Two major events in 2024 are likely to impact India’s equity markets and economy. First off is India’s next general election, expected to be held sometime in April and May 2024. The second event is the inclusion of Indian government bonds in the JP Morgan Global Bond Index-Emerging Markets (GBI-EM) starting in June 2024. This is likely to affect the equity and bond markets, and the economy. This event appears to have a positive impact on inflows in the near term, but the future outflows could be negative.
The results of the Dec 3 state polls provided a big boost to the Bharatiya Janata Party (BJP) of Prime Minister Narendra Modi, the Carnegie Institute for International Peace observes.
“These results confirm what is already common knowledge: as far as the 2024 parliamentary elections are concerned, the BJP remains firmly in pole position. This advantage is principally driven by Modi’s enduring popularity,” the Carnegie Institute says.
The BJP government has kick-started an infrastructure programme, with the building of road and rail networks, new airports and digital infrastructure, known as India Stack. Of course, the BJP is not universally popular; some parts of India such as the wealthier and more developed South support other parties. Neither are all the BJP’s policies popular. For instance, the demonetisation programme in 2016 was unpopular. But an interesting result of demonetisation is the development of India Stack and the wide use of the Aadhar card, which originated in 2009.
The digitalisation of India
India Stack is a set of open APIs and digital public goods that aim to digitalise identity, data and payments at “population scale”, referring to India’s vast 1.4 billion population. The digitalisation of the Indian economy and its banking system is already leading to more efficiencies, enabling banks to open small accounts digitally.
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“India Stack continues to evolve with the open credit enabled network, with new stacks that are getting added,” says Ridham Desai, strategist and managing director, Morgan Stanley India. “The government has been approached by many countries given the success of India Stack. It is easy to adopt in countries since the source code is open. Anybody can build applications and lots of countries are apparently interested in solving digital infrastructure needs. India is on its own track.”
Siddharth Dixit, a consultant at the World Bank, describes India Stack in a World Bank blog. India Stack “consists of three interconnected layers that provide a digital identity to every Indian while facilitating easy, cost-free, mobile-first digital transactions. These layers are the foundation on which the Account Aggregator (AA) architecture has been built. The stack uses the ecosystem created by each layer to operate an architecture that is projected to supercharge India’s credit environment,” he says.
The Aadhar card, for instance, is the first layer of India Stack. The second layer of India Stack is the United Payments Interface or UPI. In February, the Monetary Authority of Singapore (MAS) and the Reserve Bank of India (RBI) launched the linkage between PayNow and UPI. This enables participating financial institutions in Singapore such as DBS Bank and India to send and receive funds between bank accounts or e-wallets in real-time. The third layer is data governance. Every online activity and digital payment leave a digital footprint. The Indian government’s approach is to have a Data Empowerment and Protection Architecture (Depa).
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As part of Depa, according to Dixit, a personal data-protection bill will be discussed in the Parliament soon. Under Depa, an electronic consent artefact captures user consent for sharing personal data with third parties. And, a newly regulated entity called AAs has been introduced. These AAs are NBFCs (non-bank financial companies) that RBI regulates.
The AA architecture makes it easier for businesses and individuals with limited financial backgrounds or asset-backed collaterals to access formal financial institutions, such as micro-SMEs like the farmer, the vegetable seller or the tuk-tuk driver.
Make in India gathers steam
Modi’s Make in India initiative appears to be gathering momentum. The Wall Street Journal has indicated that Apple’s plans include manufacturing 25% of its iPhones on the sub-continent.
According to Bloomberg, the Tata Group plans to build one of India’s biggest iPhone assembly plants. Tata plans to build the factory in Tamil Nadu state, Bloomberg reports. The facility will likely have about 20 assembly lines and employ 50,000 workers within two years. The goal is for the site to be operational in 12 to 18 months.
“The plant would bolster Apple’s efforts to localise its supply chain and strengthen its partnership with Tata, which already has an iPhone factory in Karnataka state. Apple is diversifying its operations away from China by working with assembly and component manufacturing partners in India, Thailand, Malaysia and elsewhere,” Bloomberg reports.
Elsewhere, Pegatron is manufacturing
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iPhones in Mahindra World City, a CapitaLand India Trust CY6U property in Chennai. The plant makes about 20,000 phones a day. The models being assembled here are Apple iPhone 14 Plus and 15 Plus. Reuters reported that Pegatron plans to open a second facility near its first.
During a recent interview with The Edge Singapore, Desai pulled out his iPhone and said that was a made-in-India iPhone. Google phones are also going to be made in India, he adds.
“There is a very good reason for MNCs to relocate to India. For one, they need to diversify away from China. Secondly, they need access to the Indian markets which are going to become an increasingly important revenue driver,” Desai says. Apple has articulated it is interested in both manufacturing in India, and the Indian market.
Currently, India contributes about 3.5% of world GDP. “But it could account for 20% of global GDP growth over the next 10 years, which could translate into 10% to 30% of revenues for MNCs. So MNCs are setting up shop in India and this will increasingly gain traction over the next few years,” Desai points out.
How pertinent is the view that India has gained at the expense of its neighbour China? “I would argue that there has been some shift in FDI. Over the last five years, Japan and India have gained and China has lost. But if you look at the global share of the goods trade, China’s market share remains strong,” Desai replies.
