Portfolio Investment Opportunities in India

Section 2

Issues for Consideration

Among the key forces expected to affect India’s securities prices over the near to intermediate term are:

• Fundamental factors
• Valuation factors
• Psychological, technical, and liquidity factors

Please see Figure 4 below.

Figure 4 Select Forces Affecting India’s Securities Prices

Source: Morgan Stanley Wealth Management Investment Strategy.

Assessing India’s Economic Environment

The Indian economy appears to be capable of achieving a higher growth trajectory due primarily to improving demographics, structural reforms, and globalization.

The Indian government has expressed its continued commitment to structural reforms in support of economic growth.

At times, including during lengthy periods of 2013, India’s higher growth trajectory has been challenged by adverse global economic conditions and insufficient policy execution.

Since the 1980s, the Indian economy has been among the most rapidly growing major economies in the world. In the early 2000s, India appeared to transition to a higher growth trajectory (greater than 8 percent GDP growth) driven primarily by three factors:

1. Improving demographics. As India’s working-age population has grown, the dependency ratio (the percentage of the population dependent on the working-age population) has been declining, fueling economic growth through a growing and more educated labor force and higher savings rates as less money is allocated to dependents. 2. Structural reforms. The Indian government has continued the process of structural reform in the trade, regulatory, and investment sectors to encourage private investment, enabling increased investment in India’s infrastructure. 3. Globalization. After fostering an environment more receptive to integration into the global economy, India has experienced a steady rise in its export-to-GDP ratio and its capital inflows-to-GDP ratio, specifically increasing the services exports, which several international debt rating services believe to be of high added value and with the potential to catalyze higher national savings rates and subsequent investment.

The Indian government has continually expressed its commitment to structural reforms aimed at promoting economic growth. Such reforms include:

• Consolidation of the fiscal deficit to more sustainable levels.
• A continued focus on infrastructure investment, particularly in energy and transport.
• A commitment to universal primary education and upgrading the quality of higher education.
• An increasing liberalization of policies relating to Foreign Direct Investment in industries including trade.
• Ongoing divestment of government stakes in state-owned enterprises (SOEs).
• Further integration of FIIs and QFIs into Indian capital markets in order to facilitate investment by Indian corporations via access to deeper pools of capital.
• Continued transition of the tax system away from an indirect tax scheme to a more efficient system based on a direct tax code (DTC) and a goods and services tax (GST).

Intermediate-Term Accelerators and Hindrances in India

In the intermediate term, accelerators in India include:

• India’s economic development has been supported by several decades of persistent commitment to wide-ranging reforms and India has expressed its continued commitment to structural reform, continuing the transition from a state-owned to a market-driven economy.
• India has demonstrated prowess as a world-class exporter of services, reflecting competitive strengths of the Indian economy, including a large, educated, English-speaking workforce.
• India’s economy is in a position to benefit from continued improvement in demographics as the working-age population increases and the dependency ratio declines, driving a higher savings rate.
• The process of urbanization is supporting India’s goal of lifting millions out of poverty and into the middle class, which should drive increased consumption and investment in human capital.
• While much remains to be done in this area, India has invested significant sums in large infrastructure projects including roads, highways, port facilities, airports, and telecommunications/Internet resources.
• As the largest democracy in the world, India experiences the benefits of shared power, transparency, and adaptability that accompany a democratic political system.
• Close to 25 million overseas Indians, along with Indian returnees who have a strong desire to see India succeed, are making important contributions to India’s economy and financial markets.

Conversely, hindrances include:

• While India has made headway in reducing poverty, India’s still-present wide income and wealth gaps could continue to act as a drag on economic growth as those below the poverty line struggle to save and make productive investments for themselves and for the economy.
• India’s large fiscal deficits limit the government’s ability to increase investment as well as the level of productive private investment.
• The extent of corruption in India inhibits economic growth as investment is deterred and misallocated, and trust in the political system is eroded.
• The inadequate state of India’s infrastructure, as of late-2013, particularly in the energy and transport sectors, represents a significant constraint on Indian economic growth economic growth if not upgraded.
• India’s level of nonperforming assets (NPAs) may discourage the banking system from providing the necessary funding for increased infrastructure investment.
• Ecological, environmental, natural resource management, and health challenges remain, including India’s growing need for food, oil, coal, clean air, and clean water; such factors may hold growth below India’s potential.
• As the largest democracy in the world, India also experiences the challenges associated with a democratic political system where achieving the necessary consensus to execute important structural reforms can prove difficult in an environment of increasing political regionalization.

Potential risks include:

• The Indian government has acknowledged the need for more assertive reforms in such areas as infrastructure, labor, education, FDI, and the capital markets, among others; however, it remains to be seen how well the government can execute these intentions through legislative means as well as through the implementation process.
• The increasing influence of regional political parties should make it more difficult to continue pursuing a constructive and coherent reform agenda in an environment where coalition governance is required.
• The ongoing upgrades to India’s inadequate infrastructure carry a large amount of execution risk, with any setbacks in building out the energy and transport sectors resulting in negative implications for economic growth.
• Possible further delays in reforming India’s Foreign Direct Investment policy, especially in the retail trade sector, may slow the transfer of foreign expertise and prevent India from realizing its growth potential.
• India may continue to face delays in reforming its restrictive labor laws, which constrain hiring and labor market flexibility.
• Stagnating levels of domestic savings and investment would leave the Indian economy with an insufficient supply of key growth capital.
• Adverse legislation, such as retroactive taxation, could deter capital inflows.
• India needs to improve its education system and thus sufficiently prepare the large number of individuals set to enter the labor force.
• India needs to provide enough employment opportunities for the large number of individuals entering the labor force.
• Rising income inequality and high poverty levels in less developed states could lead to social instability.

Bullish Factors Affecting India’s Economy and Markets

Fundamental Factors

India’s key strengths and resources include its population profile and projected growth over the decades to 2050, its cultural and historical strengths and folkways, its rule of law and democratic processes and institutions, its abundant domestic and offshore supply of entrepreneurially oriented, hardworking businesspeople, and its geographical positioning in the proximate vicinity of other high-growth nations with similar strengths, agendas, and aspirations.

India’s economy is characterized by a healthy level of private consumption relative to GDP, a factor that will be key to ensuring that the Indian economy avoids the “middle-income trap” where some of the drivers that helped propel high growth in other emerging economies, such as low-cost labor and easy technology adoption, begin to fade and growth slows, stalling middle-income countries’ ascent toward becoming high-income countries. India’s strong consumerism culture, the populist orientation of the government, and the large share of household income in GDP should contribute toward maintaining a healthy level of consumption relative to GDP.

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