Indian Economy Forecast: Most Overvalued Emerging Market in 2015

India Economic ForecastThe India economic forecast in 2015 calls for the fast-growing nation of 1.2 billion people to surpass Brazil and Russia in economic size. But investors shouldn’t be greedy; India’s stock market may already account for Prime Minister Modi’s success.

Indian Economy Forecast

The International Monetary Fund (IMF) forecasts India’s economy will grow at 7.5% in 2015 and 2016. Notably, this is much higher than the estimates for China, which have now been lowered to 6.3% for 2016. (Source: International Monetary Fund web site, last accessed April 16, 2015.) India is playing catch-up to the China of the early 2000s, and this is surprising investors worldwide.

A strong performance out of an emerging market in a period of commodity weakness and dollar strength is rare, but India is defying convention. Indian economic growth is set to expand at 6.3% this year, and interest rates were decreased in March 2015 to their lowest levels in four years.

A more accommodative stance by India’s central bank and lower commodity prices will significantly help the country, which is a net importer of oil and natural gas. For example, India spends roughly five percent of its gross domestic product (GDP) on imports. This compares to 0.5% and two percent for Brazil and China, respectively. (Source: JPMorgan Chase & Company, March 31, 2015.) Another tailwind for India is its new government.

Indian Economic Development and Reforms

India’s government is led by Prime Minister Narendra Modi, who took office after the May 2014 election victory. The prime minister ran on promises of unprecedented reforms and on February 28, 2015, India’s ministry of finance finally revealed its long-awaited budget.

Some spectators were left disappointed, but the budget was full of changes aimed at taxes and business, along with some firsts—like a formal inflation target.

The budget included plans for the sale of state enterprises that were losing money. Along with that came tax reforms which introduced a harmonized state and provincial levy. The finance minister, Arun Jaitley, expects this to create a “single market” potentially adding two percent to India’s GDP growth. (Source: The Economist, February 28, 2015.)

Another critical tax change will be the reduction of the corporate tax rate from 30% to 25%, while simplifying and eliminating a myriad of tax breaks currently available. Furthermore, private sector incentives included the launch of an online portal to allow entrepreneurs to register their business and process the permits required to open shop.

Overall, investors saw this as a clear sign that Prime Minister Modi was making the right moves. As incremental as they may be, I would agree. For confirmation, just look to the bond market.

Improving fundamentals are reflected in India’s lower borrowing costs. Interest rates on government bonds issued by the Indian government are much lower compared to those of its peers like Russia, Brazil, and Turkey. For example, India only pays 1.5% more in interest on its debt than the U.S., while Brazil pays 3.5% more. (Source: JPMorgan Chase & Company, March 31, 2015.)

That’s a great sign, as the lower interest costs on government-issued debt reflects the market’s confidence in the new economic reform-focused government—all translating into a hot stock market.

Also Read: U.S. Economic Outlook for 2015

India’s Stock Market: SENSEX

In 2014, the Indian stock market returned 24% and has added another five percent in 2015. For 2014, India was one of the few markets that performed well in U.S. dollar terms, as other stock indices around the world like Germany’s DAX and Brazil’s BOVESPA dropped 10% and 14% in U.S. dollar terms, respectively.

India Bombay Stock Exchange Chart

‘India Bombay Stock Exchange 30 SENSEX Index – Apr. 2010-Apr. 2015,’
Chart courtesy of StockCharts.com

Unlike its emerging market peers, India’s stock index, the SENSEX, is almost equally weighted across sectors. Roughly 20% of listed companies are consumer-oriented, 24% are in the tech sector, 18% are in the financials area, and 17% are in commodities. This split compares to the Russian market, which has a commodity weight of 71%, and China’s market, for which the financials constitute 40%. The better-diversified SENSEX has, as a result, fared much better in this period of commodity weakness and dollar strength. But I question whether this will continue, and it’s not because India’s economy isn’t getting better.

India Economic Forecast 2015 and Risks

Wall Street analysts have pegged India as the most overvalued emerging market index. (Source: JPMorgan & Company, March 31, 2015.) I would urge investors to listen.

The SENSEX trades at a forward earnings multiple of roughly 18X (overall, investors are paying $18.00 for $1.00 of net earnings), which is much higher than China’s 11X and slightly higher than the S&P 500’s 17X.

This matters because Prime Minister Modi has a lot to juggle and many hurdles to overcome in order to materialize sustainable growth.

For example, the Central Bank of India is looking to lower inflation to four percent by 2017, while it is already expected to come in at six percent this year. This will require a balancing act of maintaining growth while decreasing price levels. At the same time, government officials are looking to reduce budget deficits, adding to the challenge of implementing reforms, which will require spending.

Look, the SENSEX has nearly doubled, returning 90% from the January 2012 lows. As of now, a lot of the potential success from reforms and future growth is already built into the price of India’s stock market. India’s economy will fare better, resulting in an improved environment for businesses and citizens. However, potential investors are exposed to the risks of high prices, an expensive SENSEX, and high expectations. Overall, this creates a level of risk I would avoid.