Investment Perspectives from the Road: India

Indian equities have long traded at higher valuations than other emerging market countries, partially because of the country’s growth potential and also because India’s closed capital account drives domestic savings into the local market. However, it saw a notable pullback beginning in October 2024. My trip focused on confirming appropriate conviction levels for our existing investments and investigating potential new ideas after a variety of companies dislocated even more than the index.

A Valuation-Driven Pullback

Source: Bloomberg

Initial Observations

Over the last several years, Indian equities were supported by inflows from domestic retail investors, which have, at times, made it behave more like a momentum market. Even with the recent pullback, Indian investors remain quite confident, as witnessed by the positive net flows below.

Source: AMFI, CEIC, Kotak Institutional Equities, from April 2019 to February 2025.

Digging Deeper

Global investors, although constructive on India’s long-term potential, have been reducing exposure for much of the last three years because of the relatively high valuation compared to the rest of the emerging markets (EM). Uncertainty about a cyclical economic softening due to rising interest rates and geopolitics was also part of the equation. Domestic inflows had more than offset international outflows until late in 2024. Renewed interest in Chinese equities following January’s news about AI advancements in China led to some additional India-to-China rotation by global investors.

A research focus during my trip was to investigate the rural economy, which has been weak since India dealt with a 2021 COVID-19 resurgence. India has seen a “K” shaped recovery, where urban consumption and urban business activity accelerated pretty quickly. But the rural economy has remained weak, which we can see in the Indian Government’s rural wage data (the government does not report aggregate urban wage data).

Source: Bloomberg
Still, other wage data points, like white collar services and business processing, are helpful to evaluate the health of urban consumers.

Source: Bloomberg
Rural wage growth has been roughly in line with overall CPI for much of the last decade, but food is a bigger part of rural spending, so rural wages’ failure to keep up with food inflation has been particularly painful for that portion of the population. Conversely, white collar wage growth has remained well above inflation, which has supported both urban consumption and savings (including the retail flows into the domestic equity market).

This is meaningful because rural wages have not grown in real terms for a decade, whereas white-collar wages have had real gains of around 5% for some time. The growth opportunity for most consumer staples companies is via expansion into rural communities, and the limited rural wage growth has also led to lackluster sales growth for much of the consumer staples sector. A newer worry is whether urban consumption is decelerating. The wage level data doesn’t indicate it, but urban workers have been taking advantage of easier access to consumer credit, which may have pulled forward some demand.

India’s Futures & Options Trading Surges

Another shift in Indian capital markets activity has been (primarily urban) retail investors participating in futures and options trading. Local investors’ primary investment method has been to buy traditional mutual funds via “Systematic Investment Programs” (SIPs), which are recurring contributions similar to a 401k. However, there has also been a notable increase in derivatives trading by retail investors through online brokerage accounts. However, while they’ve generally experienced a good ride with their SIP investments, the great majority of urban consumers have been losing money on futures and options. These losses have diluted some of the potential spending power from robust wage growth.

The following chart highlights the tremendous growth in options and futures contracts, and we’ve seen the volume of futures and options trading meaningfully outpace the incremental volume in single stock trading. Single stock derivatives volume is now approximately 6x the volume of single stock cash equities trading, compared to being only less than 3x higher a decade ago (the ratio of index-level derivatives trading vs. single stock cash equities trading has risen from about 4x to almost 50x in the last 10 years).

Source: National Stock Exchange of India, Kotak Institutional Equities

Money Supply and Banking System Liquidity

India’s general money supply and banking system liquidity are important for economic growth and capital markets stability. The system faced a liquidity deficit beginning in 2019 and troughing in 2021. As post-COVID stimulus policies (local and global) moved through the system, liquidity improved dramatically through late 2023, coinciding with much of the equity market’s strong run. Around mid-2023, the Reserve Bank of India (RBI) began withdrawing liquidity, which decelerated the economy and ultimately was probably a partial cause of the recent equity market pullback. However, the RBI’s recent moves have demonstrated it has a balanced commitment to mitigating inflation and preserving economic growth, and liquidity has again improved, creating attractive investment opportunities going forward.

Source: CEIC, RBI, Kotak Institutional Equities
An important component of the outlook, besides direct RBI action, is the guidance it’s been providing to the financial sector. Fintech innovation over the last several years led to a significant increase in unsecured lending, which was growing at 35-50% compared to overall system credit growth in the low-to-mid-teens. Banks and non-bank financials are now all speaking openly about their intentions to decelerate various types of consumer lending, likely avoiding a credit bubble. The new outlook is that system loan growth should be 11 or 12% through at least early 2026, which is a modest deceleration from recent years but still healthy at around 1.5x nominal GDP growth.

GDP Back in Range

At a high level, it’s likely that we’re currently seeing the renormalization of India’s economic growth rate. Over the last decade, there has been a lot of excitement about the incumbent government’s reform agenda. However, other than the acceleration in growth following COVID, real GDP growth has generally been in the 6-8% range. India can remain among the fastest-growing countries in the world, but it doesn’t appear likely to achieve the double-digit GDP growth that China achieved for many years from the early 1990s to the early 2010s. Nonetheless, the reforms have likely improved the durability of a solid economic outlook, even if they haven’t necessarily increased the trend growth rate.

Source: Bloomberg

Key Takeaways

Indian equities had been flying high heading into late-2024, but a pullback to start the year made this trip both critical from an investment standpoint and quite interesting from a macro perspective. Domestic investors remain bullish, although their willingness to allocate to riskier niches may continue to soften. The pullback offered disciplined global investors interesting entry points in a number of differentiated companies. There are good reasons for long-term investors to remain largely constructive about the country’s prospects, but it remains difficult to identify a positive inflection in India’s rural economy, which has been struggling to sustain meaningful growth. Global investors will likely continue to debate India’s valuation premium compared to the rest of emerging markets, but opportunities remain for fundamentals-focused investors willing to roll up their sleeves.