Why India?

The obvious answer is that it’s one of the fastest growing economies in the world, and maybe the fastest growing large economy over the next decade. There must be some investment opportunities that can harness the tailwind that everyone’s talking about. But that’s just surface-level thinking. The more pertinent questions are:

1. Why is it growing so fast?
2. Where in the economy is this growth coming from?
3. Is the trajectory sustainable?
4. How do we invest in it?

Unlike China, it’s dangerous to hang our hats on Government Policy in India. Yes, the seeds of the growth we’re witnessing now were sown by government policy – it’s been about 27 years since India’s economy was liberalized. Since then it has grown in fits and starts. Governments have come and gone, and the old saying that “India grows not because of its government, but despite it”, has generally panned out to be true. Despite bureaucratic governments, certain indisputable facts have shaken out over the last 25-30 years. And these are sustainable pillars of growth – sustainable because they’re mostly facts, not opinions:

1. The Demographic Dividend.
   1. Young population: India has about 390 million Millennials and about 470 million Gen Z kids. That’s just massive.
   2. Educated population: India now has the highest number of STEM graduates.
   3. Sheer Scale: It seems to me that no matter how I slice and dice a market segment in India, I end up with the size of a whole another country. There are 300 million smartphone users in India, for example. That’s another USA. Any company that can gain market share in some market segment in India will probably see a double-digit impact on revenue. Numbers are just that big.
2. Young people with smartphones and a penchant for mobile-payments: buy, buy, buy.
3. Aadhaar: The massive Biometric ID system that covers more than 95% of the population. The benefits of this groundbreaking project are yet to be realized.
4. Simpler Corporate Tax Rules: GST (Goods & Services Tax) is a bungled attempt in the right direction. But when executed correctly, it could grease the wheels of e-commerce across state lines.
5. New Bankruptcy Rules: It should go a long way in cleaning up bank balance sheets and it could also be the much-needed shot in the arm for the Indian credit markets.

Over the next couple of weeks, I will dig a little deeper into each of these fundamental pillars. But, as a starting point, the most interesting fact to me was this:

1. India is right where China was in 2005, in terms of GDP per capita. China soared from 2005 onwards at a pace the world had never seen. Where does India go from here? Is there a reasonable chance that she can replicate China’s economic miracle over the next 10 years? That would provide an awesome backdrop and a strong tailwind, which we could harness to capture outstanding returns.

Obviously, the answer lies not in numbers, but in logic. The numbers give us clues, but it’s more important to corroborate them with what’s happening on the ground in India.

“It is a mistake to use, as journalists and some economists do, statistics without logic but the reverse does not hold: It is not a mistake to use logic without statistics.” – Nassim Nicolas Taleb

Crouching Tiger, Soaring Dragon

Surprisingly, in 1990, India was marginally ahead of China in terms of Gross Domestic Product (GDP) per capita according to the World Bank. GDP per capita is a proxy for average income per person. Here GDP is expressed in Purchasing Power Parity (PPP) basis, measured in current US dollars. Both impoverished nations had similar average incomes in 1990; both were at about USD 1,000 a year. Since then, they’ve gone their separate ways.

1992 was the year when China went ahead of India – not very significantly though. However, by the turn of the century, while India’s GDP/capita doubled, China’s tripled. However, since they started from a low base, the numbers were still not glaringly different – India reached $2,000 and China $3,000.

In the next decade, 2000-2010, China tripled again while India did a little better than double. The divergence was significant now. By 2010, India reached $4,315 while China clocked $9,333. 

The following 5 years, 2010-2015, saw India grow at a predictable level of around 50%, cumulatively, reaching $6,570 by 2015. China’s explosive growth rate of the first decade of this century continued, although slightly tempered, with a 66% upswing.  

China reached $15,529 in GDP/capita (PPP-adjusted) – about 2.5 times that of India – all in a matter of 25 years. Why?

Yes, We’re open!

Growth patterns of India and China have been strikingly divergent. The most obvious explanation is this: chaotic democracy of India versus a focused totalitarian regime in China. There’s more to this story. History gives us some rich color.

China did not have private ownership until its reforms started in 1978. In fact, private ownership was banned since 1949. In 1978, foreign investments were welcomed by the Chinese since the first round of reforms. This happened just 40 years ago. The state provided valuable support to these investment. They were decisive and focused almost exclusively on manufacturing. They were hell-bent on becoming the factory of the world. There was no debate to be had with home-grown industrialists about seeking a protective environment. Most of the enterprises were state-owned. Many still are. 1978 onwards, China looked outward for growth. This was carefully choreographed, with minimal opposition.

India saw this across the Himalayas, but she was reluctant to follow suit. Colonized by the British for almost 200 years, India was forced to buy British manufactured goods during colonization. After independence in 1947, perhaps motivated by retribution, Indian industry was protected from imports. A messy Democracy allowed homegrown industrialists to influence governments towards protectionism at the cost of Indian consumers and India’s global competitiveness. 

India did not open up to foreign investment for most of its existence as a country, until it had no choice but to do so in the early 90s at the behest of IMF. In 1991, the nation was on the verge of bankruptcy. India had to act. It was only then that it liberalized its economy and started a massive government divestment campaign. But, compared to China, India was already 15 years behind in its development cycle.

The effects of China’s decisiveness and India’s reluctance were palpable. The economies of both countries grew – China explosively, and India at a tepid pace. India’s real GDP [not PPP-adjusted] for 2016 was at $2.2 trillion. This is where China was in 2005.  While China became the factory of the world, India’s growth came mostly from the Services sector. In 1950, soon after independence the composition of the Indian economy was: Agriculture 55%, Manufacturing 15% and Services 30%. In 2016, the proportions went down for Agriculture to 20%, with manufacturing climbing up to 25% and Services being the major component at 55%. Perhaps a major reason was an English education system left behind by the British. That, and Cricket, may have been their most significant (albeit accidental) gifts to India. China never warmed up to Cricket, but it was busy playing another sport: Broad-based Economic Development.

Hungry Dragon

On a Macro level, India’s GDP per capita today is roughly the same as China’s was in 2005. Serendipity? Probably not. But it’s a good starting point. I’m not going to inundate you with a longer laundry list of China’s macroeconomic numbers. Don’t get me wrong – I believe macro figures are all well and good. But we’re Investors; not Macro Traders. We need to keep drilling down into specifics as much as we can.

“I’m firmly convinced that (a) it’s hard to know what the macro future holds and (b) few people possess superior knowledge of these matters that can regularly be turned into an investing advantage. There are two caveats, however: 1) The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. 2) With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economies. Thus, I suggest people try to ‘know the knowable’.” – Howard Marks

Let’s try and move towards the “knowables”. As we go from macro to “smaller-picture things”, we’ll see more pertinent clues that could be applicable to India. How and where did China’s carefully choreographed State-Sponsored Capitalism propagate through the masses? Where were the tangible effects?

1. Household expenses in constant 2010 US Dollars (a proxy for domestic consumption) increased over 2.5 times from $1.4 trillion in 2005 to $3.5 trillion in 2016 in China. India’s grew about 2.2 times during the same period – from $0.6 trillion to $1.3 trillion. Notice how India’s current number equals China’s 2005 number. On a per capita basis, China’s number in 2005 was $1,049 (again approximately equal to India 2016), growing to $2,506 by 2016. India’s corresponding growth was from $538 in 2005 to $1,045 in 2016.
2. Domestic credit in China provided by the Financial Sector to support household expenditure shot up from 133% of GDP in 2005 to 215% of GDP in 2016. India moved the needle from 60% in 2005 to 75% in 2016. Going back in recent history – in 1995 India stood at 44% as against China’s 86%. Household Expenditure in China was supported to a large degree by domestic credit or loans.
3. Massive Urbanization: By the end of 2016, about 60% of China’s population were in urban areas. Migration caused by re-deployment of labor from rural areas increased Urbanization from 26% of population in 1990. By the turn of the century, China had 34 cities with 1 million plus population, and this number increased to 102 by 2012. Europe’s comparative number was 35 and USA’s 9. China had 2 Megacities with 10 million and over, with a plan to go to 8 by 2025. India’s story on urbanization has been much slower. The proportion of population in urban areas stood at 31% per the 2011 census. A UN study predicts that by 2030 this proportion will increase to 40%. India has 20 cities with population in excess of 1 million with 3 megacities and 2 emerging ones.
4. Air Travel: Air-passenger traffic is a reasonable indicator of economic growth. In 2005, the number of air passengers carried in China was 137 million. India was way behind with 28 million. By the year 2016, China grew to 488 million, while India reached 120 million.
5. Automobile Ownership grew 4 times from 50 million vehicles in 2005 to about 200 million in 2016. China is now the largest automobile market in the world eclipsing the USA in 2015 with nearly 25 million units sold. India’s Automobile ownership is approximately one third of China 2016 and not surprisingly around the 2005 number.
6. In 2016, China became the largest e–commerce market in the world, ahead of USA. Transaction volume touched $681 Billion. India’s numbers were not even in the same zip code.

