India Could Be the Next China

 | Dec 21, 2016 | 11:00 AM EST
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Are India and its share market set for a bull run in 2017?

A stern reform push, a bid to push the illicit economy into the mainstream, and an incipient middle class suggest it may be. The nation is beginning to demonstrate some of the characteristics that drove Chinese growth at such a heady pace for so long. 

India is the fastest-growing major economy in the world right now, set for growth of 7.0% next year after this year's projected 7.2%, according to Thomson Reuters.

That's ahead of China's 6.7% rate of growth this year, expected to slow to 6.3% next year -- almost a full percentage point below India. And it is greater domestic consumption that is driving India's improvement, suggesting the middle class is truly coming into its own.

The highly controversial decision to render high-value notes -- 86% of the value of the money in circulation -- worthless has been grabbing the headlines of late. Nomura  (NMR) forecasts the decision will result in a two-quarter period of adjustment, knocking one percentage point off growth. Since India is a cash-driven economy, sectors that are particularly dependent on cash transactions are already hurting: sales in agriculture, trade, transport, real estate, construction, automobiles and gold were down as much as 60% in November, after the government's move. 

But in the long run, driving "black money" into the real economy is likely another long-run driver of growth. Bank deposits have already risen 10% as people move the money from under the mattress into the financial system. There's an effective tax amnesty on the undeclared black money, which will be taxed at only 50% of the normal rate once declared. The Japanese bank expects growth in 2018 to advance at a rapid clip, close to 8%, in 2018. 

India's 1.3 billion population is expected to supplant China's 1.4 billion people as the world's most-populous nation by 2022, according to the United Nations. The sheer size of the market obviously makes it attractive, but the nation has also embarked on a series of reforms that should lure both foreign and domestic investment.

The country is notorious for its bureaucracy and corruption, but there's a drive under way to address those issues. The introduction of a goods and services tax next year should simplify the tax structure, and the 2017 budget should also revamp corporate tax in a positive way.

The goods and services tax is likely to push the price of goods down, stimulating domestic spending, while driving the cost of services higher. The emergence of the middle class and its greater spending power, coupled with a series of interest rate cuts from the Reserve Bank of India, suggest that real estate is also set to boom.

And indeed, major institutional investors have identified Bangalore and Mumbai as their top picks for both real estate investment and development next year. That supplants the "gateway" cities of Tokyo and Sydney, which have ranked top for the past three years in the annual Emerging Trends in Real Estate Asia Pacific report, put out by the Urban Land Institute

I explain why prospects look exceptionally strong for Indian real estate in this post that I've just written for Forbes. Chinese companies like Dalian Wanda and Fosun International  (FOSUY) are already sniffing around, suggesting that India may start to share some of the boom-time characteristics that drove China's growth into double digits for a decade before its recent slowdown.

India is the top Asia overweight for for the equity strategist at CLSA, Chris Wood. As of the end of the third quarter, he had 22% of his Asia ex-Japan portfolio invested there, 14.1 percentage points above the 7.9% weighting in the MSCI Asia Pacific ex-Japan weightings.

He has 13% of his Asia ex-Japan portfolio invested in Indian banks, with the largest stakes in HDFC Bank (HDB) , IndusInd Bank NSE:IIB and the Bank of Baroda NSE:BOB. Of course, they benefit from the push to move money from cash into the formal financial system. 

Real estate isn't far behind in Wood's portfolio. Housing finance accounts for 12% of the holdings. Besides HDFC, the biggest positions are in GRUH Finance (GRHFY) and Indiabulls Housing Finance (IDKQY) . For real estate, he favors Prestige Estates Projects NSE:PREG.

Other top picks are the carmaker Maruti Suzuki (MRZUY) , cement maker ACC NSE:ACC, the media company Zee Entertainment (ZEEEY) , the personal- and home-loan company Bajaj Finance (BJJQY) , and textile maker Arvind NSE:ARVND.

There's been a recent 1.4% drop in earnings estimates for the "Nifty 50," India's leading index, consisting of many of its most dynamic companies. The largest cuts in earnings forecasts were suffered by commercial and personal bank Axis Bank NSE:AXSB, which has recently been hit by a fake-accounts scandal, telecom Idea Cellular (ICLQY) , which Jefferies at least says has a stretched valuation, and Tata Motors (TTM) , now going through a boardroom battle surrounding the ousting of former chairman Cyrus Mistry. One of Wood's picks, ACC, has also seen a significant downgrade in earnings prospects, as has its rival Ambuja Cements NSE:ACEM.

Meantime, earnings forecasts are rising for aluminum maker Hindalco Industries NSE:IN, benefitting from higher commodity prices, Wood's pick Maruti Suzuki, and the Gas Authority of India Ltd., better known as GAIL NSE:GAIL. Bosch (BSWQY) , the German multinational that makes software and engine parts in India, and GAIL's brother in arms, the Oil and Natural Gas Corp. NSE:ONGC, have also seen upgrades, higher oil prices feeding through to the Indian market.

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