One Cheer for India: Hip, Hip but no Hooray?
It seems that America, and American investors, are embracing India like never before. President Barack Obama was the chief guest at India’s recent republic day celebrations. The trip was the first such visit by a U.S. president, and an honor that India has typically bestowed on traditional allies. There was a sense of optimism over India’s place in the world, with Indian media headlines optimistic about the seemingly good chemistry between President Obama and Prime Minister Narendra Modi.
Obama’s visit to India capped several good months for India’s new government. The Modi government came to power on a platform of development economics, reflecting the desire of a poor nation to see rapid economic growth rather than a redistribution of wealth. Along the way there were some unanticipated good fortunes; weakening oil prices moderated inflation and provided some leeway to pursue reforms. And India’s stock market seems to have indicated its wholehearted approval.
Optimism regarding India is becoming the norm—look at the International Monetary Fund growth forecasts, for example. The IMF now expects India’s growth rates to begin to exceed those of China sometime between 2017 and 2018. And it is not as if India’s population is particularly old—on the contrary, 29% of its people are under 15 years of age, and a mere 5% is over 65. For China, the comparable percentages are 18% and 9%, respectively.
There is much that India can do to improve just by copying China’s growth, such as building infrastructure. And India can do so with a more entrenched sense of corporate governance and capital markets. China had to destroy a communist system and try to rebuild free markets. India’s task is presumably easier. So, one cheer for India!
But investors would do well just to cool their heels a bit here. Challenges remain. Structural reforms are difficult to push through given well-entrenched existing interests. These roadblocks get magnified in a democracy, particularly in such a large populous country. India’s parliamentary democracy has two bodies—Upper House and Lower House—any legislation needs to be passed by both these houses. In the Upper House, the ruling party is in a minority and hence has been unable to pass through any significant legislation.
And, moreover, it is not as if the market is trading at cheap valuations. The BSE 500 Index’s price-to-earnings ratio* (using the last 12 month’s earnings per share) is at 21x. While this might look only marginally higher than the long-term valuation of 17x, companies in sectors, such as property have underperformed. Several sectors are much more expensive than that reflected by the aggregate market valuation.
Using forecast earnings, the valuations appear much cheaper at 17x. But this is the point. At the moment, India is trading on expectations—expectations of accelerating earnings, expectations of better governance and expectations of faster economic growth. Given heightened expectations, even minor missteps can translate to pain in the stock market.
So, it is not that we don’t see the value of Modi’s proposed reforms or the promise of a young India, freed from the encumbrances of bureaucracy; it is just that these goals have yet to be achieved. One should invest in India only after a sober look at the long term. Beware of chasing price momentum.
Sudarshan Murthy, CFA
*The S&P BSE 500 Index is designed to be a broad representation of the Indian market. Consisting of the top 500 companies listed at BSE Ltd., the Index covers all major industries in the Indian economy.
Price-to-Earnings Ratio (P/E Ratio) is a valuation ratio of a company’s current share price compared to its per-share earnings and is calculated as the market value per share divided by the Earnings per Share (EPS).
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