May 15th 2023
India
Dear Investor,
As promised, today we will talk about India. Why do we like India? Well, the short answer is that it is the opposite of China!
The slightly longer answer is that there are certain things specific to India that China doesn’t have which may or may not be an advantage, depending on your point of view. Most Asian or Emerging Market focused investors are aware of the strong macro picture for India, but it is worth repeating here for the people who may not know the full story.
So, while both China and India have large populations (in fact there have been many recent news stories of how India will overtake China this year but, in a sprawling country like India where the last census was over 10 years ago, I am not sure how accurate this is), the demographics of India are a lot better, with a much higher proportion of young people and a still growing population. This is important because historically in most economies, an increase in population results in an increase in economic growth (as long as there are jobs for those people to do). A young population is more productive and the ratio of people in the working age range of 25-64 relative to older and younger cohorts is important for economic growth.
Source: UN
As you can see from the chart above, China had a big increase in that 25-64 age bracket from the 1970s’ to today which was part of the reason for the economic success of China as a country. India also had a similar profile but also had a big increase in the non-working population. The difference was mainly due to fertility and the “one-child” policy imposed in China. Looking forward to 2050, because of that bulge in young people in India, that ratio will continue to be a positive for India while China, like a lot of the Western world, is ageing. The cliché often used to describe this is that “The Chinese will get old before they get rich.”
Another important difference between the two countries is that one is a democracy, and one isn’t. In the heydays of China growth, there were many Western commentators and investors who compared the two and stated that when China wanted to build a road, they would just clear all the people out of the way and build the road and it would be good for economic growth. On the contrary in India, they sneered, there would be protests, court cases and the process would go on for years. They called it “the Hindu rate of growth.” True, in a way, but there are some things you lose when people are treated in this fashion.
Anybody who has done business in the past in India would tell you nightmare stories of government bureaucracy and red tape (another thing to blame the British for!). But this created a class of entrepreneur in India who knew how to navigate these waters and I remember a very good quote (but I cannot remember the attribution) which summed it up perfectly. “In China people make money because of the government. In India they make money despite the government” This has now changed, in my opinion, and we will get to that later.
Getting back to population, large ones can be a boon for companies. You have a massive domestic population with which to gain scale. This is one of the reasons America grew such successful global companies and had such a great economic expansion post World War 2. You had the baby boom, kickstarting a massive population explosion and the attendant economic growth where everybody wanted the American dream of a house, a car, and all mod cons. This was a massive market for companies to grow and you had some marquee US companies become massive in the process. China and India were considered in the same light by investors, but because India was considered a harder place to do business because of all the red tape and perceived corruption, a lot of investment was directed to China especially after WTO membership in 2001. This investment helped the economy grow and lift millions of people out of poverty. Now having visited factories in China, it isn’t much fun working there, believe me, but neither was working in a coal mine or a match factory as Western countries developed.
This brings me to the next reason for India to shine now. Geopolitics. When Trump became President and he became increasingly belligerent towards China and started talking about tariffs. Businesses started taking notice and there was a shift in orientation to “China plus one’, where manufacturers would move some production to a third country like Vietnam or Malaysia. Mostly, this was just lip service and goods were made in China, transported to a third country, and packaged up in a box as the last piece of production and hey presto – Not Made in China. This is simplifying things a bit, but you get the picture.
Then COVID hit, with protracted supply chain issues, exacerbated by China’s draconian zero covid approach, and this accelerated the process of multinationals thinking seriously about a proper back up plan for China. After the Russian invasion of Ukraine and the subsequent rise in tensions, it has become clear that investing in China is not being encouraged by the US authorities. India is a natural alternative. This has been embraced by the Modi government who has been promoting “Make in India” which has both a carrot and a stick. The carrot is tax breaks and support for making products in India and the stick is tariffs on products being imported. So, we have been seeing and will continue to see headlines like the below.
India sees Apple nearly tripling investment, exports in coming years
April 20th 2023 Economic Times
US tech giant Apple could double or triple investments in India along with exports in the next few years, a minister said, as the company opened a second store in the big mobile phone market.
Apple mainly assembles iPhones in India through contract manufacturers, but has plans to expand into iPads and AirPods.
Now, “Make in India” was started in 2014 and actually the manufacturing share of GDP hasn’t increased much, if at all during that time. But we believe that will now change with the way the world is going and the lockdowns of Covid behind us. So, India can be both a massive domestic market and an exporter. This will provide jobs in the future for the youth of today.
It also needs to be remembered that it is not just about “cheap labour.” China became a manufacturing powerhouse not just due to cheap labour and subsidised corporates, but also because over the last 30 years they built an impressive logistics and export infrastructure. Supply chains are about so much more than just producing the actual product. This will be a multi-year transformation for India with an investment boom in infrastructure.
