Investment Philosophy

For the first time ever, the government has cut wealth transfers/subsidies and instead invested in productive assets. It is a hallmark achivement in a socialist country and demonstrates the seriousness of the government’s long-term pro-growth policies. The Reserve Bank of India found that, infrastructure spending creates 5x-6x more jobs than the average sector. National Institute of Public Finance and Policy also found that the ‘Multiplier Effect’ causes every ₹1 of Infrustructure spending to stimulate downstream sectors (such as capital equipment & construction comoditities) causing ₹4.8 of overall economic activity.

Nothing demonstrates “building India” better than roads. Having started from scratch at the time of India’s independence in 1947, India has rapidly built a road network that is one of the world’s longest today. Road construction continues at a furious pace and India’s ‘Km of roads added per day’ is among the highest in the world.

Most of rural India first obtained tap water connections just a few years ago. Not having to manually carry water to their houses (often over long distances) frees up productive hours of their day, dramatically boosting labour productivity. Running water also enables cottage industries and improves sanitary conditions.

India’s liberalisation reforms in 2001 were a point of inflection for the growth of many industries, including shipping and international trade. Despite having one of the largest coaslines in the world, India’s waterways are very poorly developed. There is enourmous scope for increasing domestic cargo shipping and the government is investing in ports, ships and inland connectivity towards developing maritime trade.

India’s infrastructure policy is well-rounded and balanced. Every vertical of infrastructure has showed development in line with national priorities.

Air travel has been one of the big beneficiaries of India’s burgeoning middle class. Due to India’s large size and the difficulty with acquiring land to extend the rail network, airports have become the mode of choice to expand connectivity to India’s low-tier cities.

To enable the goal of electrifying every village in India, the government has invested heavily in the construction of high voltage transmission lines. India’s disjointed grid was also unified, and a formal energy exchange established to route power demand and supply.

India has been upgrading tracks that formerly ran highly polluting diesel engine trains to electrified tracks. Although this has been a mission since India’s inception, more track has been electrified in the past few years than in the many decades before combined.

Agriculture, India’s largest employer, is reliant on the rain. Healthy rainfall leads to high crop yields and, consequently, high rural incomes. Rainfall, therefore, dictates the consumption profile of India’s largest demographic.

Since 2004 (see graph), as irrigation infrastructure improved and the economy successfully diversified away from agriculture (towards urban services), this correlation ended and India delivered high growth regardless of rainfall levels.

However, rainfall still strongly affects demand trends in India, particularly for certain sectors such as durables, vehicles, construction inputs etc.

Internet Penetration is used here to exemplify the big gap between urban and rural development. Also visible is the much higher rate of growth delivered by rural India over urban. After 5 years of drastic growth, urban India reached saturation (a figure slightly above 100 indicates dual-sim customers); an uptake likely to be replicated by the much larger rural population. Rural internet uptake will result in an explosion of digital consumers and fundamentally change consumption and social profiles.

Most infrastructure spending occurs in rural India. Similarly, most subsidies (fertilizer, “priority sector loans”, healthcare etc.), distributions (cash, food, education, housing etc.) and guarantees (crop support prices, farm insurance etc.) also occur in rural India. It is important to understand both, the sensitivities of all these different forms of wealth transfers, and the patterns of rural consumer’s onward spending of these large cashflows.

Rural India is transitioning from an Agricultural to a Service & Industrial oriented economy, a major driver behind India’s growth. This drastic economic & employment shift in rural India has had significant and broad-ranging effects on society as well, driving major trends such as Rural Migration, societal mobility and so on.

Healthcare, like many other sectors, demonstrates this; but it also demonstrates the divergence in development between urban and rural India. In most sectors, rural India lags and, consequently, there lies the opportunity ahead.

The trend of rural India trailing urban India continues here with education. Most of India’s growth and income growth is expected to come from the many lower-tier cities & towns replicating the development of the few higher-tier cities.

“India’s future looks like China’s Past”. Viewing India with a 15-year lag to China, there are important parallels in terms of working age population and GDP/capital growth rates. As China had done, India is about to reap its ‘demographic dividend’ (~67% working-age population) and double its GDP/capita by 2030.
India’s GDP/Capita is abysmally low (South Africa & Brazil are 3X higher), therefore growing it (by plucking low hanging fruit) comes naturally. This productivity growth is what sustains India as the world’s fastest growing major economy.

