The Indian elections, which kick off today, are likely to provide further evidence of the steadiness of the country’s politics. Narendra Modi has been in power since 2014, which has given him a stable platform to enact sweeping financial reforms and build out the country’s infrastructure. This has helped the Indian economy build on its long run of strength.
But is India’s buoyant economic and political outlook enough to merit its significant premium to the remainder of emerging markets? To put this in context, the forward P/E of the MSCI Emerging Markets is 12.1x. This compares to 22.1x for MSCI India. India also looks expensive on other measures – 4.1x on price to book, compared to 1.7x for wider emerging markets. Valuations have been stretched by a year of very strong performance for Indian stock markets, with the MSCI India up 39.4% over the past 12 months.
Nevertheless, the picture may be more nuanced than it initially appears. Ayush Abhijeet, investment director at White Oak Capital Partners, says: “While a lot has been said about India being expensive, it has always been expensive. Its valuation premium is not a new phenomenon.”
This is borne out by recent history – research from Siblis shows that the Indian market was more expensive in 2021 and is only marginally more expensive than in 2022 and 2023.
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This premium has a number of drivers, says Abhijeet, of which the country’s rapid growth rate is just one. He adds: “India has top notch corporate governance. It has a long history of democratic institutions and there is clear separation of power – it has an independent central bank, for example, and a strong system of property rights.” He also points out that the country has experienced considerably more financial and political stability than most other emerging markets. Unlike many of the Latin American markets, for example, it hasn’t experienced a major financial or political crisis in recent history.
China’s weakness
The problems in China have also skewed the overall statistics. The Siblis research shows the PE on the Chinese market has sunk from around 16x in mid-2021 to its current level of 12.8x. The MSCI China index shows an even lower figure – just 9.1x for the forward P/E and 1.2x for price to book. Having been more than 40% of the MSCI Emerging market index, China’s recent run of weakness has seen it shrink to 25%.
This makes India a more important feature in emerging markets. It has now overtaken Taiwan to make up almost 18% of the emerging market index and Abhijeet points out that India is now the fourth largest market in the world (after the US, Japan and China). This means international investors have to take notice. Recent strength has been largely delivered by domestic participation in the Indian market. As it grows in importance, international investors could be a source of further demand.
India vulnerability
Nevertheless, there are caveats. The recent wobble in the small and mid cap sector showed some vulnerability. In mid-March, concerns from the Indian financial regulator about froth in this part of the market prompted a significant sell-off. The S&P BSE Small Cap index dropped from 44,653 on 7 March to 40,641 on 13 March, a drop of around 9%. Share prices have subsequently recovered, but it was a reminder for investors that the market can go in both directions.
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James Thom, senior investment director, Asian equities at Abrdn, says he ‘would like to have more’ in India, but the valuation of the market is a deterrent. “We have seen some repercussions in the small and mid cap market – it got a little frothy. This is always a risk if share prices move ahead of fundamentals. We are alive to that risk.” Within the Indian markets, he is focused on areas such as real estate, which have not kept pace with wider markets, and areas that might benefit from private sector capital spending, which is starting to revive.
Catch up?
Another question is whether other markets might start to catch up with Indian valuations, which would also narrow the premium. A reappraisal of China, for example, would provide an opportunity for an equalisation of valuations between India and the rest of emerging markets.
This has looked implausible, but over the past month, the IA China/Greater China sector is up 3.5%, while the India sector is down 3.5%. This is very short-term, and many believe China’s pariah status among Western governments makes it uninvestable. However, Anuj Arora, head of emerging market and Asia Pacific Equities at JP Morgan Asset Management, says: “Not only is the valuation of the Chinese market really, really low, Chinese investors have capitulated. They have left the house. In December and January, there were massive outflows from foreign investors.”
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He adds: “Outside the US, there is no other market that offers us the stock selection opportunities that China does.” He points out that the government is finally starting to stimulate the economy and this, along with record low valuations, could transform a short-term bounce into something more enduring.
Elsewhere, he says, emerging markets are the enabler for the two huge themes going on in the world. The first is the AI revolution: “The memory comes from Korea, the components for GPUs from Taiwan, the components to connect to servers come from Thailand. Without Asia, the revolution is not possible….We are starting a new cycle and this could be absolutely crucial.” Although there has been some share price appreciation, this trend is not yet fully reflected in prices.
Emerging markets are also a key player in the move to sustainable investment. “EVs, batteries within EVs, solar panels, all of these are made within emerging markets. You cannot have green and sustainability ambitions in Europe and the US without the factories in Asia and emerging markets.”
There are a number of reasons why the gap between India and the remainder of emerging markets could diminish. India could see a measured fall, China could see some revival, or the rest of the world may start to appreciate the opportunity in other parts of emerging markets, particularly around AI and the green transition. India undoubtedly deserves its premium, but it may not be static.
