The Case For India

by: Lowell Thomas, CFA


India is the fastest growing major economy in the world.

It will surpass China in population within a decade.

There is opportunity to invest in an expanding consumer/middle class on an unequaled scale.

The recent landslide elections have created a level of political stability unique in the present environment.

India will surpass China by 2020 to become the world's largest country in terms of population. Chinese population growth has been slowing dramatically as a result of the one-child policy started in 1979, which has now been changed into a two-child policy. According to the Chinese government, the one-child policy prevented 400 million births. The related consequence is that Chinese GDP growth is also slowing. India's GDP, on the other hand, is accelerating, making India the fastest growing major economy in the world. For investors, India offers access a to a young and growing middle class on a large scale.

Source: South Shore Capital Advisors

Churchill said of India that it is "no more a political personality than Europe. India is a geographical term."

That might still be true, as the similarities between the two are striking. For example, India has 22 official languages to the EU's 24. State elections in India tend to attract higher levels of voter participation than do federal ones. In a similar vein, most Europeans cannot name their representatives in the European Parliament. Also of interest is that the income gap between states in India and EU members are similar. The GDP per capita in India's poorest state is one-tenth that of the richest, similar the gap between Belgium and Bulgaria. Churchill's views on the "political personality" of the EU today can only be guessed at.

However, where India and the EU differ is what should appeal to investors. Income disparity has led to high levels of inward immigration as the mostly young population moves in search of a better life: 4.2% of the population has migrated to a different state. This compares to a sclerotic 2.8% in the EU. It is also important to note that 50% of Indian trade is within the country's borders, which makes India less dependent on global trade flows relative to Europe where internal trade accounts for only 20% of GDP.


On Nov. 8, 2016, without warning and via an 8:00 p.m. television broadcast, Prime Minister Narendra Modi announced that 500 and 1,000 rupee (NYSEARCA:INR) notes, representing 86% of cash in circulation, were taken out of circulation immediately. The notes worth $7.50 and $15.00 had to be deposited in banks or exchanged for new notes by the end of December. The aim was to was crack down on the shadow economy and counterfeiting that funded terrorism and other illegal activities. This created significant disruption (92% of consumer transactions are in cash) and generated protests domestically and condemnation overseas. Harvard Professors Lawrence Summers and Ken Rogoff were highly critical of "demonetization," to which Mondi replied "hard work beats Harvard."

March 11 Election - Game Changer

Modi's hard work paid off. The economy for the year ending March 31 is expected to grow 7.0%, a slight tick down from pre-demonetization forecast of 7.3%. More importantly, Indians supported the move. Earlier in 2016, Modi also pushed through Parliament a national sales tax (GST). Taken together, these initiatives should have worked against him. However, on March 11, the Prime Minister's party (the BJP) won a landslide victory, taking control of three state assemblies in the five states that voted -- including a big win in Uttar Pradesh (UP), the largest state in India. The Indian press called the election the most important globally in 2017, given the UP's population of 240mn, which would make it the fifth largest country in the world. The victory was also a crushing blow for the Congress Party, which has been dominated for decades by the Ghandhi family. The BJP now controls the lower house of parliament and has become the only truly national party in the country. In my opinion, Modi is unique in the world as a politician who is liked and seemingly can get things done.

How to Invest in India

Buying shares directly on the Mumbai Exchange (BSE) is difficult. The process starts with hiring an India-based "tax consultant." We can leave it at that.

Source: South Shore Capital Advisors

In the U.S. there are eight ADRs that offer varying levels of liquidity, and there are four GDRs traded in London with adequate utility. However, focusing on the ADRs, the offering seems limited. The IT outsourcing companies Infosys (NASDAQ:INFY), Wipro (NYSE:WIT), and WNS (NYSE:WNS) generate most of their revenues from outside of India, making them less of a way to invest in the emerging middle class story. Generic drug company Dr. Reddy (NYSE:RDY) also generates most of its revenue from outside India, while Tata Motors (NYSE:TTM) depends on the Jaguar Land Rover, and the U.S. and Europe, for most of its income.

From the list above, two banks and a mining company offer some appeal (Videocon is being bought by Dish TV of India). The banking sector is dominated by state-run banks that are weighed down with bad debts. However, private sector banks that aren't so burdened can be purchased using ADRs /GDRs. HDFC Bank (NYSE:HDB) is the largest private sector bank and it is focused mostly on industrial loans and mortgages. It has grown EPS at a 23% compounded annual rate over the last five years. ICICI (NYSE:IBN) is less expensive and is estimated to grow faster as its non-performing loans shrink. Axis Bank, not listed above but traded in London as a GDR, is expected to almost double EPS this year, again on declining loan losses.

Outside banking, Vedanta (NYSE:VEDL) is active in aluminum, copper, iron ore and other metals along with power generation. Its parent company, Vedanta Resources, is traded on the London Exchange. Most of its assets are in India, but it historically has traded more in sync with global miners than the Indian market.

Best Way Into India

ETFs appear to offer a better way to access the Indian market. Of the four highlighted below, three have good liquidity. The iShares India Small Cap fund (BATS:SMIN) with a market cap of $85mn does not. However, it is that ETF that holds the most appeal. The ETF's 22% exposure to the consumer discretionary sector would seem to make it the better vehicle for accessing the growing Indian middle class. SMIN also holds 257 stocks, which provides deep exposure to companies generating most of their earnings from within India. This position can be paired with the more liquid Wisdom Tree India Earnings Fund (NYSEARCA:EPI). Its earnings, not capitalization, weighted portfolio provides exposure to India's international big caps, but with 250 holdings it also allows investors to access to smaller cap pure Indian plays.

Source: Created by the author.

Disclosure: I am/we are long EPI, SMIN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.