Despite Modi hype, India isn't the next China just yet

Modi en mode 

India is in the spotlight. That shouldn't be a surprise. It's difficult to stay out of the limelight with a gross domestic product of roughly $3.2 trillion and the world's biggest population with 1.4 billion people, but somehow the South Asian nation had managed it. Now, Prime Minister Narendra Modi's first official state visit to the US, shaking hands with President Joe Biden and high-profile executives like Tesla Inc.'s Elon Musk, has caught the attention.

The trip comes against the backdrop of a buzzing economy, equities at record highs and a rapidly growing consumer market. The confluence of tailwinds all but made the prime minister's job easier when pitching his vibrant nation — the largest democracy — to America's most influential executives and investors. As colleagues reported, the visit couldn't have come at a better time. 

And did it work? Absolutely. A series of defence and commercial deals were announced Thursday afternoon in Washington designed to improve military and economic ties. Among them is General Electric Co. planning to jointly manufacture F414 engines with state-owned Hindustan Aeronautics Ltd. There is also progress on an order for MQ-9B SeaGuardian drones made by General Atomics, as well an agreement that will allow US Navy ships to undertake major repairs at Indian shipyards. The pacts showed that "even the sky is not the limit," Modi said.

Come evening, hundreds of guests including Alphabet Inc. CEO Sundar Pichai and Microsoft Corp. CEO Satya Nadella descended upon the White House for a vegetarian-forward meal prepared by guest chef Nina Curtis that included grilled corn salad, stuffed portobello mushrooms, and rose and cardamom-infused strawberry shortcake. 

Bloomberg Economics' Abhishek Gupta said the outcome is "further evidence that geopolitical winds are blowing in India's favour." While India still has a lot of work to do before it can successfully integrate into global supply chains, "a favourable geopolitical environment is a key reason why we're bullish on India's manufacturing potential." It's also intriguing that those winds are blowing in a very different direction from the era before the Global Financial Crisis, when Bloomberg Businessweek was devoting a supplement to "Chindia." Whole books were devoted to Chindia, the idea then being that the two emerging Asian powers would develop a kind of symbiotic relationship. Now, with the notion of inexorable globalisation in eclipse, India is boosted by the west's desperate need for an alternative to China. Xi Jinping's regime is widely seen as uninvestable; Modi's is far more palatable by comparison.

However, Modi's human rights record is very questionable, to say the least. In 2021, this prompted Freedom House to drop India's rating from "free" to "partly free." It complained of a "multiyear pattern" in which Modi's government had presided over "rising violence and discriminatory policies affecting the Muslim population" while cracking down on freedom of expression. But there are layers of complexity, as Ruchir Sharma points out. Questioned by journalists in Washington, Modi said he was "really surprised" to hear India's commitment to democratic values questioned by Americans. "In both countries, democracy is in our DNA," Modi said. "We live democracy, and our ancestors have actually put words to this concept, and that is in the form of our Constitution."

For now, India's economic successes are helping investors and politicians alike deal with their qualms. Indeed, the country's manufacturing dream is close to becoming a reality, Societe Generale strategist Frank Benzimra wrote in a recent note. "The economy is growing at 6%, currency volatility has decreased, earnings are resilient and foreign investors are returning," he said. That has helped Indian equities deliver the strongest returns in emerging Asia in the second quarter. "Conditions are in place for the outperformance to extend to the whole year," he said, attributing these to manufacturing and technology. 

Dubbing India as the "fastest-growing economy" in the G-20, SocGen upgraded the nation from neutral to overweight for three reasons: 1) resilient earnings (trading at 21x their 12-month forward earnings — a more than 50% premium to Asia peers); 2) less volatile assets as domestic investors take on a growing share of equity turnover; 3) positive momentum flows from foreign investors.

Financial assets in India have outperformed their regional peers. Indian equities have attracted almost $10 billion in net foreign inflows since March, on track to be the most in any quarter since the end of 2020, colleagues reported. They are also the best performers in Asia during the second quarter, with conditions in place for the outperformance to extend to the whole year, according to SocGen. The rally of the last few months is impressive:

India emerges atop

Nifty 50 has far outperformed its Asian peers in the second quarter

This is quite a development. India has been in favour with emerging markets investors for decades, but this rally compared to the rest of the complex is startling. Judged by price/book multiples, MSCI's India index has always traded at a premium to rest of EM, though a bit more narrowly now than during the Chindia boom in 2007. Meanwhile, it is outperforming like never before:

The India premium

Indian stocks are on a tear, buoyed by generous valuations

Rupee-denominated bonds are set to see the longest streak of monthly buying by overseas funds in almost four years, according to Bank of America Corp. The local currency is also offering the second-best carry returns in Asia this year.

Like other emerging markets, India is currently benefiting from its central bank's decision to start tightening monetary policy well before developed market central banks joined in the fight against inflation. The Reserve Bank of India is set to wind down the cycle soon, and left its benchmark rate unchanged this month. In minutes of the monetary policy panel meeting released Thursday, RBI Governor Shaktikanta Das said the country's macroeconomic fundamentals are strengthening and growth prospects are steadily improving. 

Tightening cycle nears end

Strategists predict RBI could ease monetary policy early next year

"Our fight against inflation is not yet over," the governor said. But headline inflation has since fallen to within the RBI's range of 2% to 6%. Jefferies Financial Group Inc. strategist Christopher Wood is positive: "It remains much clearer that inflationary pressures have peaked in India and the rest of Asia than is the case in the US." 

India's peak inflation

Headline inflation now falls within the central bank's range of 2-6%

To Capital Economics, interest rate cuts will materialise in early 2024. Over the longer term, economists Shilan Shah and Thamashi De Silva said that "India's growth prospects are still among the brightest in the world," citing a workforce they predict will also overtake China. They added that India "stands to benefit from strong population growth and the 'friend-shoring' of manufacturing supply chains as the global economy fragments."

Does this mean India is the next China? To Jason Hsu, chief economist at East West Bank, India is "not quite there" yet:

India is still one of those economies where the financial institutions aren't mature yet. Most of the vibrant underlying economy is not listed. So you can't actually buy the exciting part of India, right? Very few things are listed in India. The market cap of India is a fifth, an eighth of China today. So India just needs to have its financial institutions mature more and as a result take on a bigger and bigger footprint within the index basket. 

Nancy Curtin, chief investment officer at AlTi Tiedemann Global, shares the same sentiment. While India holds a lot of promise, and is even the "most interesting" within the emerging market economies right now despite having expensive valuations, it still has some way to go.

"It's too early for India to be an asset class of its own," she said. "But it's certainly very, very interesting. We access India through our emerging market managers, of which India represents quite a significant allocation and maybe more so since people really are not allocated to China at the moment."

As sentiment toward China sours, many are betting India will be the windfall beneficiary. To Sunil Koul, Goldman Sachs Group Inc.'s Asia Pacific equity strategist, even if China recovers, "you may not see money coming out of India, or at least you may not see a sharp selloff," he told Bloomberg. The Indian market's fundamentals are solid enough to continue to attract long-term investors, he said. And for now, they are more than enough to overcome ideological qualms and signs that the market is getting expensive. 

— Isabelle Lee

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement