On the Long-term Structural Case for India and Eat Like an Ancient Egyptian!

From: aditya rana
Date: Sat, May 17, 2014 at 2:17 PM
Subject: On the Long-term Structural Case for India and Eat Like an Ancient Egyptian!


Following the BJP’s resounding victory (led by the charismatic Narendra Modi) at the polls, it is only fitting to look into the long-term structural case for the Indian stock market. While international investor perceptions about India have often been coloured by the lack of political leadership, a less known fact has been the stellar long-term performance of the Indian stock market, being amongst the top two to three best performing global stock markets (in dollar terms) over the last ten (16% p.a. compounded) and even twenty years (10% p.a. compounded). So given this background, what is the outlook for the Indian economy and stock market going forward? The Morgan Stanley research team, lead by Chetan Ahya and Ridham Desai, provide a helpful framework with which to view the outlook for India. To summarise the key points:

-Over the next ten years: they expect economic growth to average 6.75% p.a. resulting in a $5 trillion economy, supplying 25% of the increase in the global working age population; and a stock market capitalization of $4 trillion driven by an aggregate increase in domestic savings allocation to equities of $230 billion, and a 15% p.a. compounded growth rate in corporate profits.

-India’s trend growth rates have been rising steadily over the last three decades, from 4.6% in the ’80’s, to 6.1% in the ’90’s and to 7.6% over the last ten years (see graph below). However, growth in the last year has slipped to 4.7%, following the global financial crisis and poor policy choices made by the government.

-The recent stagflation-type environment in India has resulted primarily from: 1) an increase in rural wages (17% p.a. since 2008 from a prior pace of 5-8% p.a.), 2) a deterioration in the fiscal deficit (above 7.5% since ’09 from 4.9% in ’08), 3) a decline in public and private investment (from 26.2% in ’08 to 15.9% in ’14), and, 4) a decline in exports, which grew at a pace of 27% p.a. between ’04-’07 but have fallen to 15.9% p.a. in ’14.

-The weaker economic environment has been reflected in the decline in productivity growth, with the incremental capital ratio rising from an average of 3.5 during ’04-’08 to 6.7 currently.

-Going forward, India’s trend growth rate is likely to average 6.75% driven by three key factors: favourable demographics, reforms and globalization.

-Improving demographics (see graph below), as measured by the age dependency ratio (the ratio of the dependent population and the working-age population), has been one of the key factors behind the higher growth potential in India. This has been the case for the rest of Asia as well over the last 50 years, starting with Japan, then the former Tiger economies, followed by China and now India. This factor has driven the rising savings and investment ratios and the long periods of strong GDP growth, and has also been reflected in the rising savings rate in India (see second graph below).

-By ’25, India will contribute to 25% of the increase in the global working-age population – i.e. an increase in the labour pool of 124 mm, compared to an increase of 5 mm in the U.S. and declines of 8 mm (Japan), 12 mm (China) and 28mm (Europe).

-However, an increasing labour pool is not enough to support higher growth – it is important that their skill base is adequate to compete in a global environment. The education trend in India has begun to improve significantly in recent years – with literacy rates having gone up to 73% in ’01 from 52.2% in ’91, and in particular, they estimate that youth literacy has improved from 54% in ’81 to 90% in ’11.

-With higher enrolment levels in secondary and tertiary education, it is estimated that tertiary level graduates could increase from 2.4mm in ’04, to 6.5mm in ’14 and finally to 12mm in ’25 – bringing India’s tertiary educated workforce to 122-125mm by ’20 (from 50mm in ’10). However, a lot more needs to be done in this critical area as the enrolment ratio of 69% (in ’11) compares unfavourably with other EMs like China (89%) and Brazil (84%).

-The challenge for India is how to absorb the additional 64mm "job seeking" population (assuming workforce participation rates and increased secondary and tertiary enrolments) as the 6.75% expected economic growth rate is unlikely to absorb this population. They key here is to increase the employment generated by the non-farm sector, which created 56 mm jobs by growing at 8.5% over the ’00s.

