Up until the financial crisis of 2008, India was booming. For nearly two decades, the country exhibited stable economic growth as watershed reforms introduced in the 1990s led to lower import tariffs, the removal of some costly regulations and greater foreign investment.
In fact, in the five years prior to the financial crisis, India’s GDP growth had been more than 8%, according to figures reported by The Hindustan Times. For years, as many focused on the dramatic growth of India and China, they questioned which of the two would emerge as one of the largest economies in the world.
Fast forward to 2019 and the narrative has been somewhat more complicated following the financial crisis. Not only is the Indian economy on a lower growth trajectory than it was in the years before 2008, but recent events have many worried about an even bigger economic slowdown.
Five straight quarters of decelerated growth and a recent sell-off, which has seen foreign investors dump $4.5bn in equities since June in particular, have left many concerned about India’s economic prospects in the longer term.
Valuation of equities dumped by foreign investors since June
India’s prime minister, Narendra Modi, who for years has been criticised for his lack of economic reforms and nationalist tendencies, is now looking to reinvigorate investment in the country. In the last few weeks, he has made significant moves in a bid to halt the economy’s slowing growth.
At the end of September, Modi made a surprise decision to cut the country’s corporate tax rate to 22% from 30%. The move has shown some early signs of success, with foreign investors buying $461m worth of stocks in the days following the cut.
In the same month, Modi also held talks with the heads of a number of US businesses – including CEOs from JPMorgan [JPM], Bank of America [BAC] and IBM [IBM] – to discuss further investment in the country. During the talks, executives discussed increasing access to India’s retail banking sector as well as e-commerce, sources told CNBC. Modi was seen to be calming the executives’ concerns about the country’s economic slowdown.
At the time, analyst Nick Payne suggested that the government will follow up the tax cut with further stimulus measures, which may turn India’s economy around, Bloomberg notes.
Valuation of stocks bought by foreign investors following the corporate tax cut
Regardless of whether or not any of the proposed plans will take effect over the next few years, there are some key factors that will determine India’s strength. Its vast population of 1.3bn, only outsized by China’s 1.4bn, creates an enormous potential market for growth.
However, India’s population is not only large, but it also has a burgeoning middle class and a relatively low median age of 29. The country’s population is also likely to surpass China’s in the coming years, with the UN’s Population Division predicting that such an event will occur by 2024.
These factors have made India key for companies such as Unilever, which recently revealed that the country could become its largest market, according to Mint. In addition, Kia Motors recently said it will focus on India’s middle class in the next five years as it looks to capitalise on the country’s relatively low number of cars per capita.
Challenges facing India’s economy
Currently, though, India’s economy is stalling. The country has fallen 10 places in the World Economic Forum’s Global Competitiveness Index, now ranking at 68. There have also been issues in the labour market due to poor policies on workers’ rights, high rates of unemployment and a lack of participation among women in the workforce. These have been barriers for India’s tech businesses to expand.
Such factors have led the World Bank to cut India’s economic growth forecast. It now estimates 6% GDP growth for the fiscal year to March 2020, down from its April estimate of 7.5%. That would make it lower than the 6.8% growth recorded in 2018.
The World Bank has also said the country’s “cyclical slowdown is severe”, mostly due to a deceleration in local demand. “In such a weak economic environment, structural issues surface and the weak financial sector is becoming a drag on growth,” it stated in its South Asia Economic Focus report.
India’s stocks index review
Despite India’s challenges, investors have been bullish on the Indian Sensex and Nifty indices following Modi’s tax cuts. Bank of America suggested the Nifty’s one-year forward consensus earnings could increase by 7%, Bloomberg notes, while Citigroup [C] raised its March 2020 Sensex index target to 40,500 from 39,000.
An analysis by ICICI Securities pointed to a potential EPS boost of 6% for both the 2020 and 2021 financial years, while the expectation from Kotak Institutional Equities is that profit for the Nifty 50 will grow by 25% in 2020 and 19% in 2021, according to Bloomberg. However, some analysts noted concerns about IT, pharma and electrical utilities stocks.
Kotak Institutional Equities profit expectations for the Nifty 50 by 2020
Yet concerns about the country’s shadow-banking sector, which some have previously suggested could cause big problems for the economy, have not dampened many investors’ bullishness.
“Shadow-banking incidents are unlikely to derail the positive backdrop for India equities following the tax cuts,” said Nader Naeimi, who oversees more than $1bn in assets at AMP Capital, in remarks to Bloomberg. “Indian firms have now become a lot more competitive, which will attract a lot of investors, even those that had valuation concerns.”
Despite the market’s recent rout, Naeimi expects the Sensex index to rise by more than 20% in the next two years. Because of the tax cuts, stocks in India are “on the path of a multi-year bullish phase”, he said.
“Indian firms have now become a lot more competitive, which will attract a lot of investors, even those that had valuation concerns” - AMP Capital Head of Dynamic Markets Nader Naeimi