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Since we released in May 2022, the MSCI India index has risen by more than 30%.It is undeniable that the rising global risk assets after the peak US inflation reached the peak of US inflation in 2022 played an important role in maintaining India's risk preferences.But even from a relative perspective, the Indian market has won other parts of the world.

Can investors optimistic about India explain the country's huge growth potential?Or is this just a typical market bubble, and will it break down?In this report, we try to find a balance between the two views.

In the long run, no matter what the Indian Party's further consolidation of power to Indian democracy and religious freedom means, Premier Modi's reelection will make investors convince that the development of economic reform and manufacturing development policy will continue.After the successful consolidation of power in the first term and launching several key structural reforms in the second term, investors generally expect that the Modi government will concentrate on economic modernization in the next four years to achieve that GDP will reach 2028 to reachThe goal of $ 5 trillion.

First, what promotes the prosperity of the Indian market?

In our previous Indian evaluation report, we believe that global investors may overestimate India's economic and political preparations of the world's next manufacturing center.Therefore, we concluded at the time that in the macro environment of the Fed's interest rate hike cycle and the surge in commodity prices, the high valuation of the Indian stock market was unsustainable.

Looking back at our cautious assessment at the time, we clearly underestimated the three positive power, and these three forces have become the main driving force for the current market prosperity of India:

The recovery of the domestic capital expenditure cycle

Two years ago, there was almost no evidence that the long -term problems that had troubled the Indian economy -lack of domestic investment -will be resolved soon.The IL & FS crisis at the end of 2018 caused a sharp decline in credit. At the same time, the government has also made limited progress in controlling subsidies or stripping state -owned assets. Therefore, the resources left for infrastructure investment have become increasingly limited.But what surprised us was that the turning of the Modi government to infrastructure was proven to be decisive: in the past two years, the share of capital expenditure in the Indian government expenditure has increased, while the subsidy part has decreased significantly.From the absolute amount, since we published a report, the capital expenditure at the Indian financial level has almost doubled.

The rapid upgrade of infrastructure has also become a key factor that stimulate housing demand and real estate development investment.In the past few years, the improvement of domestic transportation in India has brought a considerable part of the rural population to urban areas to obtain better employment opportunities and living standards.With the surge in infrastructure investment, the sales of residential properties in New Delhi, Mumbai, Bangalore, Phala, Kim Nai, Kolkoba and Headraba jumped to a historical high in 2023.The rise of real estate sales and housing prices have also stimulated developers' AnimalSpirits, leading to a significant recovery of residential development investment.

What surprised many investors was that although the media promoted the Friend-SHORING strategy and global supply chain reorganization, the industrial sector was not actually the main contribution of Indian capital expenditure.We will explain this after the report and explain why it is still one of our main concerns about India.But at present, strong infrastructure and real estate investment have been enough to reverse the decline in the country's investment rate for nearly ten years.Pune Wealth Management

After ten years of downturn in capital expenditure, India once again showed signs of investment boom, and this was exactly "good medicine".Many economists believe that the current macro environment in India is similar to the mid -2000s. At that time, due to the expansion of investment, the average annual GDP growth exceeded 8%.The recovery of the capital expenditure cycle has also become the most mainstream investment theme of the Indian stock market.Among all stock sectors, CapitalGoods Index Index is the best index that has performed in the past two years.In contrast, the IT index of global investors' darlings is far from losing the market.

It is worth noting that a key factor that promotes the continuous expansion of capital expenditure is the successful cleanup of the banking system.Thanks to the 2016 bankruptcy reform and government -led state -owned bank capital reorganization, India's non -performing loan ratio has dropped to the lowest level in the past ten years, while the capital adequacy ratio has risen to a historical high.The improvement of the bank's balance sheet, coupled with strong investment demand, led to the recovery of the credit cycle, thereby strengthening the prosperity of capital expenditure.

There are two main reasons to explain why the rise in credit and capital expenditure will continue in the foreseeable future.

First of all, in the past cycle, the Indian economy has been deleveraging, while the debt of other emerging markets has increased rapidly.Today, when the Indian financial system has been cleaned up and the demand for capital expenditure is rising, the leverage of the Indian private non -financial sector is still relatively low.Therefore, Indian families and enterprises still have a lot of space to increase leverage, which may promote the formation of a virtuous circle.That is, the increase in credit demand will promote economic growth, which will further stimulate the animal spirit of the economic subject.

