As highlighted in our previous article, “Why India warrants a separate allocation”, India continues to be the fastest-growing major economy in the world. Numerous benefits justify a separate allocation to the country, however, like all investment decisions an assessment of the risks is important.
India, since the elevation of Prime Minister Narendra Modi, has experienced a rate of change seldom seen in a democracy. Modi has led a substantial and transforming reform agenda in areas such as infrastructure, taxation, deregulation of certain industries, transparency, governance and labour markets.
With these changes and International Monetary Fund projections that India’s growth will continue, the country is fast becoming an investment opportunity capable of delivering better risk-return outcomes for international investments.
Like all investment decisions, however, questions about investment risk need to be addressed:
- Can the rate of change be predicted, and the impacts on investment assessed and added into the parameters around investment decisions?
- What are the implications for international, especially Australian, investors and how will that feed into investment decisions?
In setting the guidelines for a discussion around risk, we need to remind ourselves that most investment decisions for markets outside ‘traditional’ markets centre on diversification. And, while the primary driver of diversification provides a number of benefits, collectively it is the potential for higher returns at different parts of the investment cycle that should reduce overall portfolio risks.
With all emerging markets, however, it is generally accepted there are additional risks, namely country, currency, specific market and corruption. Here is a summary of the risks and our views on India specifically.
Country risk is the collection of risks associated with investing in a particular country, such as political, economic, exchange rate or sovereign risk.
India’s political and economic risks have diminished and will continue to recede, driven in part by the Modi government. It is worth noting, however, the country is underpinned by market regulation that is both strong and long term, including:
- The legal system is akin to that in Australia and England – legislation is in English.
- Market regulator – the Securities Exchange Board of India (SEBI) provides a robust regulatory environment built on years of experience in turbulent times.
- Quarterly reporting by listed companies tends to be more detailed than reporting by Australian companies. The Companies Act was rewritten and simplified in 2013.
- Access for foreign investors simplified under SEBI (Foreign Portfolio Investors) Regulations 2014.
Currency or exchange rate risk is the change in value of a currency relative to others. A currency is normally rated against internal inflation and the need to borrow external capital. Currency risk can, in some cases, be mitigated by hedging. All international investments of course face this risk.
In India there is both falling inflation (3.41 per cent, down from around 6 per cent in July 2016) and increased capital in the banking system following the recent demonetisation. Both factors may decrease the short-term need for external borrowings and, in turn, stabilise the strong currency.
Specific market risk is judged by how heavily a market is exposed to one or more industries. A common example used in Australia is the market’s exposure to resource-based companies and the export-driven needs of China for those resources.
India is substantially different. The economy is driven by internal consumption, with an 80 per cent exposure to the local economy. There is also diversity of industry sectors – after financials at 32 per cent, the largest sectors are IT, energy and automobiles, each representing less than 13 per cent of the NSE 50 Index.
Corruption risk is often raised when India is discussed, although, unfortunately, the abuse of power for personal gain is a part of all economies to a greater or lesser extent. That is not say we should ignore it, rather recognise the need for careful assessment of the people you entrust with your money.
In India, Modi has been elected on a platform of addressing many levels of corruption endemic within Indian society and we have already seen major inroads into this. One of the key platforms of demonetisation was to curb corruption. Payments of subsidies on products directly to the recipients’ accounts and the recent restriction on cash payments to political parties unless done through banking channels highlight Modi’s resolve to stamp out corruption at its source.
In summary, to balance risk and reward an investor must be able to make decisions on their allocations to individual countries and increase or decrease the exposures as the opportunity improves or lessens.
Like all markets, there are risks when investing in India, however, also significant benefits. In our view, the risks or concerns often raised are addressed by both the long-term market regulations and the government’s reform agenda. Jaipur Asset Management has sought to further mitigate the risks in other ways, such as using a two-step qualitative and quantitative analysis process for manager selection and only using managers based in India with substantial experience managing Indian equities.
But let’s not forget the key investment benefits – diversification and a better risk-return outcome for international investors – are supported by India’s strong economic data both historically and forecast, which is largely driven by internal factors.