by Charles Roth, Thornburg Investment Management
India has implemented measures that combined should generate a surge in economic growth, corporate earnings, and double-digit annualized stock returns over the next decade.
When can a country's bluechip stocks be a bargain if they're trading at historically high forward earnings valuations after posting world-beating returns over the last two decades? Right now, if they're Indian, and your investment horizon is at least five years or, better still, up to a decade.
The dollar-denominated MSCI India Index has returned just shy of 400% over the last 20 years, but Morgan Stanley still expects India's stock market capitalization to about triple over the next 10 years to $6.1 trillion. That's the baseline; in a bullish scenario, the potential upside quadruples to $8.5 trillion, driven by eye-watering earnings growth and multiple expansion in the country's consumer and financials sectors.
India's economy and financial market are at an inflection point, driven by "digitization," as Morgan Stanley explains in a new, lengthy report. India's Digital Leap – The Multi-Trillion Dollar Opportunity describes the monumental impact that the convergence of a handful of legitimately transformative initiatives are starting to have on the country, and its economy, which the investment bank also expects to nearly triple in size over the next decade. That would lift India's nominal gross domestic product (GDP) to north of $6 trillion, and make it the world's third-largest.
Two policies unprecedented in scope are dove-tailing with the modernization of India's convoluted, antiquated tax system. Add the rapid spread of smart phones and a sharp fall in data costs, and India is poised to "leap-frog into the digital age."
The first step came in 2010, when the country set about to biometrically identify every one of its 1.3 billion people. It's nearly finished: 1.2 billion people have been registered with retina-scans or fingerprints. Then, in 2014, the government launched a financial inclusion program resulting in nearly all Indian households—around 285 million—obtaining bank accounts, which they can access remotely.
That's a key feature for India's roughly 800 million mobile users, and the 430 million now enjoying Internet access. Morgan Stanley expects the latter figure will more-than-double over the next decade, yet still comprise just 62% of the population. Smart phone penetration is growing even faster: from 300 million today to about 700 million forecast by 2020. Data costs, meanwhile, are plummeting after an infrastructure build-out and brutal price wars between India's telecom companies.
And in July this year, the government implemented "the single biggest tax reform undertaken by the country in 70 years of independence," as India's Economic Times has put it. The Goods and Services Tax (GST) essentially creates a "common market" that replaces thickets of cascading indirect central and state levies. While kinks will no doubt have to be ironed out, the GST facilitates cost-efficient inter-state commerce, which should increase tax compliance and therefore revenues. On the expenditure side, welfare payments are more efficient—made straight into recipients' bank accounts, reducing bureaucratic "leakages" and strengthening the social safety net.
Morgan Stanley reckons that if the primary fiscal deficit remains at 1.2% of GDP, public debt will fall to less than 60% of GDP by 2027, from 69% now. "This leads to a crowding in of private investments with a positive impact on interest rates and inflation," it adds. And as the GST is managed through an online network, taxpayers—both people and businesses—can easily share their income data with potential lenders, allowing creditors to better assess borrower risks and price them more accurately.
Real-time payments systems have been developed that can link biometrically identified, Internet-connected people with remote bank accounts to vendors of goods and services, allowing for immediate customer-to-customer and customer-to-machine transactions, signed with digital signatures. No physical infrastructure beyond a smart phone needed.
The initiatives, Morgan Stanley says, "have ‘digitized' India and brought the country to an inflection point in terms of growth, with a concomitant impact on stock returns, financial sector dynamics, consumption growth and e-commerce activity."
The sectors poised to benefit the most are consumer-oriented and financials. Total online shoppers in India are set to skyrocket from 60 million to 475 million in 2027, while online retail as a percentage of total retail will grow even faster, from 2.2% today to 12.1% in a decade. Unsurprisingly, Amazon, Alibaba and Naspers have been aggressively investing billions of dollars in India. Morgan Stanley figures Softbank alone has invested some $46 billion in local e-commerce and on-line payments, ride-hailing, and real estate platforms.
As for the financials, it sees total loans increasing 11 percentage points to 78% of GDP by 2027; total mutual fund assets under management jumping more than ten-fold over the same period; and collected life and general insurance premiums spiking, as well. Fin-tech companies should see exponential growth.
"As digitization takes hold, SMEs (small and medium enterprises) and consumers will have better access to credit, which should help boost domestic demand. Specifically, SMEs will be able to lift their capital spending, thereby raising sustainable growth, while households will be able to increase their discretionary spending," Morgan Stanley says, adding that the country should achieve upper-middle income status by 2027.
India is undertaking a massive social, economic and technological experiment. Linking individuals' identification, bank accounts, tax documentation with digital transaction infrastructure will certainly hit bumps along the way. But the pieces are in place. India is entering the digital age at breakneck speed.
The opportunities for investors are enormous, but not, of course, without risks. At 18.3 times, the BSE Sensex Index's next 12-month price-to-earnings ratio is trading at record-high levels, outside the Global Financial Crisis-valuation blip. Yet a number of companies will still experience huge earnings growth, supporting high and expanding multiples.
Some squeezing their free cash flows to fuel growth today for higher returns tomorrow may not ultimately generate good returns on capital. Others will. Distinguishing correctly between them will determine how much of the anticipated double-digit annual growth in expected returns investors actually realize.
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