India: a growth story to seize on
There is no market over the next 20 years which offers more growth opportunities for Australian business than India.
As the world chews its nails over just how much damage the US-China trade war will inflict on global markets, Australian government bureaucrats in Canberra have been beetling away at a report on the investment possibilities in another foreign powerhouse: India. The report— An India Economic Strategy to 2035, by Australia's former chief diplomat Peter Varghese — piqued some media interest but was drowned out by the clamour of trade tensions and the leadership turmoil in Canberra. But despite that, Varghese's 500-page tome — replete with 90 recommendations and a list of 10 local sectors set to benefit — carries both physical and economic weight.
"There is no market over the next 20 years which offers more growth opportunities for Australian business than India," Varghese says, adding Australia risks being left behind if it fails to seize on India's investment potential. To that end, he cites education and training as the "flagship" sector, and agribusiness, resources, and tourism as "lead sectors", followed by six "promising” sectors: energy, health, financial services, infrastructure, sport, science and innovation.
And Varghese is not alone. In a panel discussion to launch the report, Macquarie Group's newly appointed chief executive Shemara Wikramanayake urged Australian superannuation funds to invest in India—a market Macquarie entered in 2004. "India is a country that is very high growth," she said. "I think the reason that people have been reluctant to invest in India from Australia is that the risks have been higher historically, but things are starting to change now.”
Also on hand to help launch the report was Ellerston Capital chief investment officer Ashok Jacob, who also chairs the Australia-India Council. "There is no more explosive structural growth story than India," he said, "and that's the reason why the market has to be looked at very closely."
'There is no more explosive structural growth story than India', says Ashok Jacob
Under targets set out in the report, Australian exports to India would treble by 2025, growing from $14.9bn in 2017 to about $45bn in today's dollars, and outward Australian investment to India would rise from $10.3bn to more than $100bn. In Varghese's reckoning, this would catapult India from No 5 on our list of export markets to No 3. Big words from a bureaucrat, you might think. But then his hefty report contains some big numbers that will make investors sit up. For instance, every week there are hundreds of direct flights from Australia to China. Yet there is only one direct flight a day to India. No Australian airline offers a direct service. And yet the India diaspora in Australia tops 700,000, with a billion more in India itself. It's a curious imbalance when you consider the Indian population is on track to eclipse that of the Middle Kingdom by 2035.
Indian elephant is starting to run
Keys to this India investment story are population and purchasing power. By 2035, the UN projects India's population will have reached almost 1.6 billion, on its way to a peak of almost 1.7 billion by the early 2060s. India is the world’s third largest economy measured in purchasing power parity terms and, on some measures, will be the fastest growing large economy in the world in coming years.
As Varghese notes, since 1970, India's real GDP per capita has increased fivefold. Millions of people have been lifted out of poverty, and a consumer-class has emerged that, since household consumption accounts for 60 per cent of India’s GDP, is grounds for optimism. In the words of the International Monetary Fund’s India mission chief Ranil Salgado, the $2.6 trillion elephant that is the Indian economy is starting to run. The IMF forecasts growth of 7.3 per cent in FY19 to March and 7.5 per cent in FY20. In contrast, China's growth is forecast to slow to 6.4 per cent next year from 6.6 per cent in 2018.
India's top companies are shining too. Despite geopolitical ructions putting a dent in performance in the last few weeks, the benchmark Nifty 50 index has posted gains of up to 11.5 per cent this year, even as the MSCI Emerging Markets index plumbs 12-month lows. The country's two largest companies by market capitalisation, Tata Consultancy Services and Reliance Industries, have both been among the Nifty 50’s best performing stocks this year, rising 53 per cent and 43 per cent respectively.
