India’s post-election reckoning

• An unexpected election result saw Modi’s BJP lose its majority

• The result has created volatility but is unlikely to derail the economic growth trajectory in India

• India still has a significant pathway of growth.

Indian stock markets have regained some equilibrium after the shock of the general election result. After some initial volatility, investors are starting to take a more sober look at the impact of Premier Modi’s stumble in the polls and whether it will impact economic reform.

An unexpected election result saw Modi’s BJP lose its majority. It must now govern in coalition. However, it is unlikely that the election result will substantially derail the economic growth trajectory in India. Modi’s party still has the largest number of seats in parliament – 240. The next largest party – the Indian National Congress – has just 99. It may force Modi to water down some of its ambitions, particularly over land reform and labour reform, but there is likely to be broad continuity.

India still has a significant pathway of growth. GDP per capita is just $2,730. This compares to $13,140 for China or $11,350 for Brazil. On current growth rates, it could become the world’s third largest economy by the end of the decade. The government has set the goal of becoming a 'developed country' by 2047. Although definitions vary, this would suggest a GDP per capita of over $20,000 and would imply sustained and significant growth for India. The IMF projects growth of over 6.5% for the next three years and the recent election does little to disrupt that.

There are a range of factors supporting Indian growth over and above government initiatives. For example, India is a clear beneficiary of the ‘China plus one’ phenomenon, which has seen global manufacturing companies diversify their production away from China. The government has played a role, putting incentives in place, but the trend is self-sustaining. There has already been significant success in smart phones with Apple setting up in India, but similar growth has been seen for washing machines, renewable energy components and the food industry.

Fragilities

Nevertheless, the volatility surrounding the election does expose some fragility in the Indian market. Although it has recovered, it became clear there was a ‘Modi premium’ in some of the state-owned companies and in some family-owned businesses tied to the government agenda. While these businesses may continue to thrive, we prefer not to invest where growth is wholly dependent on the state.

It also shows why investors need to show some caution on valuations. The market is expensive relative to its emerging market peers and is a little above its own long-term average. It has always traded at a premium, given the growth prospects and strong governance of its companies, but some parts of the market are particularly highly valued.

We believe it is important to focus on those companies where there is momentum for growth and visibility on earnings. We see plenty of companies still beating expectations on earnings and this provides comfort that companies can ‘grow into’ their valuations. The abrdn New India Investment Trust focuses on six structural themes that, in our view, have momentum independent from the government agenda.

‘Aspirational consumption’, for example, is supported by rising GDP per capita. As the economy grows, the middle classes thrive and demand more goods and services. There is also a ‘premiumisation’ trend, as they move to higher quality options. Phoenix Mills is India’s leading premium shopping mall operator, which is benefiting from a first-mover advantage as the Indian consumer discovers the mall experience.

Demand for better healthcare services also increases as wealth rises. We have several hospital and pharmaceutical companies in the portfolio supported by this trend. We have a ‘building India’ theme, which incorporates infrastructure development and urbanisation. Some of this is dependent on government policy but is likely to happen under governments of any kind. Urbanisation is a feature of any fast-growing economy and India is no exception.

We’ve bought in to the real estate sector, for example, which is in the early stages of a longer-term recovery. There are also second-order beneficiaries of the housing boom. We bought Pidilight, for example, which makes wood adhesive and is a significant beneficiary of the demand for furniture.

Digitalisation is also a powerful trend. The country has developed a Digital Public Infrastructure network, commonly referred to as the ‘India Stack’. This unique initiative is designed to help citizens access their data and information online and for government and businesses to provide targeted digital services to India’s vast population underpinned by thumbprint authentication technology.

India continues to suffer from chronic power deficits. In May, the government said it was expecting the country’s biggest power shortfall for June in 14 years. Solar PV and onshore wind deployment is expected to double in India by 2028, which is also creating a range of investment opportunities.

On the abrdn New India Investment Trust, we continue to find plenty of good ideas and have initiated plenty of new positions this year. The recent turmoil around the election does not derail the Indian growth story, but it has exposed some sectors where valuations had become extended. We avoid those areas with a ‘Modi premium’ and look for companies with self-sustaining momentum. There are plenty to be found, regardless of where power lies.

James Thom is senior investment director, Asian equities.

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