India’s economy, only two years ago seen as the next big thing when it came to emerging markets, has lost its appeal lately.
The optimism that followed the crushing victory of Narendra Modi’s BJP party at the 2014 general election initially saw foreign investors flock to Indian assets, propelling strong gains in the Indian rupee, stocks and debt markets.
However, after rallying pre-emptively on the back of an expected boost to the economy from the BJP’s ascent to power, investors have become disillusioned over the past nine months.
Capital flows have started reversing, mirroring the fortunes of many emerging markets.
According to Michael Spencer, Taimur Baig, and Kaushik Das of Deutsche Bank’s economics team, deteriorating corporate profitability, a depreciating currency and concerns that momentum on reform was slower than had been expected have all weighed on investor sentiment.
The charts below from Deutsche show just how quickly Indian assets have fallen out of favour. Whether for stocks or bonds, strong foreign institutional flows seen in 2014 and 2015 have all but reversed, and then some, in recent months.
Though the trio suggest the concerns that led to this reversal were valid, they believe “sentiment may now have turned too negative reflecting perhaps excessive optimism about the pace of reform and therefore the potential rate of growth of economic activity and corporate profits in the immediate aftermath of the 2014 election”.
“It is the nature of markets to over-react,” say Deutsche. “Investors were, we thought, overly optimistic that Mr Modi’s election in 2014 would immediately lead to a surge in growth. Rather, they have learned that genuine reform takes a long time. Even China’s growth surge in the early 2000s came after a decade of opening up and restructuring.”
Instead of lamenting the lack of near-term economic reforms, Deutsche remain bullish on the outlook for the Indian economy, suggesting that continued strength in consumption will power the economy moving forward. They explain:
We think the growth outlook for the Indian economy looks stable with perhaps some upside. Consumption is the main driver of activity and this looks to have gotten a boost from the budget last month. Business investment conditions have improved and we think this could add to the consumption dynamics and take GDP growth higher in the coming years. Will this be “Chinese-style” double-digit growth? Perhaps, but probably not. India faces some constraints on growth and not just because it is a democracy. But we remain positive on the medium-and-long-term outlook for the economy.
In the absence of a renewed surge in inflationary forces, Deutsche suggests that there’s little reason to expect a significant decline in economic growth, already running above 7%, in the years ahead.
“Unless inflation rises sharply and unexpectedly, consumption is likely to remain strong enough to support this rate of growth and we think it is reasonable to expect the improvement in investment conditions to yield an increase in investment growth,” says Deutsche. “For that reason, we see growth rising modestly over the next few years.”
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