Additionally, India’s middle class is tipped to eclipse that of America by 2022, according to the Brookings Institution. Hence the emphasis on education: this cohort will need "upskilling" and Varghese cites some compelling data to suggest Australia’s education sector may be in the box seat to capitalise. India is already Australia’s second biggest education market and the second most popular destination for Indian students after the US. And according to recent research by HSBC, the number of Indian parents wanting their children to study abroad has jumped from 47 per cent in 2016 to 62 per cent in 2017. While other surveys have found over 70 per cent of Indian parents are willing to take on debt to fund education, higher than the global average of 60 per cent. As for Australian education providers set to seize on these increases, Varghese singles out IDP Education as a global leader in international education services that has become a key player in supporting the industry's growth. IDP (ASX: IDP), which listed in 2015, provides international student placement and English language testing services and is 50 per cent-owned by Australian universities. IDP recently reported a 30 per cent increase in pre-tax profits. While past performance is no guarantee of future returns, it's worth noting since February IDP's share price has almost doubled from $5.68 to a high of $10.98.
Banking on new money
Another key factor in the mobilisation of India's middle class is banking reform. There has been a boost in the number of bank accounts due in part to a crackdown on black money and the shadow economy. Since his election win in 2014, Prime Minister Narendra Modi has embarked on the kind of macro reform economists welcome, including a bid to formalise the economy, widen the tax base through GST, and a campaign to curb red tape and corruption. But it's not been without hiccups. Recall the chaos following his decision to demonetise 500- and 1000-rupee notes, which account for 86 per cent of the currency notes in circulation. Over time, however, bank queues have thinned and there's potential for long-term benefits.
"The shadow economy will be forced to pay taxes and cash-based corruption will become more difficult," says Nikko Asset Management portfolio manager Anuja Munde. "The Indian economy will benefit from higher GDP on a reported basis and a higher tax-to-GDP ratio from proper reporting of income in the future. The demand for real assets (such as gold and real estate) will come down and lead to higher financial savings."
This is perhaps why some of India's banks are catching the attention of fund managers. Platinum Asset Management's Asia fund (ASX: PAXX) — which carries a Morningstar Bronze rating — has a 9.3 per cent compound return since its inception in September 2017, and includes two Indian banks. Among the fund's top 10 holdings is Axis Bank, which it sees as "one of the nimble, well-run private sector banks taking share from India's sleepy public sector banks in India's vibrant economy". In there too, is Yes Bank. Platinum expects its credit growth to accelerate, describing it as "a well-run private sector bank, stealing share from dozy incumbent public sector banks."
Challenging investment landscape
Despite Varghese's upbeat note, he is alive to the challenges marking India's investment landscape. India's energy sector for instance is characterised by monopoly players, state-run corporations, controlled pricing and high barriers to market entry. Alongside are other concerns such as currency fluctuation and restrictive governance.
India's currency has been the worst performing this year, hitting a record low of 70.3950 against the US$ on 16 August. Although it's worth noting the acclaimed Indian economist Raghuram Rajan, former governor of the Reserve Bank of India, and the man who in 2005 predicted the credit crisis, notes this is due in part to the overall strength of the US dollar.
Another key sector, mining and heavy industries, which accounts for 40 per cent of industrial output, has been sluggish, notes Bloomberg economist Abhishek Gupta, falling to a 10-month low in May due weaker steel and cement output and a contraction in crude and natural gas production.
India heads to the polls next year, and it's hoped it can maintain its macroeconomic stability
And then there's corporate governance. As Morningstar UK's David Brenchley recently wrote, many Indian companies are run by families, who may not always prioritise the best interests of minority shareholders. On the flipside, Brenchley notes mid- and small-cap companies tend to be run by young entrepreneurs who have been educated in the US and UK, and who realise boosting value for minority shareholders also benefits family wealth. That may be so, but for the year to date, however, the Nifty Smallcap 100 has declined by 16.5 per cent while the Nifty Midcap 100 has fallen 6.8 per cent.
And despite the bullish outlook on education, Varghese flags several drawbacks: in Indian eyes, Australia lacks the educational clout of prestigious UK and US universities, and our unis are perceived to lack the ties to business that guarantee jobs. Another sticking point is the uncertainty of securing a visa.
