India has emerged emphatically onto the world stage in recent years, both in terms of its huge and fast-growing economy, but also its robust stock market returns. This outperformance has been especially impressive considering the difficult macroeconomic backdrop for emerging markets over this period. A number of the recent headwinds India has overcome would have caused significant problems historically, but key reforms and the evolution of India's economy and markets have seen them decouple from not only wider emerging markets, but also developed markets, displaying a new resiliency.
A decade ago: an economy vulnerable to foreign capital outflows
In May 2013, then-Federal Reserve Chair Ben Bernanke hinted at tapering the Fed's bond-buying program (QE), which had been in place since late 2008. This triggered the "Taper Tantrum”, causing US 10-year Treasury yields to surge from around 1.5% to 3% by September of that year. The spike in borrowing costs rattled financial markets, prompting risk aversion and a sharp reduction in emerging market investments. This led to significant currency devaluations, stock market declines, and higher borrowing costs.
Morgan Stanley labelled Brazil, Indonesia, South Africa, Turkey, and India as the "Fragile 5" − economies dependent on foreign capital to finance current account deficits. These countries faced capital outflows, currency depreciation, inflationary pressures, and rate hikes, which hampered growth. India, with a current account deficit of 4.8% of GDP in 2012-2013, was particularly impacted, as it relied on foreign portfolio investments to cover its import bill. By August, the rupee hit a record low, inflating import costs, especially oil. A high fiscal deficit constrained government response, and a lack of reforms further eroded investor confidence. By late August, India's stock market and currency had fallen 20%.
Today’s Indian economy is vastly more resilient
Fast forward to today and things could not be more different, despite a near-repeat of these same macroeconomic headwinds. The US 10-year Treasury yield surged from 0.5% in August 2020 to nearly 5% last year, remaining slightly below that now. Covid and its lockdowns severely impacted global growth, sparking widespread inflation. The strong US dollar, a traditional challenge for emerging markets, re-emerged.
Yet India’s stock market has thrived, more than tripling since the Covid lows and outperforming even the tech-driven Nasdaq, while the rupee has been among the strongest emerging market currencies. This resilience, partly shared with other emerging markets, reflects quick central bank actions and reforms creating economic buffers. Yet India nonetheless stands tall above all other emerging markets thanks to specific factors that have made it vastly more resilient over the past decade.
Modi’s significant structural reforms
The aftermath of the Fragile 5 episode of course coincided with the arrival of Narendra Modi and the BJP party, which has overseen a decade of impressive structural reforms. Taking the macro picture first, India has hugely improved its external position, delivering a current account surplus by 2020, just ahead of the Covid hiatus, before settling at a comfortable 0.75% of GDP deficit today. So too has the budget deficit improved, with a steady reduction from 2013 until 2020. This left India in a strong position to respond appropriately to the growth hit of Covid, with the prior years of fiscal austerity enabling such a powerful government response.
The government has overseen a number of major structural economic reforms, addressing key bottlenecks such as a near-bankrupt power sector, a banking sector hampered by bad debts from an over-leveraged corporate sector and a byzantine tax-code for internal trade between states.
Modi's first term set about building resilience through pro-growth reforms such as the Insolvency and Bankruptcy Code of 2016 (allowing banks to clear bad debts quickly) and the Goods and Services Tax of 2017 (simplifying state and central taxes). As a result, India's banking sector is now extremely strong, with bad-loan ratios at cyclical lows and coverage for non-performing loans at 20-year highs.
The corporate sector itself has deleveraged, with corporate debt at 20-year lows. Government debt has seen only a very moderate increase over the past 15 years, in stark contrast to the soaring debt levels in countries such as Japan and the UK.
The combination of diligent fiscal repair and the resultant ability to increase investment has vastly improved India's attractiveness to foreign capital. Indeed, the rewards for such improved fiscal management came recently with India's addition to several global bond indices, bringing in billions of dollars of passive investment flows over the period. This is important in terms of improving liquidity and stability to India's bond market as well as supporting the currency by increasing foreign capital inflows. It is also significant symbolically, reflecting international confidence in India's economic policies. Currency stability is a hugely attractive feature for emerging markets, which historically have produced strong local currency returns on the back of strong economic growth but have given back much of this through currency weakness.
India’s stock market is increasingly supported by domestic investment
While foreign fixed-income investment flows are undeniably supportive to India's macroeconomic stability, the reality is that India has become increasingly self-funded. The country’s extremely attractive demographic profile, with a high ratio of workers to dependents, means there is an abundant and rapidly growing pool of internal savings available to fund domestic investment. Rather than relying on foreign capital to build out infrastructure and develop a new, modern economy, India is able to draw on its own resources, decreasing reliance on outside support.
Moreover, this growing source of domestic liquidity has helped to transform the characteristics of India's equity market. Whereas the stock market's performance used to be a function of international investor flows, increasingly the market is now dominated by domestic investors. In recent years, domestic participation in the stock market has risen steadily − with a sizeable chunk of these flows coming from so called SIPs (Systematic Investment Plans), which are one of the most popular ways to invest in mutual funds. SIPs allow small investors to invest regular sums − often monthly standing orders − into the market, starting from as little as INR500 (£5). This has made flows much more stable, and even during the Covid-induced market turmoil of 2020, the number of accounts opened per month continued to increase each month of the year.
Now, nearly half of domestic flows into the market come from SIPs. The stock market's strong performance in recent years has largely come in the absence of foreign flows. Indeed, by the end of the summer, emerging market funds were underweight India in aggregate and at their lowest relative weighting in decades. A pickup in equity supply to the market − both primary and secondary issues − has primarily been supported by local demand. Where once it was inconceivable for a company to issue equity without the support of international investors, now companies spend the majority of their time courting local investors.
The Indian market is now far less susceptible to external headwinds
As a consequence, India's market behaviour has shifted significantly. In 2012, just before the Taper Tantrum, India's beta to emerging markets was around 1.0 − which is to say a very close match in performance. If emerging markets fell or advanced 10%, India would likely do roughly the same. In 2024, this beta now sits at around 0.4, showing a significant reduction in correlation, and underscoring the degree that Indian markets are to a much larger extent marching to their own beat, and therefore far more resilient to the ebbs and flows of global monetary conditions, geopolitics and foreign sentiment.
Of the emerging markets, India offers the best proxy to underlying economic growth
When we consider the long-term attractiveness of emerging markets, it's ultimately that − given the low starting point − economic growth rates over the long term can be much higher than average. Yet, while many emerging markets have indeed delivered impressive GDP growth over the past decades, stock market performance has often failed to capture this.
India offers the fastest GDP growth of any major economy over the next decade and, with corporate earnings driven much more by domestic growth than any other emerging market, investing in the Indian market is already a much better proxy on that underlying growth. Now that international flows are no longer the key driver of the market, India's resilience further underscores the potential for investors to increasingly make direct allocations to the Indian market rather than just as part of a wider allocation to emerging markets.
KEY RISKS
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
Overseas investments may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund. This Fund may have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on the Fund's value than if it held a larger number of investments. The Fund may encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings. Investments in emerging markets may involve a higher element of risk due to less well-regulated markets and political and economic instability. This may result in higher volatility and larger drops in the value of the fund over the short term. Outside of normal conditions, the Fund may hold higher levels of cash which may be deposited with several credit counterparties (e.g. international banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.
DISCLAIMER
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.