Until 2011, the majority of Indian’s were undocumented. In 2011, India rolled out ‘Aadhaar’, its first comprehensive (and digital) national ID card with tremendous success. Armed with new IDs, India’s undocumented (and consequently unbanked) poor opened bank accounts in droves, surging India towards the goal of a bank account for each household. The government has begun crediting cash directly to beneficiaries’ bank accounts, bypassing the chain of corruption that historically plagued benefits transfers.

As the internet began penetrating India in 2013, Indian telecom companies skipped narrowband internet technologies and directly invested in laying future-ready broadband infrastructure. Most Indians have never experienced narrowband internet.

India achieved its COP21 target (40% of total power generation capacity to be renewable by 2030) 9 years early and increased its target to 50% by 2030.
Oil is India’s biggest import. Renewable energy will bring India energy security and reduce its enormous fossil fuel import bill, improving the current account and strengthening the Rupee.

Only in 2019 did electric trains finally overtake diesel, but the pace of electric adoption has increased furiously. Despite being very delayed, the leapfrogging benefits of an electrification is immense. Train engines historically ran on highly polluting diesel (due to undeveloped power transmission infrastructure) which contributed to India’s reliance on imported oil. The current train electrification, coupled with the upcoming road EV revolution will enable India to become energy independent.

India’s under-consumption is a feature in most sectors; here, it is exemplified in the insurance industry. While India’s level of insurance consumption is understandably lower than the OECD countries, the extreme level of pent-up demand (particularly in health insurance) is underscored by the large gap between India and even the world average.

The demand for housing credit not only far outstrips that of other real estate, but of India’s overall credit creation as well. Given India’s low percentage of homeownership, rural migration and a changing culture towards nuclear families, there is a large pent-up demand for housing. The upcoming demand from India’s large adolescent population further ads to this. This rumbling hunger for housing makes it one of the first recipients of disposable incomes and thus, closely tracks income (and GDP) growth.

India spends as much on education as the OECD countries do, however it falls extremely short when it comes to healthcare spending. This to a large part reflects the society’s and government’s priorities given a constrained budget. As incomes grow, spending on healthcare, being one of the most pressed necesseties, is expected to be among the first to benefit.

The driver converting this pent-up-demand to consumption is rising wages across the board. Just as hundreds of millions have been lifted out of poverty, hundreds of millions have advanced through the ranks of India’s burgeoning middle class. In India today, products and services across the board enjoy a growing consumer base.

India since the beginning has been a cash-based economy until 2018, when ‘UPI’ (a masterstroke technological innovation in digital payment), sparked a blinding consumer adoption of digital money. The government is now proceeding to withdraw cash from circulation to counter tax-evasion and money laundering. A large portion of society (formerly un-banked un-taxed and working in the informal cash-based economy) transitioned into the formal sector as a result. One cannot overstate the dramatic and wide-ranging effects on consumption patterns this transformation had.

Driven by consumer loans and mortgages, retail borrowers have grown to become the banking sector’s biggest exposure. It reflects both the uptake of individual credit ratings and the fading cultural aversion to debt. Credit ratings uptake improved due to 1) identity verification infrastructure (‘Aadhaar’) and 2) the Indian consumer’s rising e-paper trail (e.g.: higher bank account penetration, pay slip possession, income tax filings. etc.). Consequently, the Indian consumer today has a bank behind him/her and behaves very differently from the consumer he/she was 10 years ago.

The majority of India (rural) has only recently obtained access to electricity. After the bronze age, probably no single thing has been a greater enabler of human ability than electricity. From extending the length of day with light to powering smartphones, electricity changes a person’s everything. The simplest repercussion- access to electricity opens rural India up to the world of smartphones, power tools, consumer durables etc. which will fundamentally alter their demand profile.

Indian consumers today, very bullish on India and their future, have relaxed their famous budget-consciousness and become highly aspirational. For decades, cheap humble hatchbacks (short length, low height and small fuel-efficent engines are lowly taxed) dominated the market. Highly-taxed SUVs (taller, longer, smoother and more powerful) were considered luxuries. More revealing than the trend itself, is its speed; automakers with slow feet got battered. Naturally, a rapidly developing India has rapidly developing Indians. Being in close thouch with Indian consumer trends is important.

