I V Subramaniam
This November marked the 30th anniversary of the Berlin Wall’s coming down, an event that has become the enduring image of liberal democracy’s victory over communists. The razing of the Wall – which effectively symbolised the division between capitalism and communism – brought freedom and hope to millions and led to market principles being respected again and widely adopted across Europe.
A year and a half later in 1991, India, which was only weeks away from defaulting on its external balance of payment obligations, bit the bullet to reform and rejuvenate the industry. The government lowered import barriers and established more liberal rules for foreign investment in an effort to expose companies to international competition.
Prior to this, India had been a closed economy. Bloated and inefficient Indian producers, long protected by barriers to superior foreign competition, had to pay attention to cost, efficiency, and quality, forcing them to evolve into sturdier global competitors.
While some inefficient Indian industries collapsed, many others benefited from the move towards economic liberalisation. It resulted in the launch of new products backed by modern technology and superior manufacturing methods. Post first round of liberalisation in 1991, India saw a sharp pick-up in investments (gross capital formation) and exports. Opening up markets to foreign entrants induced new capacity creation within India while also providing new overseas markets to domestic producers and software service exporters.
In September 1992, India also opened up its stock markets for foreign investments. Foreign investors long considering emerging markets as an attractive destination to invest started investing in India. Endowments, funds and family offices took steps to invest. What lured them was:
- The possibility of higher returns from an economy that could grow faster.
- Attractive businesses poised to grow at an exponential rate as they were selling products that were hugely underpenetrated. For example: Consumer durables and staples.
- Investment opportunities in financial services, infrastructure and services.
Over the years, the opportunities widened with software services, healthcare and other areas as well. Rupee returns for the Sensex since September 1992 read 10.9 percent, and after accounting for currency depreciation, dollar returns stood at 7.25 percent.
Apart from the likelihood of higher returns, benefits of diversifying also had a strong imprint on the thought process of investors. They looked for markets and economies that had less correlation with their home country. India provided that. While this is largely true from the economic standpoint, the flow of capital across the globe has to some extent – at least for short periods – removed the benefits of low correlation.
With India’s GDP at $2.7 trillion and 30 percent savings rate, we will have domestic availability of funds approximately at $800 billion annually. This domestic capital will not be sufficient for our needs. Foreign capital needs to be attracted in a big way. Therefore, India still has a lot of work to do to make it an attractive investment destination for foreign portfolio investors (FPIs) -- those who invest in public as well as private equities.
With interest rates across the globe being very low and in some cases negative, foreign investors will look for opportunities to invest here.
For 2020, the above arguments for investing in India have not changed, but it had promised a good economic growth. India’s most recent anaemic growth of 4.5 percent for July-September – a more than 6-year low – down from 5 percent in the previous quarter and 7 percent a year ago, could be disappointing for them, as it is for us.
Notably, this is the new series, which is inherently estimated to be around 150 bps (basis points) higher than the old series’ growth. Global shock such as high oil prices and the resultant impact on currency plus any reversal in the central bank policy of easing up on the availability of liquidity may make them shy away from investing in large amounts. Net-net, India needs to reform and come up with policies to drive the economy out of this moribund state. If the potential of India is not translated into earnings, the flow of money from FPIs will definitely reduce. While large FPIs have patient capital, we cannot take the risk of testing them.
Institutions are reassessing their assumption on emerging markets, given the recent performance of developed markets. Since 1991, while India delivered CAGR (compounded annual growth rate) returns of 7.2 percent in dollar terms, the S&P index has delivered 9.7 percent. Investors are therefore relooking at the assumption of investing in emerging markets (EMs), including India.
The logic of investing in EMs held true for long. But the recent 5-year performance of S&P that generated a return of 11.25 percent as against Sensex’s 6.55 percent has tilted the balance and probably makes some of them revisit their thesis of investing.
Moreover, governments and citizens are re-examining the principles of capitalism and free trade. In this scenario, India cannot falter on its promise of growth, particularly when it has tailwinds such as a strong entrepreneurship culture and a favourable demographic profile.
I V Subramaniam is Director, Quantum AMC, and MD and CIO Quantum Advisors. Views are personal.
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