Weekly outlook

India’s stock market – normal service resumed?

By Tom Stevenson, 28 July 2010

As a British delegation pays homage in New Delhi, we look at the investment opportunity in India.

India is no ordinary trading partner for Britain, as a huge delegation of politicians and business leaders this week can confirm. Led by prime minister David Cameron, the great and the good of the former colonial power has flown to the sub-continent in a new mood of "humility" to seek business opportunities in one of the world's most dynamic emerging markets. The trip is being seen as a delicate diplomatic manoeuvre to re-invigorate a relationship which has waned in importance for India and grown ever more vital for Britain as it jockeys for commercial position in a world that is increasingly dominated by newly industrialising countries in Asia and Latin America.

"The performance of Indian shares over the past three years provides some interesting lessons for investors." Tom Stevenson

The delegation is seeking to prise open the partially locked doors of India's financial, insurance, retail and legal industries and to pave the way for key export sectors like defence. In some respects Britain enjoys a privileged status in India, thanks to history and language, but it has allowed the relationship to go cold in recent years.

India's new-found prominence on the global economic stage has been reflected in its stock market. Indeed, India can look back on the financial crisis and ask with some justification "what crisis"? As the chart below shows, the benchmark Sensex index (India's equivalent of the 30 stock Dow Jones Industrials) has recovered from its heart attack in 2008 and resumed its upward path – albeit at a more sustainable pace than in the five years from 2003.



The performance of Indian shares over the past three years provides some interesting lessons for investors. First, it shows that talk of decoupling – the idea that emerging markets can prosper whatever happens in the developed world – was premature in 2008. Like other emerging markets, India fell off a cliff during the financial crisis as hot money withdrew from whatever investors perceived to be the most risky markets. The V-shaped recovery in 2009 showed that at times of stress the emerging markets remain a magnified version of the developed world's bourses.

What is interesting about India's performance in recent months, however, has been the way in which its shares have managed to shrug off all the woes in the euro-zone and fears in the West of a double-dip recession. Investors have started to recognise that in a world of potentially sub-par growth for many years to come, the above-average potential of the world's biggest emerging markets is even more attractive.

Last year, Indian GDP grew by 5.6%, well ahead of anything seen in the developed world, and it is expected to grow even faster this year. This is a reflection of a number of key competitive advantages enjoyed by India, principally: demographics, a skilled workforce and an expanding middle class.

India's 1.1bn people are young, with nearly a third being under the age of 15. This means that the dependency ratio is very low (in contrast to many developed countries like Japan, for example). The vast majority of India's population is either working or poised to join the workforce and with 100m people set to enter the labour market over the next 10 years the outlook for consumer spending, for example, is excellent.

Another key comparative advantage for India is the fact that its workforce is highly skilled compared to other emerging markets. The country has plenty of scientists, engineers, lawyers and financial managers to build successful high-value industries and that, in turn, is attracting foreign investment. Agriculture employs around half the population but it only represents around 15% of GDP thanks to the growth of industry and services.

The third key factor from an investment point of view is the size of India's middle class. Just as the economic future of China hangs on the growing numbers of people entering the middle earnings band in which the purchase of things like cars, TVs, computers and mobile phones becomes a possibility (and then a necessity), so India is on the cusp of a massive expansion of consumer spending.

The retail landscape reflects this fundamental change. Five years ago, just 3% of the Indian retail market was described as "organised" – this sector now accounts for 10% of the market.

There are still risks associated with investing in an emerging market like India. First and foremost of these is volatility – investing in India must be a long-term proposition, with patient money that will not need to be withdrawn from the market at short notice.

Valuations are also no longer at the bargain basement levels of early 2009, although they are not untypical for mid-way through the economic cycle. With earnings looking like they are returning to pre-crisis rates of growth, share-price multiples look manageable.

Inflation is another issue and the Indian central bank, like others in the high growth emerging world, has already begun to tighten policy in order to keep prices under control.

Despite these short-term risks, the long-term picture in India looks very bright. The demographic tailwinds for India are unique and despite the strides it has already taken there looks to be much further to go for this exciting emerging market. No wonder Mr Cameron is prepared to turn three hundred years of history on its head and acknowledge that, in economic terms, Britain needs India a great deal more than the other way round.