Traditionally, Indians saved in gold & real estate. However in 2018, the government’s support for mutual funds and the of invention of slick brokerage apps catered to millenials, sparked an explosion of retail participation in equity markets. The speed at which young indians broke from their parent’s saving norms demonstrates the rapidly evolving Indian consumer. Furthermore, the private sector does not offer defined benefit pension plans. Savers today, unlike the previous generation (who lived when the public sector culture was dominant), must take the risk associated with funding their returement into their own hands. Similar to brokerage apps, digital-first businesses in any sector that taps into this newly developed, uncatered-to and globally-exposed consumer stand to capture explosive growth.

Peaking in 2018, India’s state-owned banking sector was heavily burdened by bad loans due to ‘evergreening’, poor regulation, weak foreclosure laws etc. For years the problem snowballed, hampering fresh loan disbursals, and curtailing economic growth. Action was taken in 2018 (government recapitalized state-owned banks, an empowered RBI passed shrewd regulation and a special bankruptcy court was established) and today the Indian banking sector is strong, able to withstand systemic shocks, and aiding economic growth.

India’s government, bound by the legal debt ceiling, has demonstrated budgetary dicipline over a long period of time, consistently keeping debt:GDP manageable (even through Covid 19). Furthermore, since the indian government borrows mainly in Rupees, it is reletively insulated from currency depreciation or balance of payments stresses.

Indian households are essentially completely unleveraged. Household Financial Assets (savings) far exceed Financial Liabilities. Even excluding non-financial assets (such as home equity, jewelry etc.), the average Indian household is gradually accumulating wealth.

Household Financial assets mostly reflect cash-in-hand and bank deposits, (and also Life Insurance & mutual funds).
Liabilities include secured (e.g., mortgages) and unsecured (e.g., education loans) loans from banks and non-banks.

Corporate India’s underleverage compared to both advanced & emerging economies is on account of banks remaining India’s only debt avenue of size. Banks face difficulty underwriting SMEs (the bulk of corporations), neglecting their huge credit demand. Conversely, bank’s risk management limits further exposure to large enterprises. To resolve this, NBFCs (who are better equipped to lend to SMEs) and a corporate bond market (with increasing depth as it develops) are emerging to fill the void left by banks and drive the leverage upcycle.

India’s central bank, the Reserve Bank of India, has demonstrated its willingness to curtail economic growth in the pursuit of stable price levels. India’s policy inflation rate (“New CPI”) began in 2012 (see graph) and since 2017, RBI has managed to keep inflation close to its target of 4% (+/- 2%). In India, like elsewhere, food (whose production is dependent on the rain) and fuel prices are the biggest inflationary risks. RBI also monitors the rupee’s devaluation given its impact on domestic fuel prices- India’s biggest import.

The cacophony in this graph demonstrates:

1) Indian Index’s sector diversification

2) how each decade’s index returns was driven by a different sector which then rose to dominate the index in that decade.

India’s growth is not uniform, and it is rarely firing on all cylinders. Each sector is at a different phase of its development and take turns driving India’s overall growth. For an active manager to beat the index, it is absolutely imperative to identify the sector-of-the-decade early.

India added nearly 3X more GDP in the past decade than it has in the prior 7 decades combined. After wasting 60 years, it has finally learned to walk.

The ‘Great Indian Consumption Story’ is also apparent here. India is home to one of the world’s largest & fastest growing consumer markets. Its sheer size and speed of growth makes it the country’s greatest asset and the primary contributor to its GDP growth- historically and going forward. Behind this macro consumption statistic is productivity growth, the rising middle class, a young population, urbanisation, poverty alleviation, the ‘India Stack’, the digital economy etc.

Over decades, India gradually evolved from an agrarian to a service-led economy.

Indian services have seen robust growth both domestically and in exports. India’s IT, BPO & KPO industries- the crown jewels of its exports sector- are some of India’s largest employers. India’s demographics (a large, young, internet-connected, well-educated, English-speaking workforce) coupled with abundant engineering colleges and low labor rates have given the Indian services sector a strong competitive advantage globally.