Eye of the Tiger

I mentioned 6 tangible avenues of growth in China from 2005 to 2016. With India 2016 resembling China 2005 in overall macro figures, let’s turn to India to see if she is on a similar runway when it comes down to the “knowables”. Will she see the same type of socio-economic transformation like her neighbor? There are some similarities and some differences. But overall, the signs are positive.

1. Rapid connectivity and e-commerce: 
   1. Internet penetration as a percent of population has grown rapidly. It was 3% in 2005, 30% in 2016 and forecasted to cross 55% by 2020. Local language internet activity has catalyzed rural adoption who are now jumping on board. By comparison, China was at 53% in 2016.
   2. With cell phone usage poised to reach nearly 100% of the population, internet enabled smart phone penetration reached 22% of total population (300 million) in 2017. Forecasts suggest at least over 50% penetration by 2020. China is at 52%.
   3. India is the fastest growing e-commerce market in the world with compounded annual growth forecasts exceeding 30%+. In 2016, China’s e-commerce market size ($681 Billion) was 10 times India’s. Even if India doesn’t catch up to China, there is massive headroom here.
   4. Within e-commerce, mobile-commerce takes center stage (see point b). According to a 2016 study by Forrester Research, approximately 20% of total retail sales will take place online by 2021 in Asia Pacific, with 78 percent of that coming from mobile, up from 63 percent in 2016. With M-commerce E–tailers will have vastly improved access to non-metro and rural areas.
2. Rapid increase of mobile payment transactions – There is a strong mobile payments infrastructure and a growing use of electronic wallets, especially as the idea of a “cashless economy” is gaining popularity. Take a walk on any street in Indian cities, and you’ll find it difficult to avoid signs of Paytm at the local grocery store or at the neighborhood chai shop. Paytm is the largest mobile payments app in India. India’s young population loves “Paytm-ing”, at a scale that Venmo can only dream of in the US.
3. The nationwide bio-metric identification through Aadhar for nearly 100% of the population – a first in the world. This is massive and deserves a Worldview of its own. It has repercussions through several massive industries – banking, healthcare, and agriculture just to name a few. Accountability just got democratized. I can’t overemphasize the social and economic potential of this massive achievement.
4. Indian millennials are the driving force behind the growing digital economy. A recent Morgan Stanley research report says that, millennials at 36% of the Indian population, will account for 61% of its Internet users and 78% of its online shoppers by 2020. They are eagerly embracing online shopping through smartphones. The report describes Indian millennials as the largest disruptive force in India for years to come and currently this trend is still in the early innings.
5. A 2017 Boston Consulting Group study segregated India’s population into 5 categories according to real incomes expressed in US dollars. Obviously, the classification and acronyms used are in the context of India. There were “Elites” with annual household incomes above $31,000/annum, “Affluent”, with incomes $15,400-31,000, “Aspirers” with income of $7,700 – 15,400, and
    “Next Billion” and (sadly) “Strugglers”. According to their estimate, the top 3 categories comprised 51% of India’s population in 2016 (top 2 being 27%). By 2025, they expect the top 3 categories to increase to 65%, with the top 2 being at 40% of the population. Meanwhile the lower 2 rungs that collectively stood at 49% in 2016 are expected to shrink to 35% on the back of upward mobility. Why will this happen during 2016-2025? We have some clues from China: 
   1. Rising incomes
   2. Increased Urbanization
   3. Changing family structures (From 68% to 76% of the population will be in nuclear families).

This 2016 Goldman Sachs report places a high degree of emphasis on the urban working population in India. It states that the relevant (comparatively higher-spending) working population is 146 million or about 30% of India’s total working population. Including family members, we could be looking at 2.5X that number i.e. 365 million people. That’s roughly equal to the current number of Elites and Affluents of the BCG report. So, the current base line is a consuming population of around 350 - 400 million urban residents. If we go by the BCG report, then this number will go up to around 520-550 million by 2025. That’s an increase of 150-200 million in the top 2 echelons of the consuming population, an increase of roughly 50%. Now, that itself is a large number somewhere from half to two-thirds of the population of the USA.