Secondly, it is worth noting that India's current capital expenditure expansion occurred during the US dollar bull market, which violated the negative correlation between these two variables in history.This progress shows that India's investment demand is very strong, and even if the Federal Reserve raises a sharp interest rate, it has failed to suppress its growth.Therefore, in the Federal Reserve's interest rate reduction cycle (unless a hard landing situation occurs), the depreciation of the US dollar will catalyze the stronger global growth momentum, which will also help India to extend its capital expenditure cycle.Chennai Investment

Assets under geopolitical changes are re -allocated

Over the past two years, some overseas capitals have flowed from India for various reasons.This has brought major challenges to global configurations -where should the funds flow if they do not invest in India?

The easiest solution is to allow capital to return to the United States.However, the problem is that most of the global capital configurations have been extremely super all over the United States.In addition, investors are increasingly believed that in the multi -polarized world, they need diversified investment to balance geographical risks.

Although we realize that the decline in the Indian stock market may have a positive impact on India, we have not accurately predicted the scale and duration of this positive impact.Since Beijing began to rectify the Internet platform company four years ago, Indian stocks have risen straightly for Indian companies' valuation premiums.This straight -line rising has not only lasted for more than three years, but also India's stock market premium for India's price -earnings ratio was already twice as much as the Indian stock disaster in 2015.Although the growth gap between the actual GDP between the two countries is much smaller, the relative performance of India and Indian stocks also looks more ridiculous.

Local investors are enthusiastic

In early 2022, we worried that the start of the Fed's interest rate hike cycle would lead to foreign investors sell Indian stocks.Byly, this expectation is proven to be correct. Foreign institutional investors set a record of Indian stock selling records with the largest -scale Indian stocks in the history of 2022.However, we have not foresee that India's local investors -especially public funds supported by retail fund inflow -have maintained amazing toughness in the entire Fed ’s interest rate hike cycle.

There are three mainstream interpretations on the market that the sudden outbreak of such local investors.

First of all, the new crown epidemic may structurally increase the participation of retail investors to the stock market.Some academic research shows that due to the extension of the epidemic blockade, the stock market may be used as a substitute for gambling.Therefore, it is not surprising that the scale of asset management in the Indian public fund industry began to surge during the epidemic situation, which itself reflects the structural change of family financial behavior.

Secondly, compared with other major economies, Indian families have always only distributed a small part of financial assets to stocks.As the stock transactions during the epidemic increased the level of financial knowledge of the family, the composition of family financial assets may have begun to change.Although the scale of public fund asset management has increased significantly, this may only be due to the low base effect.In other words, as the family continues to transfer its financial assets from bank deposits to stocks, the strong inflow of public funds may continue in the foreseeable future.

Finally, Indian investors' growing "Fomo" mentality has undoubtedly played a certain role.Since 2021, the largest retreat of the Indian stock market is 16%, the lowest in the world's major markets.In the past few years, the VIX index of the Indian market is even lower than the United States.Therefore, the mentality of buying dips has become a strong consensus of local investors, and the market for sale every time -especially in the first half of 2022 by foreign institutional investors selling -in fact they are regarded as an excellent buyingChance.

2. But "Made in India" is still a mirage

In recent years, one of the main optimistic arguments about India is that due to the tension of Sino -US relations, the diversification of the supply chain, and the Modi government's commitment to revitalizing the industrial department, India is likely to become the world's next manufacturing superGreat country.

It is undeniable that Indian manufacturing has made some exciting progress.For example, the Indian manufacturing PMI has recently soared to the highest level in 16 years, while the PMI gap between India and the world's four major economies (the United States, India, Japan and Germany) has expanded to 10.5.In addition, since the outbreak of the new crown epidemic, the export of Indian electronic products has increased by nearly tripled.Recently, there have been reports that about 14%of iPhone is currently produced in India, and this proportion in 2021 is almost zero.Apple quickly transferred iPhone production to India, which is widely believed that the speed of supply chain from India to India is faster than expected.

Although investors are becoming more optimistic about the rise of Indian manufacturing, a series of macro data still shows that the transfer of supply chain to India is still a mirage so far.

