We recently visited India to get a first-hand account of the economy’s prospects and what that might mean for our investments. Indian markets started the year on a positive note, but hit a patch of turbulence towards the end of January following the publication of a report by Hindenburg on the Adani group. Some tax changes in the country’s annual budget too caused a wobble, but also offer longer-term opportunities. Finally, the backdrop of bank failures in the US and Switzerland have highlighted the strength and conservatism of India’s largest lenders.

India remains a bright spot, the International Monetary Fund said in a recent report, adding it will account for half of global growth this year together with China. We found a lot of anecdotal evidence of that optimism. A rapid digitalisation of the economy is taking hold, with consumers in remote towns now able to pay street vendors with 5G enabled phones. Physical infrastructure is also getting a fillip, with the road network expanding at a rapid pace. Such improvements underpin strong demand for goods and services. While we find opportunities across many sectors, we particularly favour domestically focused businesses in sectors such as healthcare staples, consumer discretionary and industrials, which are poised to benefit from the current environment.
Budget blues

The biggest surprise in the budget for financial markets was the change in taxation of life insurance savings policies. Favourable tax treatment of these policies had made them increasingly attractive to affluent customers. However, we believe that insurers will be able to mitigate the roughly 10-12% impact on revenue growth via changes to the product mix. Our view is that the market has overreacted to the tax hikes, particularly with regard to SBI Life (our largest insurance holding).

It’s not all gloomy
The budget also included INR300 billion ($3.75bn) of capital support for the three big state-controlled oil marketing companies (OMCs). There is still some uncertainty regarding exactly how this would be implemented. However, it is a sizeable sum that could offset the effect of losses incurred during the oil price spike seen in the first half of 2022. We own two of the OMCs, Hindustan Petroleum Corporation Ltd. (HPCL) and Bharat Petroleum Corporation Ltd. (BPCL) on the view that their extremely low valuations reflect an overly pessimistic view of through-the-cycle earnings.
London vs Mumbai
But perhaps the main highlight of the budget was the 33% increase in capital spending. There are enormous gains to be made from improving India’s transport and power infrastructure, which is still relatively underdeveloped in the global context. Mumbai metro, for example, has less than 50km of functioning track on just 3 lines, serving a city of 20 million people. The London Underground has over 400km of track on 11 lines serving a population that is roughly 3x smaller.
Going green
The city, which is India’s financial capital, is also looking to make its bus fleet greener, adding 10,000 electric buses over the next 3 years – a trend that is visible across India as cities aim to tackle severe air pollution problems. Our funds hold a position in Olectra Greentech, the country’s leading e-bus producer, which plans to expand capacity several times over to meet this demand.
Construction boom
Other portfolio companies stand to benefit from the pick-up in construction activity, which seems likely to continue apace in the run-up to next year’s general election. Contractor Larsen & Toubro has enjoyed very strong order intake in recent months and has scope to improve margins as projects whose deadlines were extended during the pandemic approach completion and the cost pressure from commodity prices eases. Cement companies should also benefit from the boom in construction, but they are not able to pass on relatively higher input costs to consumers yet.

Consequently, the earnings dynamic seems likely to be better further up the value chain, or in cement companies that have a company-specific cost optimisation story, such as Ambuja Cement (held in the strategy).
Robust banking sector
India went through a banking crisis caused by bad loans a few years ago. But now non-performing loans are at record low levels. Tighter regulations have forced banks to make adequate provisions.

While banks in the Western world are facing stress due a rapid tightening of monetary policy, interest rates in India, initially high relative to developed nations, have inched up slightly. Of course, India is not an island and global problems will have repercussions on India too, but we need to wait and watch how the situation unfolds.

Market participants have been keenly awaiting the start of a new capex cycle in the private sector, and we are seeing some early signs of this in accelerating loan growth to companies; ICICI bank, for example, reported corporate loan growth at 18% y-o-y with SME loans growing even faster at 25%. Balance sheets are strong, with corporate debt as percentage of GDP at a 15-year low of around 50%, significantly below the level seen in most other large economies. Households are likewise underleveraged, and loans are growing double digits, undeterred by interest rate hikes that have simply brought rates back to where they were pre-Covid.

Banks in India are significantly more conservative and risk-averse than their developed market peers. With no shortage of deposits, they focus on the basics of banking: traditional, vanilla lending and credit analysis, with exposure to the riskier end of finance avoided entirely.
Positive outlook
While valuations for India remain high, we see that as a reflection of the premium growth outlook for the market. Overall, the earnings outlook for Indian companies remains very positive, particularly in the banking sector, for consumer staples, and for infrastructure plays; in other areas such as information technology where a slowdown was feared, we see that things are not as bad as they looked at the beginning of the winter.

* Holding examples are for illustrative purposes only and are not a recommendation to buy or sell.

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