In the annals of global equities, India presents itself as an enduring conundrum.

Since liberalising its economy in 1991, it has emerged as a compelling growth story — yet, for foreign investors, it remains a paradoxical market, celebrated for its potential but perennially elusive valuation. Shaun Cochran, the seasoned head of research at CLSA who early on began his career as a business strategy consultant at Accenture, eloquently encapsulates the dilemma: "The growth miracle is apparent, but struggle with valuations." That's a telling commentary given that CLSA is among the oldest foreign brokerage houses to have set up shop in the early 90s.

India's economic allure is undeniable. A burgeoning population, robust domestic demand, and accelerating GDP growth have fostered a narrative of high returns and resilience. Yet, this narrative is counterbalanced by persistent concerns over valuations that are often seen as exorbitant. As Cochran notes, "If you want to own India cheap, understand that you will probably either always be underweight or may never own it." The observation comes amid a massive selloff of ₹1.16 lakh crore over the past one-and-a-half month in Indian equities by foreign portfolio investors (FPIs).

The Structural Shift

India’s emergence as a favoured investment destination has gained momentum, particularly in the context of a shifting global order. For two decades, China was the undisputed darling of global investors, buoyed by its accession to the WTO and dominance in global manufacturing. However, as Cochran explains, “The world has reached a point where China’s share of global manufacturing is about as wide as it can get. Covid taught us the importance of supply chain diversification, and this is where India rises.”

The transition of the iPhone supply chain to India exemplifies this shift. Global manufacturers are increasingly viewing India as a viable alternative, albeit with complexities. Unlike China’s top-down efficiency, India’s decentralised governance and regulatory maze present unique challenges. Still, as Cochran observes, “India has scale, liquidity, and growth—a trifecta that few emerging markets can offer.”

After Donald Trump’s winning at the hustings, CLSA announced a major switch in its allocation from China to Indian stocks. "We committed a little more at the start of October by tactically deploying some of our over exposure to India towards China, at the time reducing our Indian overweight to 10% from 20% and raising our China allocation to a 5% overweight from the benchmark. We now reverse that trade," the November 14th report, titled Pouncing Tiger, Prevaricating Dragon, stated.

The Valuation Premium: A Blessing or a Curse?

India’s market has historically commanded a valuation premium, a characteristic that underscores its perceived stability and growth trajectory.

For instance, till recently, the MSCI India’s forward price-to-earnings ratio at 24.3x was 27% higher over its 10-year average and a massive 104% premium over 11.9x of the MSCI Emerging Markets index. However, this premium has been a double-edged sword. While domestic liquidity — driven by burgeoning mutual fund flows — has provided a cushion against global selloffs, it has also priced India out of reach for many value-oriented investors. Net inflows into equity mutual funds jumped 25% in FY24 to ₹1.86 lakh crore. “India has such a vibrant domestic investment community that it creates a flywheel of flows and performance,” Cochran says. Yet, this very dynamism often deters foreign investors waiting for a correction that may never come.

Comparisons with other emerging markets further highlight India’s unique position. ASEAN markets, for instance, offer growth at a much cheaper price, but they lack India’s scale and liquidity. Cochran cautions that while ASEAN could outperform India in the next market cycle, India’s structural story ensures its long-term appeal. “Owning India from a long-term perspective is a must,” he asserts. “It’s the structural Asian growth story with scale and liquidity.”

The critical question remains: how much of India’s growth story is already priced in? According to Cochran, “India is probably capped at its fundamentals now.” With nominal GDP growth expected to hover around 10%, the market’s potential for outsized returns seems constrained. Yet, Cochran emphasises the unpredictability of markets: “Expensive can remain expensive for decades.”

For value investors, this creates a dilemma. Should they wait for a correction or recalibrate their approach to accommodate India’s premium? Cochran suggests the latter, drawing parallels with legendary investor Warren Buffett’s evolution from a “cigar butt” approach to embracing growth at a reasonable price.

The India vs. China equation

The narrative often pits India against China, particularly in the context of the China+1 strategy. While India is increasingly seen as a viable alternative, Cochran tempers expectations. “China was welcomed into the global economy with open arms and white space. India, by contrast, faces fierce competition from ASEAN, Mexico, and others.”

Despite these challenges, India’s long-term trajectory remains compelling. Its demographic dividend, coupled with a shift in global manufacturing, positions it as a key player in the next economic cycle. “India will outgrow China on a nominal GDP basis,” Cochran states, “but its success will depend on productivity gains and continued structural reforms.”

Cochran is diplomatic but clear that both markets have their merits. However, he emphasised that India's growth trajectory is more robust over the long term, driven by demographic and structural advantages. Despite this, he acknowledged that China, at its current valuations and peak negativity, offers a compelling opportunity. He says, “On a 10-year view, I would rather own China than the U.S. right now with my money because as long as I have 10 years for that to express itself.”

With global sentiment being overly negative, he argues that China doesn't need much growth to deliver decent returns. He says: "China is absolutely slowing down, but it’s hard to justify labelling it as 'uninvestable.' On a valuation-to-growth basis, it’s compelling, especially at these levels of pessimism."

As of March 2024, foreign portfolio ownership in NSE-listed companies had fallen below 18%, for the first time in over 11 years. As of September 2024, as per Prime Database, the share further slipped to 17.5% and could possibly hit an all-time low once the December quarter holdings are revealed. Since foreign investors have pulled out double the 2008 outflows in over a month, the holding pattern will be a telling one.

In other words, in the EM allocation landscape, India will remain both a riddle and a revelation—caught in a perpetual matrix of relative valuations, no matter how compelling its growth story may be.

Shaun Cochran

Why India remains an 'investment conundrum' for foreign investors