The excitement about India has resulted in rich valuations. How are you thinking about the valuation of Indian markets and how are you positioned?
On valuations, with any metric we look at, the Indian market does screen to be expensive – but we have to think about why investors pay a premium for India, and there are some very compelling reasons for that.
Besides the fact that there is a long runway for growth, the Indian economy is very domestic oriented. It’s a democracy, and the institutions in India like the Reserve Bank, the Election Commission, the Judiciary (of India) are fairly strong and independent. The Indian equity market is the most diversified within emerging markets, from a sector as well as a company perspective, and, most importantly, as investors we pay for the earnings of the underlying market. Indian corporates have done a good job in converting growth into earnings over the many years. I think India also gets a premium because of the lower risk of geopolitics. So there are some good reasons why India should command a premium.
Having said that, we look at India within an emerging market context, and we are always looking at the risk-adjusted returns of the market following the very strong run we have seen in many of our holdings. We have reduced our India exposure because we find better risk reward in other markets. As a result, we are currently slightly underweight on the market. In the background, we have been building a pipeline of ideas in the companies that we would like to own at a sensible price. Structurally I would say, I can see we will be allocating more capital to India over time, but we have to be very mindful of the price we pay, because that will determine the returns that we get from the market.
I can see we will be allocating more capital to India over time, but we have to be very mindful of the price we pay, because that will determine the returns that we get from the market.
As we've seen with other emerging markets, a burgeoning retail participation in the stock market and strong domestic flows have been hallmarks for India over the last few years. Do you think that’s sustainable?
Historically, if we look at the Indian markets, they have been primarily driven by the foreign flows. There is a significant high correlation between India’s equity performance and the foreign flows into the Indian market. But over the last few years, that has now changed. So domestic institutions have now become very meaningful in the market, and I think it is a good thing because it provides a counterbalance when there is foreign selling. So the volatility in the Indian market as a result of the domestic flows have reduced. The beta of India, compared to other emerging markets, has also come down. Now whether these flows are sustainable, I think we have to look at the flows in context. Historically Indians have preferred physical assets like property or gold. The allocation to equity has been very low. Now, with the economy formalising, that is driving a move into equities as well, because the cash economy is reducing and digitisation is making it very easy to invest small sums of money into the market. I think it’s only like 5 or 6% of savings, which is coming to the equity market right now, and for the household, maybe 6 or 7% of their net worth is tied to the equity market. So I think, yes, the flows have been excellent. But where from where we are, I think there is a long journey ahead.
What is the biggest risk to India's economy in the long term?
So, I think in the long term – or maybe it’s a medium-term risk – is climate change. Although it is a global risk, India is one of the countries which is most vulnerable to the impacts of climate change. We are already starting to see that with rising temperatures, like the heat wave which is going on right now in many parts of India. There is water scarcity in some parts, while there is excessive rainfall and flooding in other parts of India. So, extreme weather conditions are happening already and climate change has an impact not just on the economy but on society at large. It is going to impact food security, agriculture, physical assets – you name it. India is not standing still, by the way. I think there is a lot of progress which is being made on the policy front and on the industrial development front to move towards a green economy.
But I think the challenge is very big, and I would think it requires to double down on the efforts and India has to keep at this. The other challenge, which is not as visible right now is on geopolitics. The current administration has done a fantastic job in building relations and managing the global powers, and India has benefitted from that. India has a strategic benefit in the sense that many countries see India as a counterbalance to the rising influence of China. But geopolitics is a very tricky thing; relations can change over time and India has to manage that very well. Any misstep on geopolitics could prove to be very costly and risky for India.
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