Five Megathemes That Will Dominate Indian Economics Over The Next Five Years

Lately it seems that the entire world has forgotten that in addition to China, the EMs are also the BRI - Brazil, Russia and India. However, now that Brazil is outright hostile toward US policies (not so much toward China), and Russia continues to be Crazy Ivan, the only relevant other overheating economy appears to be India. The reason why India has not attained much media attention in recent years, is that unlike China, the country has been doing its thing and not engaging in overt or covert conflict with the developed world. And as China's inflationary star may be waning, we believe ever more investors will continue looking toward India. Which is why, courtesy of Ambit, we present an analysis of what the investment bank believes will be the five key megathemes which will dominate the Indian economy over the next five years.

Megatheme 1: Structurally high inflation

Supply constraints in India’s manufacturing sector have historically caused core inflation to spike every time the economy expands rapidly (see Exhibit A on the left). Limited access to finance, hard infrastructure deficits and labour market issues have and will prevent timely supply responses in this demand powerhouse thus driving manufacturing inflation higher. Furthermore, a growing and young population with rising incomes will cause food demand to grow rapidly, while supply responses continue to be weak. This supply-demand mismatch will drive food prices higher over the next decade.

High inflation has historically been a negative for stock market returns (see Exhibit B on the left) as it crunches companies’ margins through higher input costs. Financial services’ companies emerge as being the most inflation-immune due to their limited exposure to employee costs as well as to raw material costs. Commodity-driven sectors emerge as an obvious hedge against higher commodities’ prices. IT and other labour-intensive export-facing sectors appear to be the most vulnerable to high inflation as higher domestic wages erode their price competitiveness.

Megatheme 2: the rise of the “aspirational” consumer

As a country’s per capita incomes rise, the consumption basket of its citizens changes away from food (see Exhibit C on the left) and essentials to non-food and aspirational items (such as cosmetics, motorbikes and jewellery). India’s consumption basket has been undergoing just this sort of change. Given the structural drivers of this trend (rising incomes, high share of youth and urbanisation), investors should focus on aspirational product manufacturers vis-à-vis essentials within India’s broader consumption story. Exhibit 25 on pg19 gives a list of aspirational stocks. Exhibit 23 & 24 on pg 19 show the outperformance of aspirational stock vis-à-vis consumer essentials.

Megatheme 3: a capex boom in the making

The experience of India’s Asian neighbours suggests that a high GDP growth rate coupled with the investment:GDP ratio hitting 33% triggers a surge in capex (see Exhibit D below). These trigger points along with India’s infrastructure deficit and the Government’s desire to address this deficit has set the scene for a seven year surge in capex. History suggests that the Indian Capital Goods sector stands to gain most, both from profitability and from a stock price perspective, from this impending surge in capex.

Megatheme 4: The coming of age of financial intermediation

India’s per capita income in PPP terms recently breached the $ 3K and its savings to GDP ratio stands at a healthy 32%. Cross country experience suggests that India’s savings ratio should touch ~40% in FY15(see Exhibit E on the left) and will continue to rise until India’s per capita income reaches $ 8 K (in PPP terms) and will max out only at 46%. The disproportionate rise in the quantum of India’s savings over the next decade heralds tremendous opportunities for financial intermediaries as the Indian saver looks to channelize these savings into not just bank accounts but into stocks and bonds as well.

Megatheme 5: India will become a hotbed of conflicts

Whilst the ongoing and widespread conflict in central India between the Indian establishment and Maoists generates headlines, we see a broader theme in these stray instances of conflict and expect their intensity to trend upwards over the next decade as inequalities persist.

As corroborated by cross country experience, the unequal distribution of gains of economic development across social groups and individuals will be the main driver of this trend (see Exhibit F on the left). A vast and stratified populace with a youth bulge will add to the conflict risk.

The escalation of the Maoist movement, indisputably the biggest threat to internal security will pose challenges for the Metal and Mining Sector (refer to Exhibit 59 on pg 36 for details of company-level exposure to Maoism). Security costs for the corporate sector as a whole will rise as crime rates and the frequency of conflict trends upwards. Indirect costs in terms of political donations, bribes and CSR initiatives will be the other head under which costs will rise. Additionally, the corporate sector will continue to partially fund the Government’s fiscal transfers directed at rural India. FMCG and aspirational product companies stand to gain from these transfer payments.