India heads to the polls next year, and the world will be watching to see if it can maintain its macroeconomic stability and capitalise on the radical demographic shifts taking place.
An India economic strategy to 2035
'Flagship' Sector
Education & Training
Peter Varghese sees boosting our education links with India as a hedging strategy against an over reliance on the Chinese market, which accounts for roughly 30 per cent of our education exports. "China is investing heavily in its domestic education institutions, is moving up the quality curve quickly and has adopted aggressive targets as a provider of international education. India’s tertiary-age (18–22) population is the largest in the world and is projected to peak at 126 million in 2026 before stabilising at 118 million by 2035. Indian enrolment in higher education (27 per cent) lags far behind peers like China (43 per cent) and Brazil (51 per cent). By 2030, India aims to lift the enrolment rate to 50 per cent, which would mean one in four graduates in the world would be a product of the Indian higher education system. Challenges remain, however. India created additional capacity for over 40 million students in the last two decades, but requires a further 200,000 secondary schools, 35,000 colleges and 700 universities to meet growing demand."
'Lead' Sectors
Agribusiness
According to the Varghese report, "India's overall food demand will grow at 2–3 per cent until 2025, and demand will outpace supply out to 2035 even if Indian productivity increases. This is driven by demographics, a corresponding increase in volume demand and the growing consumer class, changing diets and a shift in favour of higher value products (such as proteins, fruit, dairy, packaged goods, high end products) similar to the trends seen in other developing countries. Growth potential for Australian exports remains in commodities India needs due to shortfalls in production (pulses, grains, horticulture, oilseeds). Opportunities also exist, or will emerge, for value-added products sought by the growing middle class (wine, processed food) and for providing specialised services to Indian governments, institutions and farmers." However, there are challenges. "India’s agriculture sector is politically sensitive (with a protectionist sentiment that is unlikely to fade). The central and state governments seek to balance smallholder and consumer needs with the broader goals of minimising social disruption and maximising electoral rural support. The Indian government has three objectives: food security, food self-sufficiency, and income support for farmers. So, India will remain a difficult market, prone to fluctuating import demand and sharp policy changes—hedging against this volatility is part of spreading risk. But there is scope for it to become more predictable."
Resources
"India’s projected growth will keep resources trade high in our bilateral economic relationship," Varghese says. "Demand for Australian resources will be strongest where domestic Indian reserves are limited, including in metallurgical coal, copper, and gold. India’s demand for both metallurgical coal and copper is forecast to grow at about 5 per cent per year to 2035; over 90 per cent of this is expected to be met by imports. India will continue prioritising price over quality and product life-cycle costs, creating some unpredictability for resource commodity exports to India. As a result, the extent of our market share in these key commodities will depend primarily on the competitiveness of our exports against others."
Travel & Tourism
Varghese estimates by 2035, the number of Indian tourists to Australia is expected to grow four-fold, from 300,000 in 2017 to nearly 1.2 million. This puts India on track to go from being Australia's eighth largest tourism market today to fourth. An estimated 70 million Indians will travel overseas annually by 2035 meaning Indian tourism could be worth more than $9 billion each year to the Australian economy.
Energy
A key challenge for India is that it is unable to produce enough energy for its swelling population. According to Indian government figures, the country’s share of the world population is 18 per cent but its share of world gas and oil reserves are only 0.6 per cent and 0.4 per cent respectively. And it's estimated India’s energy consumption will grow at about 4.5 per cent annually to 2035 (up from 3.5 per cent from 2000–2017), driven by economic growth, urbanisation, rising incomes and industrial activity. "In terms of commodities, India will be heavily dependent on imports of oil and gas," Varghese says. "It will also provide a market for services and technologies that improve energy efficiency and the uptake of renewables."
This article was originally published in 
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Lex Hall is content editor, Morningstar Australia
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