Talking Heads – La buena racha de la renta variable india

This is an audio transcript of the Talking Heads podcast episode: Indian equities on a roll

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing Indian equities. I’m Daniel Morris, Chief Market Strategist. And I’m joined today by Jayesh Gandhi, Head of India Equities. Welcome, Jayesh. Thanks for joining me.

Jayesh Gandhi: Happy to be here.

DM: Jayesh, let’s start with talking about performance and then also valuations. Certainly, we’re aware of the good performance you’ve had with Indian equities over the last three years, but at this point, that then raises a question about how sustainable that is. What can we expect in the medium to long term? And very much alongside that, there’s a question about valuations, which, thanks to the strong performance, are much higher than they’ve been in the past.

JG: Historically, Indian equities have traded at a premium to emerging markets and to global equities, and we believe this premium is likely to be sustained. There are many reasons for this. If we compare [India] and emerging markets, China accounts for 30 to 40% of the emerging market index. And we know that China is going through a slowdown. And because of China’s larger percentage, the numbers for emerging markets [generally] are depressed. Hence, comparing Indian valuations with emerging market valuations today could be misleading.

The best would be to compare Indian equity valuations with its own history or with global equities including developed markets. In that context, we find the premium is in the 10 to 15% range, which is not exorbitant, as some reports suggest.

There are fundamental reasons or differences in Indian equities compared to emerging market equities. For example, India is dominated by service sector companies: 50% of Indian companies are service sector companies, which [typically] have a much stronger balance sheet, stronger ROIC [return on invested capital] and deliver consistent returns.

If you compare [that with] most emerging markets, they are dominated by cyclical and commodity sectors, businesses that are dependent on global economic growth. Indian companies are dependent more on domestic growth. And the domestic economy has been growing pretty healthily.

The earnings for Indian companies have been growing consistently faster than those of most other emerging markets, given India’s strong economic growth and improved corporate profitability. This is the one clear reason why the premium exists. Also, the resilience of the Indian economy during the last two or three years has actually enhanced a premium during difficult times when economic growth remained robust.

Finally, we think the premium is also attributed to the large domestic flow of savings, which is going into equities. One of the big trends in India is the financialisation of savings. Younger investors are moving away from traditional assets such as real estate and gold. The steady inflow of money into equities provides a much stronger investor base and [is] also countering the volatile foreign investor flows. The strong domestic flows have lowered market volatility and made Indian equities more attractive as the benefit of diversification is available with the low correlation with other [emerging markets]. All this makes Indian equities stand out compared to other emerging markets and hence the premium. So, it is fair to say that Indian equities are not cheap, but we believe that strong growth and a better corporate profitability will result in decent returns for investors over the medium to long term.

DM: Of course, it’s all very good to talk about how good the returns have been and naturally we all hope that those returns will continue. But at the same time, we have to address the risks. There’s an election coming up in India. There are other challenges that the country faces. Could you talk about some of the key risks you see for Indian equities?

JG: The big risk for India essentially is energy imports. India depends on high imports of energy, particularly crude oil, gas and coal. As the economy grows, the need for these imports also keeps on increasing. [High] energy costs will hurt growth and slow down economic output.

The Indian economy is also dependent to a fair extent on foreign savings, foreign capital inflows, particularly for infrastructure. The underinvestment is well-known and is the key focus for the Modi government. High interest rates globally and quantitative tightening globally does hurt capital flows and to some extent would lead to some slowdown in economic growth in India.

Now, both these challenges have played out in the last two years, but policymakers in India have been able to successfully overcome these and grow the economy. That gives us a confidence that the policymakers are well aware [of this challenge] and have the toolkit with them to manage this situation.

Last but not the least, there is the risk of having a large population with a relatively low per capita income. There is always scope for social unrest and populism which can impact long-term growth. Political stability and a continued focus on [the] economic agenda are critical when it comes to preventing this from happening. National elections are under way in India, with the Modi government seeking its third term and by most estimates, it is clear that the Modi government will come back into power. What this will bring is continuity in reforms, continuity in policymaking and political stability, which I think is critical for India and its long-term economic growth.

DM: Jayesh, thank you very much for joining me.

DM: It was my pleasure. Thank you very much for having me.