Can India’s growth sustain?

Please note: All data referenced in this article is sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.

Key points

• India’s growth story remains resilient and broad-based across industry, services and agriculture
• Goods exports, in particular, should benefit from global supply chain diversification, stronger domestic balance sheets and the government’s policy support
• A relatively stable currency, and productivity gains aided by massive infrastructure spends, should also continue to support this progress
• Central elections in mid-2024 bring their own set of anxiety amongst investors, but while cautioning against historical performance not repeating itself, risks arguably remain marginal 
• With much uncertainty on the outlook for inflation, interest rates and global growth, diversification is particularly important in managing portfolio risk levels
• For discerning investors, private credit could provide a good risk premium.

India’s growth story remains resilient and broad-based across industry, services and agriculture. Exports, while dependent on global growth, should comparably do well. Goods exports, in particular, should benefit from global supply chain diversification, stronger domestic balance sheets and the government’s policy support. A relatively stable currency, and productivity gains aided by massive infrastructure spends, should also continue to support this progress.

With investment in traditional sectors being typically government-led, we believe more public investment will be needed to drive the structural shift upwards in overall investment, and push the gross domestic product (GDP) growth rate above 6.5%. Encouragingly, fiscal capex has increased over the past year, with the government planning investment of more than INR 150 trillion over the next five years. That said, massive capital injections such as the INR 10 trillion planned in the FY24 budget cannot keep rising at the same pace, and the need for fiscal consolidation means that the private sector will need to step up if the economic momentum is to be sustained. 

Strong corporate profitability, high capacity utilisation levels, and a twin balance-sheet advantage suggest that conditions are ripe for private investment to pick up. Early signs indicate a more considerate and gradual private capex plan, which is healthy. The challenge then becomes the financing of such a massive investment spree by both the government and the private sector. We think a 4-5 percentage points increase in the investment-to-GDP ratio over the coming years will have to be financed largely by domestic national savings, in order to retain India's hard-earned macro stability.

A steady increase in employment is key to harnessing the power of one of the world’s largest working age populations. While IT jobs (and wage growth) are witnessing some (healthy) correction, job growth across financial services, construction, and retail is picking up. Private investments pick-up, especially in manufacturing, should also help. Rural income should make some progress too, benefiting from the upcoming elections. Domestic household savings, disposable income, consumption and investments should therefore remain healthy, although their growth may moderate.

Importantly, the increased global (IGB's global bond index inclusion being just a case in point) and domestic investment flows, coupled with overall healthy balance sheets, should gradually bring down the cost of capital in the country.

The two key risks to the Indian story in the coming year are sustained high oil prices and the central elections mid-2024. 

If oil prices remain above $90 a barrel, the current account deficit will probably be higher than expected. That said, financing requirements are unlikely to be a concern, given the positive effects of India's impending inclusion in some of the global bond indexes in 2024, likely prompting some front-loading of debt investment inflows in the first half of 2024. Meanwhile, the government may continue to somewhat dampen the effect of high energy costs by reversing the hikes in excise duty and price cuts to stabilise fuel prices. 

Equity outlook 2024

Among emerging markets, the Indian equity market has been standing tall post pandemic, thanks to strong domestic retail flows and foreign flows, as well as wider participation from institutional players. We expect the domestic flows to continue in 2024, complementing foreign flows and providing a cushion against any global risk-off events. 

Amidst a strong macroeconomic backdrop, estimated earnings growth for Nifty50 companies for fiscal year 2025 is in the range of 12-13% (1-2% higher than the expected nominal GDP growth), which is reasonable. In terms of valuation, markets may trade at slightly higher price-to-earnings multiples than the long-term averages, reflecting a more sustainable high earnings growth.

Central elections in mid-2024 do bring their own set of anxiety amongst investors, but while cautioning against historical performance not repeating itself, we would highlight the following interesting data.

Performance of the Nifty50 index before and after central election results

As can be seen above, since the central elections in 1999, Nifty50 index returns have been positive in the six months prior to the date of election results announcement, as well as in the six months following. While never a guarantee, history therefore suggests that it pays to stay invested through such events.

Investors may do well to maintain their strategic allocation to equities, while keeping some dry powder available to capture any potential market corrections.

However, with much of the positive macroeconomic developments already priced in to some degree, and following a solid performance in 2023, investors may need to be more selective in 2024. Rotations across factors, sectors, and themes could be faster and picking out companies that may continue to gain market share,  protect profit margins, demonstrate sustainable earnings growth and that are available at reasonable valuations, will be key.

From a sectoral or thematic perspective, domestic cyclicals such as infrastructure, capital goods, financials, and consumer discretionary appear well-positioned, as they should be the main contributors to earnings growth going forward. Meanwhile, global cyclicals like metals and technology seem more challenged.

Fixed income outlook 2024

Cash is now a comforting and arguably rewarding alternative. Yet, it’s unlikely to be the long-term answer to meet anyone’s investing goals. While 2023 was about locking in yields, 2024 could be about extending duration to capture more than just coupons until maturity. 

As India goes to polls in 2024, bond market participants may be worried about sovereign debt. However, this arguably remains a marginal risk since the present government has demonstrated in the past two election years its propensity to present a sober and pragmatic budget. With fiscal issues likely manageable, the key source of risk for Indian debt in 2024 remains inflation.

On that front, and bar the risk of sustained and elevated oil prices, inflation in India should trend lower and remain within the central bank’s (RBI) comfort zone. However, with economic growth momentum likely to remain relatively strong, the RBI is unlikely to cut rates. In fact, in the past 20 years, interest rate cuts have always been linked to quarter-on-quarter contraction in GDP growth.

For now, the RBI may consider rate cuts towards the second half of 2024, but the pace of cuts may be slow and considerate, thereby presenting a ‘higher for longer’ rates environment. Our analysis shows that historically in India, bond markets usually price in the rate cuts 2-6 months prior to the first rate cut announcement.

Bond markets (especially sovereign bonds) are likely to see a boost in demand in 2024 as Indian bonds find inclusion in the global bond indices, triggering flows from Foreign Portfolio Investors and potentially providing an additional nudge to lower yields in domestic markets. Once again, the RBI may use various tools at its disposal for an orderly evolution of the yield curve, while keeping liquidity at adequate levels.

As a result, and broadly speaking, there is a compelling case to be overweight on Indian bonds and to add duration to the portfolio with a medium-to-long-term investment horizon (18-24 months).

Alternative assets as diversifier

With much uncertainty on the outlook for inflation, interest rates and global growth, diversification is particularly important in managing portfolio risk levels. Among alternative assets, and even if cross-asset correlations globally have recently diverged from their long-term historical trends, gold remains an useful diversifier. In addition, the yellow metal is likely to benefit as real yields start to weaken, especially in the US. For Indian investors, any rupee weakness against the US dollar should add to the attraction of holding this commodity.

For discerning investors, private credit could provide a good risk premium. Indeed, the asset class tends to perform well at times of improving macroeconomic and balance-sheet cycles, as is currently the case in India.

Similarly, with price and time corrections seen across venture capital and private equity investments, as well as deeper scrutiny on business models through the ongoing funding winter, 2024 could be a good vintage to add to one’s portfolio.