Maybe I should tie a ribbon around all that talk of numbers and statistics with a simple summary that passes the common-sense test. The Goldman Sachs study pointed to 7 categories of spend that will gain momentum:

• Looking Better
• Eating better
• Living better
• Mobility and connectivity
• Having more fun
• Healthcare and Education
• Luxury items

But wait…

What’s the counter-argument? What could hold back consumption in India in the next 10 years? Apart from its chaotic democracy, a big negative would be Jobs. India’s demographic dividend could be a sink hole if not handled well. Undoubtedly, there are some trends that need close monitoring:

1. Proliferation of new technologies based on Artificial Intelligence, Robotics, and Machine Learning could slow the use of offshore workers due to a narrowing of the cost arbitrage.
2. In fact, the trends point towards some elements of “re-shoring” where jobs are brought back to respective home countries, responding to political demands. The Middle-East, which used to be a big market for Indian labor is also looking at shoring up local labor in the face of lower long-term oil prices;

But these clouds may be temporary. The fundamental profile of India’s young population is still very positive. Here are a few silver linings:

1. Abundant supply of STEM [Science Technology Engineering and Mathematics] graduates. (China and India are expected to supply more than 60% of the G20 workforce with a qualification in science, technology, engineering and mathematics by 2030. [OECD education indicators 2015)
2. Despite shifts in technology consumption around the world, Indian Information Technology workers have successfully evolved with several technological cycles over the past 25 years;
3. Indian workers have developed a very high level of proficiency in wireless, mobile technologies and big data; The number of smart connected devices in India is expected to increase from the current level of 200 million to 2.7 billion by 2020 there by creating demand for new job roles such as IoT wireless network specialists according to this E&Y report.
4. Last but not least: This point is subjective, and rather wishy-washy, but I think it’s true. A young and educated population tends to be hungrier and more risk-taking. In India, this massive group of young guns is decidedly unshackled from the baggage of colonization and mismanaged socialism. Those are simply bullet points in a history book for most of the country today.

The fundamental blocks are in place. The Tiger may catch up to the Dragon. But it’s still a tall order.

Big leap ahead

“Invert, always invert.” – Charlie Munger

I asked myself: What would I need to believe if the Tiger were to catch up with the Dragon? Is India poised to forge a growth rate for the next 10 years that may mirror the period 2005 – 2016 in China? Perhaps not. Because, if that were to happen:

1. Per Capita Household Expenses will need to grow at an annual growth rate of 9.5%.
2. India’s GDP [real, constant USD, World Bank] would grow 5 times – that’s a tough proposition; growing by 2.5X, at a rate of 8% per year is more reasonable.
3. FDI in India would need to reach 3% of real GDP (this was achieved by China in 2013 – now fell to $170 billion in 2016) from India’s current level at $44 billion (2% of real GDP). Will this happen?
4. India’s Per Capita Income (not PPP-adjusted) would need to reach close to $7,000 from India’s 2016 level of $1,861. That does not seem possible. China had achieved India’s 2016 level at the turn of the century. However, if India’s per capita GDP were to mirror to top end of overall GDP growth expected i.e. 8% then we would be looking at an income of about $4,000 around 2025. And this level, it could easily support household expenses level of $2,500 leaving 37.5% for savings.

In my view, an average growth of 9.5-10% in Household Expenditure, during the period ending 2025, considering India’s current savings rate of 30%, is very possible.

Purchasing: Powered

Ok. So, I hope I have convinced you that India’s economic growth should flow through to huge increases in consumption by a large, young, educated, informed, newly rich section of the population. Their conspicuous consumption may not achieve China levels of growth, but the headroom is too big to ignore. Best case: Consumer spending in India is at an inflection point a la China in 2005. Worst Case: it keeps growing at the same pace as today. The reality may shake out somewhere in the middle, which ain’t bad at all.

If there is one behavior pattern from the Chinese that the Indians will follow it is this: Consumption of Luxury Goods is bound to increase exponentially over the next few years. Peruse through the Annual Reports of LVMH or Richemont, and you’ll notice how instrumental China has been to their growth over the last 10 years. People in India are aware of the latest brands in the US or in Europe. They know what Hollywood celebrities are wearing, what products they endorse and what the “specs” of a particular model of Ferrari are. The middle-class in Tier 1 and Tier 2 cities are young and their disposable income is growing. Youth and new money is a potent combination anywhere in the world. They want new, shiny things and new experiences. It’s the best and the worst of capitalism, depending on your perspective. It’s the “me-conomy”. It’s what happened in China since 2005, as was widely expected back then. As I’ve laid out through facts, figures and inevitabilities, it could very well happen in India, albeit a milder version. If you can, take a trip to New Delhi and you’ll know what I mean. Consumption is certainly conspicuous, to put it mildly.

