India: Solid Fundamentals, but Check Sentiment

While investor sentiment is overall still pretty skeptical, there is one place where it is considerably warmer: India. For months, headlines have hyped it as the next Emerging Markets (EM) darling and beneficiary of funds and firms fleeing China. Now, hot on the heels of last week’s seemingly bangish Q4 GDP report, analysts are ratcheting up their forecasts. Indeed, India has come a long way in terms of growth and infrastructure development over the past decade and overcome some big self-inflicted speedbumps like 2016’s demonetization along the way. Yet its many tailwinds are so well known that, at this point, disappointment seems like more of a risk than positive surprise. Q4’s GDP is actually one way to see this.

The vast majority of the GDP reporting focused on the 8.4% y/y headline growth rate, which accelerated from Q3’s 8.1% and beat expectations rather handily.^[i] Many now extrapolate it forward. Coverage was riddled with projections of future income growth, a rise in the number of ultra-rich people and how quickly India will rocket up the leaderboard of the world’s largest economies. The problem: That white-hot growth rate isn’t quite what it looks like. India’s GDP math includes net indirect taxes, which tallies all indirect taxes (e.g., fuel duty and alcohol and tobacco excise taxes) and then subtracts subsidies. Subsidies tanked in Q4 as falling fertilizer prices reduced the need for government assistance, which caused net indirect taxes to jump 32.0% y/y in Q4.^[ii]

Given this skew, many economists look at India’s gross value added (GVA)—which measures pure output—for a more accurate readthrough. This figure slowed from 8.2% y/y in Q2 to 7.7% in Q3 and now 6.5% in Q4.^[iii] Agriculture output, which is a relatively large share of India’s economy at 16.1% of GVA, slipped into contraction at -0.8% y/y.^[iv] Manufacturing’s rebound from late-2022 weakness continued but slowed, with growth easing from 14.4% y/y to 11.6%, while construction and mining also slowed by several percentage points.^[v] On the expenditure side of the ledger, private consumption grew just 3.5% y/y, pretty far off the eyepopping growth rates most associate with fast-ascending EMs.^[vi] Overall, India is still growing at a fine clip, a very respectable one globally, but the enthusiasm over a headline rate flattered by taxes seems a tad unwarranted to us.

This isn’t the only area where sentiment toward India risks running a tad hot. Ahead of the upcoming election, there is a lot of talk about Prime Minister Narendra Modi winning a third term and advancing a reform agenda. Yet his government has already accomplished most of the big-ticket items on his agenda when he first took office, leaving limited scope for meaningful reforms from here. Similarly, echoing what happened in Japan under the late Shinzo Abe, the government’s focus appears to be shifting from economic measures to sociological issues, raising the risk of policy disappointment. Add in the country’s long history of keeping foreign investment at arms’ length and hitting foreign firms with retroactive taxes, and one can see the potential for uncertainty to rear its ugly head and disappoint investors.

Mind you, we aren’t bearish on India. It is a big, increasingly important economy and one with healthy domestic economic fundamentals. But with sentiment so hot and the country’s positive drivers so widely known, surprise power to fuel continued outperformance looks limited. Good news alone isn’t enough to keep fueling a monster rally—it has to be better than expected, which lofty hopes make difficult. India probably keeps participating in EM’s and the world’s bull markets, but long-lasting leadership seems unlikely to us.