Compared with a year-and-a-half ago, when its economy had just begun to reopen after a devastating surge of the delta variant, India's stock market is unchanged in dollar terms. And yet, its weight in the MSCI Emerging Markets Index has zoomed past Taiwan and South Korea to second place, with almost the entire gain coming at the expense of the gauge's biggest constituent: China.
The world's second-largest economy has seen equities slump by two-fifths since June 2021, thanks to Beijing's isolationist Covid-19 policies, turmoil in the real-estate industry and a punishing antitrust campaign against the country's valuable tech firms. If China has been mired in a surfeit of pessimism, the opposite is true of India. Thanks to pent-up urban demand after the pandemic, stocks have held up reasonably well despite the US Federal Reserve's aggressive monetary tightening.
As a result, while China's share of MSCI EM has slid to 28 per cent, from 35 per cent in May 2021, India's has risen to 15 per cent, from 10 per cent.
Will the current reopening of the Chinese economy put an end to India's outperformance? That will be a question for global investors in 2023.
If other countries' experiences are any guide, the pivot away from zero infections toward letting the virus rip through communities will be chaotic, and possibly deadly for China's elderly of whom only 40 per cent have booster shots. However, a decisive transition may help pull consumer and business sentiment away from near-record lows, shake the property market out of its slumber and accelerate auto sales. That may also prompt analysts to bump up their forecast of 4 per cent earnings growth over the next 12 months. Before the pandemic, those expectations were at 17 per cent.
In India, the pain of Covid-19 - and the gains from reopening - are both in the rearview mirror. The economy is now losing momentum, although the market continues to be frothy. Even with some caution getting baked into estimates because of high inflation (hurting margins of local consumer firms) and a global slowdown (affecting software exporters), the consensus expectation is for earnings to rise by 18 per cent over the next 12 months. Optimism is the highest with banks. They're benefiting from higher business volumes as well as superior pricing: Elevated commodity prices have boosted demand for working-capital loans even as rising rates have shored up interest margins.
The case for some rotation away from Indian to Chinese stocks is already firming up. BNP Paribas recently downgraded India to "neutral" from "overweight" by removing the country's consumer-staples stocks from its model portfolio and pruning exposure to software exporters. "Our tactical caution on India arises from the market's sky-high relative valuations and the possibility of fund reallocations to North Asia with China's reopening," says Manishi Raychaudhuri, BNP's head of Asia research. The consensus opinion on India's consumption-oriented stocks is probably too optimistic, while the federal government's budget - the last before the 2024 elections - could introduce additional volatility, he adds.
In the longer term, India is seeking to buttress its investment appeal by emerging as an alternative to China. With President Xi Jinping's policies aggravating a rift with the West, Prime Minister Narendra Modi is pitching his country as a destination for multinationals to reduce their overexposure to Chinese supply chains.
There's no guarantee that the gamble, backed by $24 billion in subsidies for manufacturers, will work. As Arvind Subramanian, an economic adviser to the Modi administration until 2018, and Josh Felman, a former International Monetary Fund official in New Delhi, noted in a recent Foreign Affairs article: "India faces three major obstacles in its quest to become 'the next China;' investment risks are too big, policy inwardness is too strong, and macroeconomic imbalances are too large."
Other countries may also have a claim. Vietnam, more open to trade than India, is on track to edge Britain out of this year's list of the US's seven largest goods trading partners. The Southeast Asian manufacturing powerhouse didn't even figure among the top 15 until 2019. Besides, regardless of how inviting New Delhi's policies are on paper, it's not at all certain they will be implemented impartially and not tweaked to benefit national champions - "the giant Indian conglomerates that the government has favored," according to Subramanian and Felman.
Just the firms controlled by Gautam Adani, the richest Indian businessman, have accounted for a third of the 33 per cent jump, in local currency terms, since 2021 in the BSE 500, a broad index of the nation's largest companies. Throw in rival Mukesh Ambani's telecoms-to-petrochemicals empire, and half of the gains are spoken for by the two wealthiest tycoons.
So far, however, a rising concentration of wealth seems to have worked well for local investors - they are neither too skeptical of their country's destiny, nor too critical of its direction. That's because their prosperity is also hitched to the same bandwagon of pro-capitalist policies. Four years ago, India's largest firms earned a combined pre-tax income of 7 trillion rupees ($85 billion), out of which the exchequer took almost a third. Now, the pre-tax profit has risen to 13 trillion rupees, but the government's share has fallen to about a quarter. The relative importance of indirect taxes - including on petroleum products - has grown.
It isn't a great outcome for India's poor, who are hurt more than the rich by levies on consumption, particularly in an inflationary environment. But to the extent the burden of taxation is light on companies, the stock market is unlikely to question the absence of meaningful purchasing power beyond a tiny affluent class. India's wage-led economy has become a profit-driven enterprise, and domestic investors seem fine with it. In five years, India's managed investments - life insurance, mutual funds, retirement accounts, hedge funds and portfolio services - has grown to 57 per cent of gross domestic product from 41 per cent, according to Crisil, an affiliate of S&P Global Inc. As the hunt for yield reaches more of the smaller cities and towns, the $1.6 trillion industry may not take long to catch up with $2 trillion in bank fixed deposits.