Financial markets

Indian economy: positive in the long term?

Looking ahead as an investor has become more difficult than ever. But it's worth not to lose sight of the Indian economy and its long-term potential.

Date
Author
Rajesh Cheruvu, CIO India, Stefan Hofer, Chief Investment Strategist APAC
Reading time
6 minutes
Indian economy: positive in the long term

The Covid-19 pandemic has rendered even the most mundane economic forecasts exceptionally difficult to make, in our view. The pandemic, in multiple waves with differing characteristics, means trying to factor in new variables that we have little or no precedent for. 

Thankfully, longer term forecasts, where we can assume the world has moved firmly beyond Covid-19, may not face these challenges. In this light, for this article, we look at recent research on long-term forecasts for India's economy.

Economic forecasts: how to look ahead?

Forecasts on economic growth and inflation are arguably the first building blocks for fundamentals-driven investors. They help to decide when, where and how much to allocate their capital:

  • Economic growth: This factor should ideally correlate with corporate profits. Ultimately, investors are interested in seeking out where the next "wave" of earnings growth will come from.
  • Inflation: Having a view on inflation results in more nuanced conclusions. Rising or falling inflation however may signal how a given central bank may react. Easing monetary policy can be interpreted as being a "support" for financial assets, whereas the tightening conditions often result in higher volatility, at least in the shorter term.

Longer term growth, as argued by mainstream economics, for emerging markets hinges upon a multitude of factors. Some are much harder to quantify or evaluate than others, but in our view, are no less important.

For example, the stability, reliability and transparency of public institutions such as the central bank or ministry of finance is key to building investor's longer-term confidence and willingness to put their capital at stake. But how could investors factor in these aspects, given that they are not directly measurable?

The importance of Foreign Direct Investment for Indian economy

A "short cut" to answering the above questions is to evaluate Foreign Direct Investment (FDI) flows into a country. High and rising FDI flows signals that non-financial investors see attractive investment opportunities and are willing to invest in real assets such as factories or other projects, some of which can take years before they become operational.

According to data collected by Deutsche Bank, India saw gross FDI inflows over USD 100 billion over 2020-21, which as the below chart illustrates, is substantially higher than levels seen a decade ago.

India: Foreign Direct Investment (FDI)

So far, most of these ventures have been on the one hand in the services sector and in tech start-ups. One especially impressing figure is for instance the number of unicorn start-ups. In 2021 India has become an important location for these start-ups, valued more than one billion US-Dollar. With 32 unicorns located in India (according to Statista as of April 2021), only the US and China had a higher number of these valuable newcomer companies. Other ventures of foreign investors were lucrative businesses in sectors like insurance, retailing, communications, banking or defense.

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Another way to look at this phenomenon is that countries compete with one another - especially emerging markets. All of them aim to attract FDI as this is one important source of job creation, and ultimately can contribute to rising standards of living. In this regard, India has come a long way in terms of attracting international capital. In our view, the country is building a stronger foundation for future growth. The following points support this assumption:

  • The economy in India today offers a stronger ecosystem of manufacturers in various segments, often concentrated in clusters. Therefore, new businesses have a wide range of possible suppliers.
  • Its domestic market has a huge potential, waiting to be unleashed, for example in areas like life and general insurances, investment services, processed food and beverages or personal cars.
  • The local market is sizably large and favourable demographics may make for attractive investments for over next three decades over comparable emerging markets.
Indien GDP

Both local and India's federal governments have supported the economic renaissance with various tax incentives. In many cases, Indian regions have competed with each other to win new ventures, especially hoping for new employment opportunities. India's economic success has also contributed to economic stabilization because corporates and banks have used this momentum to undertake balance sheet deleveraging.

Structural reform: often the most challenging of all

India, like many emerging markets, has a sizeable "informal" economy. Deutsche Bank forecasts that incorporating more workers into the formal economy, then India's gross domestic product (GDP) per capita could double to USD 4 300 by 2030.

In our view, achieving this ambitious aim requires a host of further legal and structural reforms. Typically, this means increasing the flexibility of the labour market while investing heavily in physical infrastructure (transportation, energy etc.) so businesses can operate with greater ease and efficiency.

In the case of India, the legislature has scrapped 1 500 arcane laws and adopted a modern insolvency code and goods and services tax. The government also had an eye on equitable growth. The measures ranged from direct cash benefits and digital transfers to initiatives in housing, sanitation, health, education and the transport infrastructure.

In agriculture, incomes have been increased, as has the productivity of the sector. Investments in storage and processing have also improved value creation and measures to improve rural infrastructure and housing conditions are contributing to better living conditions on the countryside.

India Taxi

Summary

Following the positive outlooks mentioned above and further reforms proceed as envisaged, investors could witness a doubling of India's economy through to 2030. That would be nothing short of a game-changing outcome, in our view.

Sure, Covid-19 has absorbed the urgent attention and enormous resources of governments the world over. However as we transition to a post-pandemic environment, we argue that fundamentals such as FDI flows and meaningful structural reform will once again take centre stage. India could occupy that spotlight and be investor's first port of call - for emerging markets and beyond.

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