All post WW2 ‘miracle economies’ (Germany, Japan, China, etc.) developed by, at some point, increasing their share of world exports. However, unlike with services, Indian goods exports have never taken off despite very low wage rates and a large young workforce. Realizing this, the government’s new National Manufacturing Policy aims to capitalise on ‘China+1’ and raise manufacturing % GDP. It launched its flagship ‘Make in India’ program, liberalized FDI restrictions and enacted pro-manufacturing reforms. By far the strongest export stimulator- the Production Linked Incentives (‘PLI’)- subsidizes Indian manufacturers for each incremental unit that they produce for export. Exports are India’s single biggest untapped opportunity.

India has emerged as the 3rd largest ecosystem for startups globally. Widespread start-up success, Western social exposure and rapidly evolving technology have inspired India’s youth to become enterpreneurs and India’s investors to embrace venture funds.

Startups make India’s economy more dynamic and form a healthy pipeline for public markets. Until 2017, India added one unicorn each year. Between 2018-2022, there was 66% CAGR in the number of unicorns being created each year and by 2023, India was home to 108 unicorns.

The World Intellectual Property Organization ranks 132 countries on the quality of their institutions, human research capital, infrastructure, sophistication (of markets & businesses) and outputs (of knowledge, technology and creativity). India leads the world in the ICT services exports indicator and hold top rankings in other indicators, including venture capital recipients’ value, Finance for startups, Graduates in science & engineering, Labor productivity growth and Domestic industry diversification.

The cost of labour (for Skill Level 1 jobs) in India is still the lowest quartile amongst the developing countries.

Power generation has for long been deemed by the government as a core sector- critical to the India’s development and national security, and therefore extremely influential in the power it bestows to those who control it. The slow erosion of the government’s grip on the power sector is symbolic of both the government’s growing comfort with relying on private enterprise to develop India out of poverty and its acceptance of the private sector’s superior ability raise capital, attract top talent and operating far more efficiently than the public sector.

In 1969, the government, suspicious of private control of capital, nationalized India’s banks to take control of bank deposits. Nationalized banks soon allocated capital in line with political interests (e.g., agriculture & infrastructure), accumulating large credit losses. They also served social functions (e.g., employment generation & financial inclusion) resulting in bloated cost-structures.

The government’s economic liberalization unleashed private banks who offered better service and more efficient operations to take market share from public sector banks.

Akin to banks, the influence that arose from the Insurance industry’s large float was deemed a strategic national asset and the Indian government, suspicious of private control of capital, nationalized the insurance industry in 1956.

In 2001, the insurance industry was opened to the private sector sparking a rush of global insurance firms (who brought underwriting knowhow) forming joint ventures with Indian business houses. In 2015, the FDI limit for foreign partners was increased from 26% to 49% however Indian players now proficient in underwriting are less reliant on JV partners. Today, 100% Indian owned digi-insurers have witnessed explosive growth.

Owing to their capital-intensive nature, the government has welcomed private capital in heavy infrastructure assets such as roads, ports & airports.

Roads: The PPP (Public-Private Partnership) scheme and ‘build & transfer’ model has involved private capital through vehicles such as InvITs (Infrustructure REITS)

Ports: Although industry capacity has remained stagnant, the private sector captured market share due to its far superior operational efficiency.

Airports: A large wave of privatizations of airports in tier 1 cities and tenders for new airports in Tier 2 cities transferred market share to private players.

Of Investment’s share of GDP, the private sector accounts for a far larger share than the public sector. In India, it has been found that public Investment “Crouds In” the private sector.

Also observable is the national CapEx cycle which has profound effects on GDP growth and the performance of the capital goods industry.

Education has for long been viewed as a social service rather than an industry and consequently, the governement actively encouraged the private sector involvement to educate India’s vast population. Today, given the demand of India’s large young population, many are for-profit. The quality of education, ability to raise capital and availability of seats have resulted in private colleges capturing almost all the growth in education.

In the decade after India’s bankruptcy & economic liberalization, India’s private sector became the dominant force driving India’s GDP growth. Public and government opinion decisively shifted, and both accepted that embracing private capital & capitalism would achieve India’s development goals faster than the centrally-planned state-run enterprises could.

It became the government’s policy to aid- not compete with- the private sector (later declaring it “has no business to be in business”); it resolved to privatize state-owned enterprises. These divestments helped India offload inefficient loss-making businesses and raised funds for infrastructure.