-Increasing globalization has also been a key driver of the Indian growth story, supported by a growing skilled labour pool and the government’s liberalization policies. This has been reflected in a significant rise in trade flows as a % of GDP (from 14.9% in ’90 to 24.4% in ’00 and 54% in ’13). Gross capital flows also increased from 5.5% of GDP in ’90 to 8.7% in ’00, peaking at 35.2% in ’08 and then stabilising at around 25% currently (see graph below). Exports of goods and services have also increased from 12.3% of GDP in ’02 to 25% in ’14 (see second graph below), thereby doubling India’s share in world exports over the last ten years.

-Reforms are critical to convert favourable demographics into higher growth. The first wave of reforms took place in the early 1980s which resulted in GDP moving from a 3.9% pace in the early ’80s to a 5.3% level by the late ’80s. The second wave of reforms came about in the early ’90s (in response to the balance of payments crisis), but economic shocks to EM (and later the developed world) in the late ’90s and early ’00s meant that the reforms were not able to fully translate into significantly higher growth until the mid-’00s when the global economy had recovered. However, post the global credit crisis, reforms were stalled and some even reversed, as policy shifted from growth-oriented to redistributive policies.

-The six key areas of reforms the government needs to undertake going forward are: 1) manage growth in rural wages in line with productivity (see graph below), 2) reduce the fiscal deficit through rationalization of expenditure and tax reforms (see second graph below), 3) improve business environment through more policy certainty and less regulatory hurdles, 4) implement transparent allocation of natural resources and clear supply bottlenecks, 5) focus on accelerating urbanization (see third graph below) to increase productivity, and, 6) focus on reversing the decline in infrastructure investment (from 8.4% of GDP in ’11 to 6% in ’14-see fourth graph below).

-India’s strong macro outlook implies superior prospects for the stock market. This is likely to be driven by the following four factors:

-Increasing profits: A reacceleration of GDP growth should translate into higher profits due to the rising corporatization of the Indian economy (see graph below). The relative share of profits to wages are at a low and should mean revert (see second graph below) – increasing profits at a compounded rate of 14.6% over the next ten years (see third graph below).

– Increased liquidity: The secular decline in the share of equities of household savings since the early ’80s has lead to significant underweighting of equities, which should be begin to be reversed with rising real rates and favourable demographics.

-A stock-picker’s heaven: Over the last ten years, India has been the second best stock market performer amongst all the large markets around the world (see table below), with a compounded return of 15.8% p.a. (in dollars). This has been driven by low volatility of earnings growth (see second table below) and ROE (see third table and graph below) versus other countries, diversified sectoral opportunities and low correlation of stock returns versus the market.

-A stock market forecast : High growth does not necessarily translate into high stock returns – for this to happen the starting-point valuations need to be attractive and the corporate sector needs to be efficient in converting high growth into high profits-on both these accounts India has had a good track record and they expect the Indian stock market to compound at 12-15% (local currency) over the next decade.

A comprehensive and plausible case for having a core weighting to the Indian stock market in a globally diversified asset portfolio. India is a classic market for contrarian investing – and being highly dependent on foreign portfolio flows (73% of total capital flows compared with 23% for other EMs – see table below ) it is also a great barometer for the global "risk-on/risk-off" trade. The market therefore has a significantly higher volatility compared to the volatility of corporate earnings when compared to other countries (more than 3x!-see second table below).

As a friend recently quipped, "the time to sell India is when the press only talks about "India Shining" and the time to buy it is when you cannot get anyone (local or foreign) to say anything positive on India". On the day of the 2013 low of the stock market, Ratan Tata, the former head of the Tata group said in a widely reported interview that India had "lost the confidence of the world", and he criticised the government for failing to provide leadership (Economic Times, 8/28/2013). The stock market went through a dramatic reversal since exactly that day, with the Sensex rising by 28%, and more importantly, the most beaten down sector – heavy industry – leading the other sectors by rising 80%!

Eat like an Ancient Egyptian:

An interesting piece of research which highlights the largely plant based diet of the ancient Egyptians.

PRCM, May, 2014:


Researchers analyzed the hair, teeth, and bones of various mummies who lived in Egypt and found their diet was mostly grain-based, with high consumptions of barley and wheat. Based on other research, the authors suspect legumes and vegetables were also staples in the diets.

They note that Egyptians from this period are renowned for their exceptional longevity as an organized civilization, especially considering the significant changes politically, culturally, and technologically. Maintaining a diet high in grains reflects ancient Egyptians’ knowledge of a sustainable diet.

Here’s to buying the long-term India investment story and eating like an ancient Egyptian!



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