On track to unseat China and become the world’s most populous country, India’s economy has some growing pains. But there are still great opportunities there for investors looking to expand their portfolios into an emerging market.
First, the bad news. India’s economy has slowed dramatically. Rocking along last year at a substantial annualized rate of 9.2 percent, economic growth slowed this summer to a more sedate 5.7 percent, according to data from Trading Economics.
Likewise, manufacturing continues to struggle. The Nikkei India Manufacturing PMI, which measures the strength of the factory sector, was 51.2 in September, unchanged from August, according to data from IHS Markit. The reading was below the long-term trend rate of 54.1. A reading above 50 indicates expansion in the sector.
So while there’s expansion and growth — and certainly many countries would love to have growth of “just” 5.7 percent — India is struggling to maintain its breakneck economy.
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The reasons for the slowdown are two-fold. First was an abrupt effort in November by Prime Minister Narendra Modi to crack down on corruption. Without prior announcement, certain large-denomination bank notes were to be retired in short order. The resulting cash crunch was like leaden feet slamming on the economic brakes — its effects lasted for months.
The second problem was the introduction of the GST (the so-called goods and services tax) in July. Companies stopped ordering new goods for their shelves until they were clear about how the GST would be implemented.
“There was a lot of uncertainty about its introduction, and the traders were keen to run down their [inventories] so that they weren’t left unable to reclaim the tax,” says Jon Harrison, managing director of emerging markets macro strategy at T.S. Lombard in London. “It may still be a couple of months before things get to back to normal.”
The GST is meant to replace a patchwork of state-by-state taxes across India.
Short-term problems. However, neither the cash crunch nor the implementation amount to matters that will last forever.
The cash crunch was economically disruptive but eventually will work itself out as long as the country doesn’t make a habit of suddenly retiring high-value bank notes.
The tax changes should help in the long run, by nudging many of India’s more significant manufacturers to be more productive.
“The GST is good in terms of rationalization of tax,” Harrison says. Companies that operate over state lines will be able to consolidate their production to maximize efficiency rather than minimize their taxes.
Another problem is a growing threat to India’s high-tech sector that made Bangalore famous in the west. “The new Bangalore is Lagos, Nigeria,” says Pippa Malmgren, founder of DRPM Group, based in London. “If you want to hire a coder you go to Nigeria.”
She says that the coders there are cheaper than in India “and they are turning out be top notch,” she says.
The long-term outlook is rosy. India has better demographics than China, and its economic engine has more life. “The consensus is that India will be the next the engine of global growth,” says Vincent Deluard, head of global macro strategy at INTL FCStone in San Francisco.
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The population is growing fast, with 33 percent growth since 2000. The median age in in India was 28 in 2016, and younger people are more likely to have families and tend to spend more of their money, both of which are good for commerce. Contrast that positive demographic outlook to China, where the infamous one-child policy has slowed population growth.
Foreign investors also like India’s legal system, which resembles that of the U.S. and the U.K.
The beauty of the legal system is that in the event of a commercial dispute businesses can take the matter to court to get a resolution. That’s true in most countries, but in many of those countries the outcome when suing the government is pretty much predetermined — the state wins. That isn’t true in India, or in most places that operate using a British-style legal system. A company can sue the government and win. Such a matter is important when the state has a hand in the economy, as it has historically in India since its founding as an independent country in 1947.
That legal system also provides a solid foundation for the market reforms that the country has been enacting for years.
Investing implications. While the likely temporary economic slowdown won’t help Indian stocks, the long-term outlook remains appealing. So, if you are already invested, then stay the course. Picking individual securities is always a tricky thing, and it is made even harder in emerging markets such as India, where local knowledge is paramount.
There is also the burden on investors to set up accounts with brokers who deal in shares of companies on the local stock exchanges.
Small investors would be wise to skip such a hassle and consider buying funds instead.
For instance, consider the iShares MSCI India exchange-traded fund (ticker: INDA), which holds a basket of securities which is quite concentrated with the top five holdings accounting for around 30 percent of the total. The fund has annual expenses of 0.71 percent, or $71 per $10,000 invested.
Alternatively, try the WisdomTree India Earnings ETF ( EPI), which tracks the WisdomTree India Earnings index, a selection of stocks in India. Similar to the iShares fund, it is relatively concentrated with 28 percent of the fund held in five stocks. The fund has annual expenses of 0.84 percent.
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If ETFs aren’t right for you then look to mutual funds such as the Matthews India Investor ( MINDX), an actively managed fund that has a minimum investment of $2,500. With 24 percent of the fund held in the top five securities, it is slightly less concentrated than the two ETFs. It has annual fees of 1.12 percent.
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India Stocks Remain a Great Long-Term Play originally appeared on usnews.com