First of all, we are particularly shocked that in the past two years, India's net foreign direct investment (FDI) inflows have fallen sharply.Many investors may point out that the shrinkage of FDI has become a global phenomenon due to the Fed's interest rate hike cycle.However, the share of India's FDI in emerging markets (except India) has also fallen sharply, indicating that it is actually behind other emerging markets in the competition that attracts global capital.In addition, we showed that the region's FDI in the region rose in the case of global investment shrinking last month.In other words, not investment in all regions is declining.

Secondly, the recovery of the Indian domestic credit cycle is mainly promoted by the service industry (especially the real estate market) rather than the industrial department.Ironically, this is in stark contrast to IndiaPune Investment. Beijing has bet on the growth of the high -end manufacturing industry, which has led to a surge in credit in injected by banks to manufacturing.In view of the weak credit expansion of the industrial department, the growth of production capacity in Indian manufacturing may be much limited than many investors imagined.For example, India ’s industrial output has not yet returned to the level of trend before the epidemic, which is very different from the situation in India.If India is expected to replace India to become the next world manufacturing center, the situation should not be the case.

Third, the growth of Indian goods exports in the global market is not obvious so far.If the growth of the export market share is the best indicator of a country's manufacturing strength, then ironic is that the biggest winner is India instead of other countries in the "global supply chain reconstruction" of the hype.

Therefore, despite the media propaganda, the reality is that India has made a very limited progress in transforming into a manufacturing leading economy.This reality deepened our long -term concerns about India's early -industrialization.Economist Dani Rodrik believes that de -industrialization will prevent workers from low -income economies transfer from rural areas to cities with much higher productivity, thereby hindering the rapid integration of the economy.Due to the slowly upgrading of the manufacturing industry, although its GDP growth figure is amazing, India's labor productivity growth is still much lower than the level before the epidemic.

Perhaps because the manufacturing industry is not satisfactory, a new point of view has appeared in India in China that India's growth model will be different from the East Asian model, but rely on the dual engine drive of the manufacturing and service industry.For example, more and more scholars and investment experts believe that India does not have to choose between manufacturing and service industries.Some people even claim that India's resources should not be used to promote the manufacturing industry, but should be used to strengthen their traditional competitive advantages in the service industry.We believe that India's re -turning to the service industry is a worrying sign of development, and it also implies that the Modi government's efforts to build India as a superpower manufacturing industry have not been proceeded as the original plan.

The leading growth of the service owner is facing two major problems.First of all, the service industry does not have the ability to absorb large -scale labor owned by low -income economies like manufacturing.This is the main reason why Indian workers are still employed by low productivity agricultural sector. This proportion is still the highest among major world economies.

Secondly, the service industry is difficult to export on a large scale due to its local and non -tariff trade barriers.The total potential market (TAM) of Indian service exports is much smaller than the export of goods.Even if India can increase its market share in global service trade from current 4.3%to 15% -the same level as the peak of the United States -means that India ’s exports will increase by $ 760 billion.In contrast, to achieve the same export amount, India only needs to increase its market share in global commodity trade from the current 1.8%to 4.8%, that is, India reached in 2002 (one year after joining the WTO)level.We believe that the latter is obviously much easier than the former.

If it cannot be successfully transformed into a manufacturing leading economy, India's labor productivity growth may still be weak.In this case, India's only way to maintain high GDP growth is to extend the capital expenditure cycle.However, the deficit economy (the result of weak manufacturing exports in itself) is difficult to maintain domestic investment forever.Once the fiscal situation worsen (India has developed in this direction) or the economic overheating forces the Central Bank of India to raise interest rates, the current fanaticism of infrastructure and real estate may end, and India's excellent growth in the past few years will end.

Although our judgment on the Indian market is wrong, we have not been ready to become the world's manufacturing center's forecast for India. It has proven that it is correct.Although there are several unique optimistic stories, we find that there are few macro evidence to confirm the rise of Indian manufacturing.In view of the collapse of FDI inflows, the small growth of the export market share, and the weak loan of the industrial sector, the statement of migrating the supply chain to India is still more hype more substantial.Although India's competitive advantage in the service industry is undeniable, service -oriented development models are difficult to expand on a large scale and increase overall labor productivity.

