funds and fund tax groups, have led to uncertainty for some investor groups and these claims could have repercussions on equity market flows.
There have, however, been some policy improvements over the last two decades. Reforms in the early 1990s liberalised the outputs of the economy, sweeping away licences and quotas that restricted which companies could produce which goods and in what quantities.
However, policymakers insufficiently liberalised the rules governing inputs such as land and labour markets, which remain restricted by red tape. Only by freeing businesses from this red tape and introducing simpler, more effective laws can India’s potential be realised.