Luxury brands such as LVMH are, of course, dependent on fashion trends of the day. While these companies position themselves as “timeless style”, their brand cache is fickle and can evaporate quickly. Just ask Burberry what happened after its legendary run from 2005 to about 2015. LVMH, however, has a much broader portfolio of brands and products. But I wonder if we may still be a decade away from a situation where these companies can see any meaningful impact on their cash flows from India.

The more tangible, intermediate step for the new Indian consumer may be utilitarian goods that can be construed as Luxury. Technology and Food/ Staples come to mind. Products from Apple, for example, could have massive headroom. They barely sell any phones in India, relatively speaking – iPhone’s penetration is roughly 3% in India compared to roughly 24% in China and around 40% in the US. I suspect economics, as opposed to consumer preferences, is the main reason behind these market-share differences. Imagine if, with rising incomes in India, Apple’s iPhone market share rises from 3% to 10%. 15%? How many million iPhones is that?

Online shopping, as I mentioned, is growing fast. But there is still massive headroom there – why else would Walmart and Amazon get into a bidding war over Flipkart? As a lateral play on Retail, via the theme of increased home-deliveries, The Buylyst is already invested in Volvo AB, which has a joint venture with Eicher – one of the largest truck makers in India. But is Tata Motors, a homegrown stalwart, capturing a higher share of this growth?

High-end liquor is another possible area. Does Diageo, for example, expect a significant bump from India? The “Single Malt spike” of the last 10-12 years may have already played out in the US. Is it ripe for a take-off in India? I guess alcohol is not exactly “utilitarian” but it’s pretty much a “consumer staple”.

Automobiles is the last logical arena I’d mention. Hybrids and Electric Vehicles have barely made a dent in India. But there must be pent up demand. Gas is expensive in India. And if Renewable Energy actually takes off (the merits of which aren’t really a point of debate there amongst India’s political parties), electricity could be much more affordable than gasoline (or petrol as it’s known there). Of course, the other factor is Auto Loans. Will credit be easier in the coming years? More on that below.

Companies that have compelling products to sell to a burgeoning middle-class and a growing affluent class population are prime candidates. When combined, those two population segments are roughly the size of the US. That’s massive. Who can capture share in this massive market? Who’s ready? This is a rough working list:

1. Apple
2. Walmart
3. Diageo (Johnny Walker…enough said)
4. Tata Motors
5. LVMH (Louis Vuitton, Tag Heuer, Glenmorangie, Hennessy…)
6. The Swatch Group (Omega, Longines…)

I’m sure there are other luxury and semi-luxury brands that haven’t quite gained from the India story yet but have put in the work to create a distribution channel to be there when it takes off. Companies that could see an extra 10-20% jump in revenue just from India, would be prime candidates. It’s a tough ask to find these “pure play” vehicles for this almost inevitable growth story. And with the Retail sector, things aren’t so simple anymore, regardless of geographical location.

But there is another, lateral way to play this story. This one is right in my wheelhouse.

Credit where it’s due

With the rise in consumption going forward outstripping history, will we see retail borrowings going up? That seems logical. Remember the comparison of domestic credit stated earlier: Domestic credit provided by the Financial Sector to support household expenditure shot up from 133% of GDP in 2005 to 215% of GDP in 2016 for China [India moved the needle from 60% in 2005 to 75% in 2016, In 1995 it stood at 44% as against China’s 86%]. The headroom for growth of domestic credit is immense. Also think about this: Now with Aadhar for instantaneous customer identification, established credit bureaus for online credit history, rapidly increasing mobile payments mitigating last mile access, retail lending in India is bound to grow at a very fast pace both in terms of volume and geographical coverage.

The banking sector could be a (leveraged?) proxy for what seems to be an inevitable growth story that’s fueled by consumption. The demand for credit being there, the supply will probably follow. The beneficiaries of this trend will be lending institutions that have their sights pegged on “retail” and are not plagued by the scourge of non-performing assets which has infected some parts of India’s financial sector. The Central Government has put in place some structural reforms to strengthen the banking sector, which should make some room for banks to innovate and offer products that make it easy for people to borrow. A stronger banking sector should grease the wheels of consumption, and more consumption should grease the banks’ Net Interest Margins.

That’s a feedback loop worth exploring. I can’t wait.