Although the election brings short -term fluctuations, from the perspective of cyclical time, Indian risk assets seem to be in a favorable macro environment.Overall inflation and core inflation have declined sharply, and economic growth remains tough.The United States is about to start the interest rate cut, and the Indian Bank of India may also relax monetary policy to maintain high valuations in the Indian market.

Nevertheless, we are expected to have a rate cut at the central bank of India below the Fed, with two reasons.First of all, in view of our optimistic attitude towards continuous capital expenditure and credit improvement, India's economic growth may still remain strong in the short period of time.Secondly, in the case of the Federal Reserve, the Central Bank of India will be able to restore foreign exchange stability more effectively.Especially when the strong growth of the US economy limits the Federal Reserve ’s interest rate cuts, the Indian central bank’ s stance relative to the eagle stance shows that investors should prepare to do more Indian rupees.

For foreign investors, the combination of India's Rude's appreciation potential and strong economic growth indicates that the Indian stock market will rise further.It is true that excessive valuation is always the main problem.But the lesson we learned is that it is difficult to predict when the emotions are finally reversed, especially when the shift from deposits to stocks from household financial assets has become a long -term trend.

We believe that the only major risk facing the Indian market is New Delhi, but Beijing.As mentioned earlier, if the Indian government takes a decisive action to reverse the trend of domestic deflation, global investors will turn their attention to India, and this is likely to be at the expense of alternative assets such as India and Japan.

From the middle period, we are still optimistic about the current capital expenditure cycle of India.It is worth noting that the decline in infrastructure and corporate investment is the main reason why India has slowed down in 2012-14.At that time, the reason for the investment collapse was the comprehensive role of the Indian central bank's interest rate hikes, fiscal tightening, and rising policy uncertainty.In view of the gentle inflation and the successful re -election of Premier Modi, these three unfavorable factors are unlikely to occur in the short term.Therefore, we recommend investors to continue to hold Indian capital expenditure stocks.

In addition, due to the large number of Indians, the huge number of software engineers, and the rapid transformation of digital transformation after the new crown epidemic, we still have the same long -term littering point in Indian technology.As early as 2022, we wrote: "For open market investors, we believe that the adjustment of the Federal Reserve will provide a better entry point for multi -headed investors in the BSE IT index." As both the Fed and the Indian Bank of China are about to be about toEntering the loose cycle, investors can use the adjustment of the past two years to re -participate in Indian technology stocks from a long point of view.

In the long run, the two most important problems facing global investors are:

Although we are optimistic about the current capital expenditure cycle, we are still having a doubt about whether India is ready to become the world's next manufacturing center.India's investment -driven growth is mainly concentrated in infrastructure and real estate, not manufacturing.

Global investors have voted with their feet, and have increased their investment in Mexico, Indonesia and Vietnam, which is in sharp contrast to the FDI collapsed by India.In a broad sense, Latin America, especially Mexico, is essentially the backdoor of India's entry into the United States, while the Southeast Asian economy has deeply integrated into the Indian supply chain and tried to maintain a good relationship with the West.From the perspective of geographical politics and supply chain efficiency, India is dwarfed compared with two other regions.If India cannot increase the proportion of manufacturing in the economy, its growth model will continue to be limited by domestic financial conditions and weak international revenue and expenditure conditions.

Although Premier Modi will be 79 years old at the end of the third term of 2029, few people have discussed the future of the post -Modi era.According to our exchanges with global configurations, a part of the optimism of India is related to Prime Minister Modi himself, because he is a very popular pro -market leader.In other words, there has always been "key character risks" in this theme of investing in India.In other words, India's economic agenda may undergo tremendous changes under new leadership collectives, especially considering the left -leaning policy preference of the Indian National Party.For example, unlike Prime Minister Modi focusing on expanding national infrastructure investment, the National University Party has recently promised to provide 100,000 rupees (about $ 1,200) for each poverty -stricken Indian family each year as unconditional cash transfer.In order to avoid caught off guard in the policy changes in the post -Modi era, investors should start paying attention to the prime minister Modi's internal succession plan and whether the new faces can continue to obtain sufficient public support to continue Modi's political heritage.

*Note: CLOCKTOWER Group is an asset management company headquartered in Los Angeles in the United States. It was founded in 2007 by Steve Drobny and serves global institutional investors (including national sovereign wealth funds, pension funds, school donation funds, etc.).Investment consultants provide them with customized services.

Editor in this issue: Yang Qianjiang Yi