The search for geographical diversification leads us to focus on countries that offer a hedge during times of global turmoil and exposure to industries and trends missing in Australia’s economy. Having an exposure to India will be vital to such a strategy. In our last blog post “In pursuit of growth: Why the Reserve Bank of India has it better than other central banks” we highlighted the unique position of the Indian central bank relative to its developed market counterparts and how lower oil prices and rising disposable incomes are underpinning growth. In this article, we further explore this theme and focus on the Indian banking sector, which is in the early stages of a massive overhaul and is central to the India growth story.
Low correlation with the world economy
Australia’s economy has enjoyed one of the longest running growth streaks for any country in the world. We have had 24 consecutive years of economic growth over 1992 to 2015 and are on track to beat the record of the Netherlands, which enjoyed 26 consecutive years of economic growth between 1982 and 2008.
Our open and international trade driven economy (exports & imports together make up 72% of GDP) means that our economic growth is closely linked with global economic fortunes. Indeed, the 30-year correlation between world economic growth and Australia’s economic growth works out to 49% (see Chart 1). While this is lower than most developed economies, it is much higher than other Asian countries like India (26%), China (11%) or Indonesia (4%).
Chart 1: Australia’s economic growth is more correlated to global growth relative to Asian economies Source: World Bank
Our search for geographical diversification leads us to focus on countries that offer a hedge during times of global turmoil and exposure to industries and trends missing in Australia’s economy. India checks both boxes - the Indian economy has shown remarkable resilience to the turmoil following the 2008 financial crisis as much of its growth is domestically driven. Also it currently has a number of tailwinds favouring its economy.
Seeds of “real growth”
Unlike much of the developed and developing economies, the Indian economy possesses the seeds of “real growth” – viz. demand for goods and services by its billion plus population and the derived demand for infrastructure to meet their growing needs. Driven by sectors like housing, telecom, healthcare, education and transportation, India’s infrastructure market is expected to reach USD6.6tn by 2025 according to PwC.
Chart 2: India’s GDP growth on an uptrend Source: World Bank
Here we focus on two key sectors – autos and banking. India’s large growing young population, which contrasts with Australia’s ageing one, offers an opportunity to invest in sectors (like automobile and logistics) that have a larger potential in India than in Australia. Getting access to stocks listed on Bombay Stock Exchange (BSE) can be a bit challenging for retail investors. One of the Indian auto majors that you can access via US listed ADR is Tata Motors (TTM-US). It is one of the largest automotive manufacturers of cars, utility vehicles, buses, trucks and defence vehicles and also includes Jaguar Land Rover in its portfolio.
Another sector that is central to the India growth story is banking. In a domestic consumption and infrastructure growth driven economy like India, banks are one of the first order beneficiaries of growth. Credit is a key necessity in a growing emerging economy – be it infrastructure projects, mortgages and consumer or personal loans. Additionally, the banking sector in India is in the early stages of a massive overhaul and presents an attractive investment opportunity. ICICI Bank (IBN-US) and HDFC Bank (HDB-US) are two of the largest banks in India with loan books of US$65 billion and US$44 billion respectively.
Indian banks have a low exposure to risky assets when compared to those in developed markets. In 2014, the Reserve Bank of India (RBI) approved licenses for establishing new private sector banks for the first time in a decade and has also started allocating licenses to payments banks and small finance banks. It has also allowed foreign banks to operate fully owned subsidiaries, a move which effectively removes the restriction on the number of branches that they are allowed to open. Regulatory oversight is strong. The RBI has just conducted a review of asset quality on banks’ balance sheets and recommended provisions for stressed loans with a deadline of March 2017.
Implications for investing
We certainly hope Australia beats Netherlands’ economic growth record. Nonetheless, the mature stage of its domestic economy and the near efficient market mechanism implies an equilibrium GDP growth of around 3%. Compared with this, the Indian economy is expected to grow above 7% in the coming decade. While it is difficult to map an exact relationship between economic growth rates and financial asset returns, the numbers do provide a reference point. As we look to diversify our portfolio, exposure to Indian shares can provide benefits in terms of diversification and growth. An easy way of investing in India would be to either go with an India focused ETF or with the India Vue. The India Vue is a basket of ten leading blue chip companies across diverse industries like Infosys (INFY-US), Dr. Reddy’s Labs (RDY-US), Wipro (WIT-US) and ICICI (IBN-US). So go ahead – spice up your portfolio.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.