Treading the fine line between growth, inflation and inflows
The inclusion of certain Indian sovereign bonds into the JP Morgan GBI-EM — a potential source of volatility — will be staggered, starting in June 2024, up to March 2025. According to Fitch Ratings, this will likely support a diversification of the investor base for Indian government securities. “This could serve to lower funding costs slightly, and support further development of domestic capital markets, but direct positive effects on India’s credit profile will be marginal in the near term,” the ratings agency says.
On the other hand, India’s high government debt and interest/revenue ratios are weaknesses in its credit profile, and developments that help to lower funding costs can have a significant influence on the sovereign’s creditworthiness, Fitch adds.
The JP Morgan GBI-EM indexes will limit their investments to local-currency government bonds issued under a fully accessible route, comprising 23 bonds with a total value of about US$30 billion ($32.2 billion). Inclusion in the indexes could facilitate about US$24 billion in passive inflows between June 2024 and March 2025, Fitch estimates. Flows could be greater if other indexes also move to include Indian government securities, Fitch adds.
As it stands, inflows are unlikely to be overwhelming. “We believe foreign investors will still represent a fairly small share of overall holdings, so their influence on debt pricing is likely to be limited,” Fitch says.
IMF research published in September 2020 suggests inclusion in major benchmark indices can reduce the sensitivity of a country’s capital flows to domestic economic shocks, but at the cost of raising exposure to volatility in international sentiment and global financial market conditions. The vulnerability of India’s sovereign financing costs to external drivers is currently quite limited, reflecting the dominant role of domestic financing, but could increase over time if non-resident holdings of government securities were to rise significantly and the fiscal metrics remain weak.
The increase in foreign investment in India’s government securities markets is likely to have other positive effects, albeit small in scale, Fitch reckons. A more diverse investor base could reduce crowding-out risks: if the government becomes less reliant on financing from domestic financial institutions, it could give them greater leeway to provide credit to the private sector. It could also stimulate further capital-market development.
Too bullish?
India remains the focus for investors, given the inclusion in the JP Morgan GBI-EM. In the meantime, economists from Barclays and Citigroup have raised GDP growth forecasts for the fiscal year ending March 2024 to 6.7% from 6.3%. In the July-September quarter, GDP growth of 7.6% is above the RBI’s projection of 6.5%. Against this background, India could suffer from two side-effects.
First off, inflationary pressures are normal. The faster-than-expected GDP growth would inevitably fuel inflation. If it does, the RBI may have to raise the repo rate to put some brakes on the economy. (The repo rate is the rate of interest at which commercial banks in India borrow money from the RBI. Commercial banks are required to deposit securities such as government bonds or treasury bills as collateral to avail these loans from the central bank.)
The second side-effect is more serious. For those who remember the Asian Financial Crisis, the outflow of hot money coupled with the unpegging of the Thai baht from the US dollar led to a capital flight and a contagion effect on the Indonesia rupiah and the South Korean won.
The immediate concern for India is the inflow of investments into its sovereign bonds ahead of the inclusion in June 2024 in the JP Morgan GBI-EM, which could exacerbate the inflation backdrop as GDP picks up.
Fitch sees inflows as a double-edged sword. “In theory, increased exposure to foreign investor sentiment around government securities could encourage the authorities to pursue policies consistent with macroeconomic stability and fiscal prudence, benefitting the sovereign’s credit profile over the longer term. However, there are examples of governments whose bonds are included in benchmark indexes that have pursued economic policies that had clear adverse effects on foreign investor confidence,” the ratings agency cautions.
“We do not believe that inclusion in the JP Morgan GBI-EM indexes will significantly affect India’s fiscal policy approach,” Fitch adds.
Desai of Morgan Stanley does not see a problem in the near or even medium term. “We shouldn’t conflate volatility with downside. Even when stocks go up, they can be volatile. Volatility is essentially the movement of prices, both positive and negative,” he says.
“There is likely to be net inflow into [Indian] bonds because it’s passive money that has to be reallocated. But the inflow in itself is going to be a source of volatility because it causes upside,” Desai says. This will raise India’s balance-of-payments surplus, which means that the RBI will have to do more intervention or let the rupee appreciate, he adds.
On the economic front, the fund managers at Tantallon India Fund have warned that there could be constraints on growth eventually. “Given the pace of industrialisation and urbanisation, India is in danger of being in a serious power deficit by calendar 2027; there is a palpable sense of urgency in the new orders being issued as the government is committed to boosting both thermal and renewable generation capacity over the next 2-3 years, together with significant investments in the grid to ensure better connectivity and stable power supply,” they say.
On a positive note, the fund managers at Tantallon India Fund point to Indian Railways investing to upgrade its rolling stock, accelerate network connectivity and rail infrastructure, and boost electrification of the system.
Elsewhere, “the geo-political realignment and a concerted push to reduce the Indian Armed Forces’ historical dependence on Russia, to secure technology transfers and to indigenise supply chains and manufacturing, is a long-term structural tailwind for the domestic defence industry”, the Tantallon India Fund managers say.
And of course, rising sales of mobile phones ahead of Christmas and beyond is likely to cement the Make in India proposition. In sum, despite concerns over inflows, the subsequent outflows, and inflation, the general election may turn into a vote of confidence for the BJP, as the Carnegie Institution expects, representing continuity and stability.
