fNew stock markets prospered in 2022. Strong performers include those in commodity-exporting countries like Brazil, Indonesia and the Gulf States, which have benefited from scarcity of natural resources. They also contain an oddity: India. The country’s Nifty 50 and Sensex indices hit record highs in late November. Indian equities are up 4% this year in local currency terms. Global equities are down 20%.
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All of this means it is a hopeful time for India. Investors are reconsidering their exposure to China, the largest emerging market. Even after a recovery sparked by China’s reversal of its “zero Covid” policy, the msci The China index has fallen by a quarter since the start of 2020, taking its annual return to under 1% over the past decade. For many fund managers desperate for diversification, India appears to be the most promising alternative.
Still, the country’s markets are facing issues that will limit its ability to fill that role. The simplest is their size. Indian equity markets are worth $3.4 trillion, less than the $6 trillion accounted for by Hong Kong- and New York-listed Chinese companies — not to mention the $10 trillion of stocks accounted for international investors are still largely unreachable in mainland China. India could now absorb only a fraction of the capital reallocated from Chinese equities, and an even smaller fraction of what investors ultimately choose to invest on the mainland.
Optimists argue that the growth of the Indian economy will solve this problem. it Companies like Infosys and Tata Consultancy Services will benefit from outsourcing. The decision by Foxconn, a Taiwanese contract manufacturer, to produce iPhones and semiconductors in India points to the potential for larger manufacturing centers in the future with local firms. But there is a problem: Indian equities are expensive. Their forward price-to-earnings ratio of about 22 is more than double 10 multiples of Chinese stocks and more than 3 times multiples of 7 Brazilian stocks. In fact, they’re expensive compared to America’s tech-heavy offerings.
India is a commodity importer and the central bank has been forced to raise interest rates in defense of the rupee. This should have reduced ratings; the fact that this is not the case reflects an outbreak of retail frenzy. The number of participants in the Indian markets has more than tripled since the beginning of 2022. During the same period, retail buyers spent a net Rs.3 trillion ($36 billion) on equities, a sharp increase from the tiny inflows and occasional outflows seen between 2015 and 2019. India’s economic outlook is bright, but 2023 looks set to be a difficult one globally year. A slump in retail interest could lead to a slump in asset prices.
India’s stock markets are far more open to foreign investors than mainland China. But when you widen the lens to look at debt and forex trading, capital markets remain only partially open, reflecting fears that speculation could destabilize the economy. Raghuram Rajan, Governor of the Reserve Bank of India (rbi) 2013-16 wanted to internationalize India’s markets and currency. Despite his instincts as a market-oriented liberal, his progress was slow. Last year the rbi has reportedly relied on domestic banks and discouraged participation in the offshore rupee market in order to retain more control over the currency’s value against the dollar.
There are signs that India wants to open up further. In October, T. Rabi Sankar, Deputy Governor of the rbi, spoke of the need to attract the capital needed to finance India’s growth despite the inevitable reduced control of domestic monetary policy. But there are logistical hurdles. That same month, JPMorgan Chase decided not to include India in a widely adopted bond index, reflecting investor concerns about cumbersome registration processes and whether its clearing and settlement systems could handle a surge in inflows. In any case, further opening up of Indian capital markets at a time when global markets are fragile and American interest rates are rising would be a bold move.
India has a fascinating history. It offers a vibrant it-Service industry, an up-and-coming domestic tech scene, an increasingly attractive location for global manufacturers – and strong economic growth. That’s tempting when the pull of its powerful northeast neighbor has waned. But an expensive stock market and a hesitant opening-up approach are preventing the country from realizing its potential in the capital markets. Fund managers desperate for diversification should not rely on India alone.
Read more from Buttonwood, our financial markets columnist:
For bond investors today, every country is an emerging market (December 8)
Has Private Equity Avoided the Crash in Asset Prices? (December 1)
How crypto goes to zero (November 24)
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