This leads into the next comparison with China. China has already had its boom investment phase. The whole economic model of the last 30 or 40 years has been an investment led expansion aided by a deliberate effort to keep domestic consumption subdued. This has kept household income and expenditure at the bottom of the totem pole. As an aside, this is a longer-term problem for China as the “early” investment growth phase has run its course and now investments funded by debt are producing muted results. Debt is growing faster than GDP, and at an increasing pace, a dynamic which will likely lead to a crisis / hard reset at some point. The transfer of income to consumers will be the best option going forward but it will be a hard political battle.
India, in contrast, desperately needs infrastructure investment. Looking at the chart below you can see a 5-10% difference per year over the last 40 years in investment between the two countries. That adds up to a large amount over time. Now as we said, it is India’s turn.
Source: World Bank via theglobaleconomy.com
So that is the macro story – a large domestic economy, with a class of entrepreneurs who have succeeded despite the obstacles put in their way. A young and growing population who are all reaching for a better life and have opportunity coming with a big increase in investment and potentially an export production base. And a government which is pro-business which hasn’t always been the case.
I am not commenting here on Prime Minister Modi’s politics, but from the way I see it, he has done a lot of economic good for the country. His efforts to bring business out of the informal economy into the formal economy has also had the added benefit of reducing a lot of the corruption that was present in India. This corruption hurts the poor the most and having a frictionless system means more money in the poorest people’s pocket which benefits consumption.
It started with demonetisation in November 2016 , where the government made totally new INR500 and INR2000 notes and making the old INR500 and INR1000 notes valueless overnight. Anyone holding the old notes had to exchange them at the bank by the end of the year. If you didn’t have a valid reason to have that money, then that was a problem. What it did do was bring about an increase in the number of tax returns filed and the resulting tax income. The execution of this was chaotic and caused a lot of problems, not the least being there were not enough notes printed to replace the valueless ones, but that’s a different story. The direction of travel is clear, and broadly constructive despite initial issues in the implementation.
It also spurred the country towards increasing digital payments with the value going from around US$15B in 2016 to US$150B in 2022, a 10-fold increase in 6 years. Covid accelerated this trend like in many other places and bought another section of society into the tax net. The government payment system called UPI is essentially free for small amounts so street vendors could now use it. If you are not familiar with India, it isn’t a place that has 7-11s or convenience stores on every corner. It is instead dominated by an army of mom-and-pop stores and street vendors in the vast areas that are not the major cities. Electronic payments means electronic records, which means more tax revenue….
The Modi government also introduced a GST (General Services Tax) which replaced several other taxes and so made tax filing easier, reduced paperwork and again increased tax revenue. We cannot emphasis enough the difference in doing business in India today vs even 5 or 6 years ago, let alone 10-15 years ago.
As we said, last week, we just visited India after a 4-year break, after going there 3 or 4 times a year for the last 10 years for business. The differences are striking. In the past, the first impression while arriving at the airport and in many government offices was the staggering overemployment. So, you would arrive and then after an interminable wait and thorough scrutiny of your documents (common everywhere), your passport would be stamped and you would go past the immigration officer. Then you would walk maybe 50 metres to another area and someone else would check your stamp. This process would be repeated 3 or 4 times before you exited the immigration and then went to baggage claim. This is a way of creating employment. This time, at Delhi airport I had one stamp and that was it. It was an unexpected, welcome surprise and I saw it repeated in many places – an anecdotal indication of increased productivity and that real jobs are being created.
Driving around the capital and other satellite cities of the capital region, it really does feel different. These areas are being planned and so roads are better, less congested and apartment blocks are being built for the new middle classes. We believe that th domestic demand and infrastructure sectors will be good places to invest. It is hard for non-Indians to buy individual stocks currently which is why we have recommended an ETF and a holding company which invests directly in India.
Now what about the negatives? India’s Achilles’ heel has generally been big fiscal deficits together with a reliance on imported oil which has the potential to turn into a balance of payments crisis together with a devaluation of the currency. The former is still there but the deficits nowadays are being created by government investment rather than giving money to poorer sections of society. The investment should, at least in theory, provide a return on the investment while giving money away doesn’t, so that is a positive change. In addition, as noted above, tax revenues have been increasing as the informal economy gets drawn into the formal economy.
Business Today December 2022
A whopping 303% jump! India’s tax collection growth in last 12 years
India’s GDP at the constant price has increased 93 per cent from Rs 76.5 lakh crore in FY10 to Rs 147.4 lakh crore in FY22. The government’s gross tax revenue to GDP ratio has improved to 17.1 per cent in FY22 from 8.2 per cent in FY10.
