Quick Thoughts: India votes—Unprecedented window of opportunity

Franklin Templeton Institute’s Kim Catechis recently hosted a discussion with Murali Yerram, Portfolio Manager, Franklin Templeton Emerging Markets Equity, and Marcus Weyerer, Senior ETF Investment Strategist, Franklin Templeton ETFs EMEA, for perspectives on India’s election dynamics, initial trends, potential challenges and the road ahead. Kim shares his key takeaways. 

• Unprecedented window of opportunity. The fifth-largest economy in the world appears to be facing an unprecedented window of opportunity. India is currently a lower-middle income country (as classified by the World Bank), but over the next decade, it could double its gross domestic (GDP) per capita to move up to upper-middle income country status.
   
• Policy continuity is key. Murali emphasized that, in his view, policy continuity underpins India’s growth opportunity. Over the past decade, the government has already detailed its policy framework and reforms, and he said the next 15-20 years will likely be about reaping the benefits of those policies and reforms. The most important outcome of this election, and the next one in 2029, would be political continuity and policy continuity. On the flipside, maintaining that continuity is also the biggest challenge to its longer-term growth prospects. A change in government and a lack of policy continuity would impact that trajectory. Data available so far on the 2024 election indicate that Prime Minister Narendra Modi’s government will be re-elected with a large majority, which could assure policy continuity.
   
• Opening up India to free trade. India has always had one tremendous thing to offer in trade, and that is a massive domestic market. As a result, successive governments over the years have jealously guarded that and protected industries through limits on foreign ownership and tariffs on foreign product import. Kim noted, the fastest, most effective catalyst a country can put into its economy is to open up its borders and indulge in as much free trade as possible—despite the inevitable short-term pain that inefficient industries will suffer.
   
• Progress on trade agreements. Marcus believes that the progress being made on free-trade agreements is key to the opportunities ahead, and that the cumulative benefit of selective deals can make a massive difference for India going forward. The government has signed trade agreements with the United Arab Emirates, Australia and the European Free Trade Association (EFTA). It is also in the final stages of a trade deal with the United Kingdom and in talks with the European Union (EU). More importantly, the government is involving India’s private sector in consultations around the trade agreements as international companies appear eager to invest and set up manufacturing plants in India following these agreements.
   
• Potential geopolitical strains. Geopolitical issues with some of its neighbors remain a key challenge for India. The country may continue to benefit from its central philosophy of non-alignment, i.e., it aims to not pick sides, over the years ahead. However, over time it may be forced to show its hand. India maintains links to Russia based on military procurement and the benefit of discounted oil and wants to have a reasonably good relationship with China. While openly not picking sides between the United States and Russia, Murali believes the government is softly aligned to the United States.
   
• Challenges from oil and food prices. India is an importer of oil, so any spike in oil prices would likely have a reasonable impact on inflation and, to a lesser extent, on the economy’s external account. A large proportion of India’s consumer price index is based on food prices, and Indian agriculture is very dependent on the annual monsoon rainfall. Murali noted that India experienced this in the early 2000s when it had consecutive years of below normal rainfall. If that scenario were to arise, inflation would be a concern. The trade deficit is likely a lesser concern for Murali compared to inflation. India’s exports have grown, and the trade deficit has improved. India is a net exporter of mobile phones, and it has seen a significant increase in software exports and other services exports. International companies are setting up global delivery centers in India, and that trend could grow even further.
   
• Equity market valuations reflect high growth expectations. In our analysis, India’s equity valuations appear fully valued or high compared to historical levels, and many international investors are concerned whether these current valuations are justified. Marcus noted a number of factors supporting valuations. Relative to other emerging markets, India benefits from a geopolitical premium—that is, it is viewed as having lower geopolitical risk and thus higher valuations—while Chinese valuations have dropped partly because international investors have demanded a geopolitical discount. The strong local market, with retail investors participating and saving for the future, also bolsters Indian valuations, in our view. One of the main arguments in favor of high valuations is the high growth backdrop and growth expectations for the equity market. And this is where the challenge lies. Current valuations are riding on the delivery of strong growth and corporate earnings. If we were to see cracks developing on the growth front, equity market valuations risk derating. But with policy continuity, Marcus sees little risk India will be unable to deliver on the growth expectations, as reflected in the equity market. Murali also believes India can sustain its strong economic growth for a much longer period in this cycle.
   
• No significant implications for the European Union (EU) from India’s election. With indications that the Indian government is likely to remain in place with a similar majority, Europe should be able to look forward to a continuity of its constructive relationships with India’s government and increased openness for European companies. However, the EU also has elections coming up in June, and from an India perspective, the biggest change going forward could be a more inward-looking EU and an EU parliament that may not be looking to do big scale free-trade agreements that allow a lot of market access.

As we have discussed, the investment case for India depends mostly on policy continuity and additional reforms. If we indeed see political continuity from this election, and the new government delivers on policy reforms, India should continue to provide international investors with potential investment opportunities.