An eggregiously low percent of India’s working population file income taxes and the majority claim zero tax liability; The income tax department’s increased vigilance has forced Indians- historically major tax evaders- to file their taxes and disclose their true incomes, many for the first time. A good indicator of improvement in governance. The rise of digital payments (which hurt the cash-based economy), GST and the rise of the formal sector has also contributed majorly to this trend.

The Goods & Service Tax (‘GST’) of 2017 is a landmark achievement in governance. Before GST, each state set its own VAT tax rate, causing customs duties at state borders within India. This restricted the movement of goods within India and fragmented India into a collection of many small state markets. In 2017, GST’s “one nation, one tax” policy abolished state taxes and unified India into one enormous common market- a huge boost for corporate efficiency and the ease of doing business in India.

In addition to unifying India, the ‘GST Input Tax Credit’ also incentivized businesses to declare their incomes and shift from the informal into the formal sector. This is apparent in the increasing GST collections in the graph.

Alongside developing physical and social infrastructure, national development also entails (and necessitates) developing regulatory institutions. The World Banks’s ‘Regulatory Quality’ metric “captures perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development”.

High quality regulators create an environment where competition and public trust thrives. Good governance creates fertile ground for private business to flourish.

A common trait of listed Indian equities are ‘Promoters’- a person/group, usually the founder, with the largest shareholding and control the board. Promoters usually bring an experienced and committed management with a long-term mindset; however, some, with conflicts of interests and low governance standards are prone to self-deal at the expense of minority shareholders. In a stock market where most businesses have a promoter, most market participants are minority investors; a regulatory regime that protect minority shareholders is essential to the legitimacy of the exchange.

Civil strife such as sectarian violence has been a historic cause for social and political instability. Falling democracy indicators, and the social instability that could arise as a resuly, has emerged as a concern regarding India as an investment destination.

India’s dependency on foreign oil had been a major concern-without a robust export economy, India would not generate the USD to fund oil imports; and the resulting oil shortage and Rupee devaluation would cause even domestic consumption to falter.

IT Services emerged as India’s golden ticket. IT Services alone earn India more USD than it spends on oil; and even more impressively- it does so with far greater stability than oil during recessions.

Similarly, BPO and Pharma exports pay for India’s imports of capital goods.

What India lacks in natural resources, it makes up for with its human recourses.

India’s large trade imbalance in goods (led by oil imports) is balanced out by its large and burgeoning exports of services. Services exports are a factor of India’s large labor force- both educated (export IT, BPO & KPO services from India) and uneducated (migrant laborers abroad repatriating their earnings).

An almost balanced overall Current Account negates India’s need for foreign currency borrowing.

India has a large consistent Current Account surplus led by foreign investment flows.

India’s Capital Account is almost entirely driven by FDI & FPI, demonstrating India’s Capital Account is almost entirely raised as equity, not debt.

Even within equity, a healthy majority is FDI. FDI (foreign investments made directly into productive assets) are far more stable than FPI (foreign purchases of financial assets). This is because FDI investments have a longer timeframe whereas FPI flows (or “hot money”) are more liquid and susceptible to short-term investor sentiments.

India’s Trade Deficit (in Goods & Services) is dwarfed by its Capital Account Surplus (driven by foreign investments into India). This creates a consistent & increasing Balance of Payments surplus which is accumulating to the Reserve Bank of India’s Foreign Reserves.

RBI’s large and increasing FX reserves stands in testament of its ability to support the Rupee during times of excess volatility.

India’s ‘hot-money’ FPI investment flows executing carry trades are strongly influenced by the USA-India G-sec spreads. Unwinding these trades puts sudden short-term pressure on the exchange rate. However, since India attracts high-quality and more stable FDI- not FPI- inflows, it is less susceptible to short-term outflows.

Additionally, since most Indian sovereign debt is held domestically and denominated in rupees, Indian bonds are not dumped as substantially as others when spreads fall.

Furthermore, as spreads hit the zero lower bound, the potential for further Rupee devaluation is also bound.

Inflation rates in India have been stable and within RBI’s target range of 4-6% since 2015. Although inflation rates have risen post 2020 in many developing and developed nations around the world, Indian inflation has remained relatively stable. Consequently, India’s currency has also remained more resilient thaans most post 2020.

Given the government’s long-standing policy against borrowing in foreign currency, India’s low external borrowings is constituted largely of only commercial borrowings and deposits from Indians living abroad (Non-resident Indian). Foreign reserves, therefore, more than cover India’s external debt position.