As for oil, one silver lining to the Russia/Ukraine war is that India (and China) is able to buy cheap Russian oil which is a great benefit to both countries, even if, as we believe, oil will move up from here, India will likely be buying at a discount. And as a further demonstration of the futility/absurdity of sanctions, India and China can legally import this oil, refine it and sell it to Europe, although of course this means much longer routes for shipping the products.
Economic Times May 7th 2023
India’s imports from OPEC at all-time low as Russian oil buy peaks
Imports from Russia are now more than combined purchases from Iraq and Saudi Arabia – India’s biggest suppliers in the last decade.From a market share of less than 1 per cent in India’s import basket before the start of the Russia-Ukraine conflict in February 2022, Russia’s share of India’s imports rose to 1.67 million barrels per day in April, taking a 36% share.
Indian refiners in the past rarely bought Russian oil due to high freight costs but now they are snapping up plentiful Russian cargo available at a discount to other grades as some Western nations rejected it because of Moscow’s invasion of Ukraine.
So, if the story is so good, why hadn’t we put an Indian allocation into the thematic portfolio thus far? It’s not, as I see it, that the good news is already in the price. Rather this was based on a short term tactical stance. In a previous commentary we showed this chart and of the Indian and Chinese stock markets and said the below:
“Over the last 2 or 3 years due to the well-publicised issues in China, a lot of dedicated investors to this asset class have been avoiding China and “hiding out” in India.
See the performance of both markets for the last 5 years below: a massive 80% difference. So even without new money coming into the asset class, we could see (and probably are seeing) money move from India to China”
Updating the chart for today shows the gap has narrowed to 50% outperformance, mainly due to China going up and India staying flat, so we now feel more comfortable starting a position in India. India is perennially expensive because it has such a good story and as stated above, we believe it is a multi-decade story. At the very least, if investors exit China, then we know where they will go and so this is a natural hedge.
You can see the more details on the picks in the thematic portfolio section of the website or in the last commentary, but we have added a mid and small cap Indian ETF as well as Fairfax India which holds both public and private investments in India.
Back to the USA, there have been some data releases which continue to point to recession and credit issues in the short-term. You have smaller regional banks under continued pressure.
PacWest shares plunge after it reports drop in deposits
May 11 (Reuters) – Shares of PacWest Bancorp (PACW.O) plunged 23% on Thursday after the Los-Angeles-based lender said its deposits declined and that it had posted more collateral to the U.S. Federal Reserve to boost its liquidity.
PacWest deposits fell 9.5% or $1.5 billion last week, with the majority of those outflows occurring on May 4 and May 5 following news reports that the bank was exploring options to bolster its finances, including a sale.
As we said would happen, you have started to see less willingness for banks to lend and less willingness to borrow.
CNBC May 8 2023
Fed report shows banks worried about conditions ahead, with focus on slowing economy and deposit outflows
Tumult in mid-sized institutions caused banks to tighten lending standards both to households and businesses, potentially posing a threat to U.S. economic growth, according to a Federal Reserve report Monday.
The Fed’s quarterly Senior Loan Officer Opinion survey said requirements got tougher for commercial and industrial loans as well as for many household-debt instruments such as mortgages, home equity lines of credit and credit cards.
The loan officers further said they expect troubles to persist over the next year, owing largely to diminished expectations for economic growth as well as fears over deposit outflows and reduced risk tolerance.
Asked their expectations for the next year, respondents gave a fairly gloomy outlook of what’s ahead.
“Banks reported expecting to tighten standards across all loan categories,” the report said. “Banks most frequently cited an expected deterioration in the credit quality of their loan portfolios and in customers’ collateral values, a reduction in risk tolerance, and concerns about bank funding costs, bank liquidity position, and deposit outflows as reasons for expecting to tighten lending standards over the rest of 2023.”
At the same time, the survey showed that demand weakened across most categories.
As we have noted previously, in a highly leveraged economy, you need credit to continue growing to keep things moving. This unfolding contraction in credit will bring recession and the market is showing this by selling cyclical stocks. The major indices are holding up due to a few mega cap tech stocks, but to repeat, this is a very precarious technical situation. Investors will continue to herd into the stocks still considered safe but in our humble opinion, these will succumb to gravity also and that will be, after a significant further leg down, the beginning of the end of this bear market in US equities.
We continue to have the view that US rates will stay higher than most people expect and that they will be cut once we have more of a financial crisis or the bond market seizes up. The Fed is currently providing liquidity to those banks while keeping financial conditions tight and rates at the current level. Once it becomes clear to the Fed that the US economy is in recession AND inflation numbers are contained (in the sense of a continued reduction in CPI), we will most likely see the monetary spigots open and that, we believe will reignite the secular increase in inflation and we would want to own more precious metals and certain commodities. The trick is what happens in between and most likely, all assets apart from government and investment grade bonds and the USD will go down in a rush for liquidity. We need to be prepared to buy what will drive the next bull market.
Until next time,
