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This article was originally published in The Telegraph.  

INVESTORS routinely draw a distinction between the expensive but high growth US stock market and others in Europe, Japan and the UK, which look less exciting in growth terms but seem to offer better value. One of the key questions is whether the S&P 500 justifies its premium rating.

There is, however, another similar comparison which receives less attention. The gap between the valuation of the Indian stock market and those of other emerging markets mirrors that between the US and the rest of the world. India’s stock market is far and away the most expensive of its developing world peers, standing on around 20 times expected earnings, which is in line with Wall Street and twice the 10 times earnings multiple of the out of favour Chinese stock market. As with the US, the jury is out on whether this is justified by the country’s better prospects.

Price earnings for key global markets

None

Source: Goldman Sachs, August 2023, next twelve months price earnings for FTSE 100, S&P 500, TOPIX, Nifty and HSCEI.

India is in focus this week as it celebrates 76 years of independence. On 15 August 1947, independent India’s first prime minister Jawaharlal Nehru described his country’s ‘tryst with destiny’, announcing that India had awoken ‘to life and freedom’. It was the start of the journey that has brought India to where it is today, the investor’s favourite emerging market, with enormous potential but a long list of challenges. How those two balance each other out will determine whether the market’s love affair with the country is warranted. 

1947 was the start of the journey but it was not the most important milestone along the way. Arguably that was the 1991 economic reforms that, 13 years after China’s similar re-awakening under Deng Xiaoping, ushered in a period of re-engagement with the rest of the world and increasing economic importance. 

The reforms created a more service-focused economy, less protectionist and state-controlled, and with a rise in foreign investment. They opened up India to the world and made it more market-driven and consumption-focused. The reforms were not a panacea, however. Since 1991 the gap between rich and poor has widened further. The income share of the top 10% in India rose from 35% to 57% between 1991 and 2014. So, the reforms did not help everyone equally, but they set the country on its path to modernity. 

That has been reflected in more than 30 years of strong stock market performance, albeit with bouts of significant volatility. Investing in India is not for the faint-hearted, but it has rewarded long-term investors handsomely. In the last 30 years, the MSCI India index has grown more than 20-fold. Over the same period, the S&P 500, has risen 10 times. Our own FTSE 100 index, by contrast, has grown by a factor of just two and a half. 

So, what is the case for investing in India today? According to Morgan Stanley, the country is set to become the world’s third largest economy by 2027, leapfrogging Japan and Germany. In a world in which growth remains hard to find, India is set to be one of only three economies to generate more than $400bn annually in economic output, rising to $500bn in the years after 2028. Taking it there will be a super-charged GDP growth rate that has averaged 5.5% a year over the past decade. At the same time as the economy is growing, so too is India’s stock market. The US bank forecasts that the total value of shares in India could surpass $10trn within a decade.  

The key drivers of that growth are not new, but the trends are unstoppable. India is the prime focus for companies looking to outsource software development, customer services and other business processes. The number of people employed in India for jobs outside the country is set to double over the next 10 years to 11 million as spending on outsourcing rises from $180bn a year to $500bn by 2030, according to Morgan Stanley. 

India is also set to take over China’s mantle as the factory of the world, with manufacturing’s share of the national economy set to rise from under 16% to 21% by 2031. At the same time a decade-long investment in digitalisation will boost consumer credit. The ratio of consumer loans to GDP, a key driver of economic growth, is forecast to nearly double over the next decade. In 2021, more than three quarters of Indians lived on less than $10,000 a year. By 2031 more than half will earn more than this, putting them firmly in the consuming middle class. It is a story with which investors in the Chinese miracle were familiar a decade ago. 

Other positives include the youth of India’s population. If demographics is destiny, then India’s future looks considerably brighter than its giant rival China’s, with a third of the country’s 1.4bn population under the age of 20 and half under 30.  

It’s not hard to make the case for investing in India. But no-one should pretend that it does not come without risks. Perhaps the greatest of these is the unevenness of Indian society. The country may have a demographic dividend, but it will only be realised with massive investment in its people, many of whom do not have the skills, education and basic literacy to flourish in the modern world. 

Political illiberalism under the Hindu nationalist Bharatiya Janata party (BJP) is a fundamental weakness too, with declining press freedoms and rising incidences of targeted attacks on religious minorities. The Indian business world is too prone to fraud, corruption and weak governance. Prime minister Modi’s Make in India campaign, with its rising tariffs on foreign components, is not the answer. The protectionist instinct easily survived the 1991 reforms. 

The biggest challenge for investors in India is that too much of the good news story has been baked in. On a valuation par with the US, but with significantly less mature institutions, and a long list of challenges, India is no longer investment’s best-kept secret.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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