An Essay on nearly everything of India and its Stocks & Bond Markets

..... the story of India and its markets, its history and performance. Not everything but some of the most important things.

If you are a foreign or local investor in India, you must know that we are a credible country- one that never defaulted on its debt, to anyone. Never ever. An emphasis is must here because most emerging countries of past and present, have defaulted time and again. That’s the reason on the eve of our independence, while we were very poor, our Sovereign bond was trading at near 4%.

Another cool thing about our country is that we have never had hyper-inflation. Every investor knows that inflation is a termite that depletes the value of assets but hyperinflation is a torpedo that destroys value of all financial assets. Our public hates inflation that’s why our politicians fear it the most. So your money is safe here. The evil design to rob your money of its worth is not in works in our country. Highest inflation episode in India was in 70s- at 18% odd during 1973-75. Same time when rest of the world too was struggling with high oil and food prices. In recent times, during 2009-13, we had close to 10% inflation. Even that rattled our people & politicians and led to inflation targeting framework in 2015.

Inflation targeting framework promised to deliver 4% inflation but the growth sacrifice to achieve that ended up being too high. People in know of history called it out even then, but ones enamored with western idea of low inflation forced a regime on us. That costs us heavy. Who forces wider real rates in an economy that seems to struggle from banking crisis? Imported intellect has its way to do strange things. Anyways, I think a change is underway. We will embrace 6%, today or tomorrow. In any case, you should know that that we are more likely to have 6% inflation over next decade than 4% in pricing our assets, our currency, bonds and stocks.

You would also know that in 1940s China, 1918’s Russia - value of stock markets came to nil as state confiscated all properties. This has happened at many places at many times in different parts of the world. Never here in our country. We have been a very poor country with socialistic biases, yet state has rarely confiscated the assets of private citizens. Look around and you won’t find many such countries in emerging world. Don’t jump to conclusion that respect & protection for private property was due to British rule. Even in antiquity, property rights were in place in our country. We did not have feudal raj of the sort that Europeans had. Indian rich whose sprawling bungalows are surrounded by slums don’t fear the mob attacking them. Not because our people are fatalist, nor even because that sort of show off isn’t disgusting but perhaps because our people respect diversity of outcome and don’t resort to violence to equalize it. Yet again, a cultural gift. We had enlightenment much before barbaric Europe had it.

Profit is not seen as a bad motive here. That’s perhaps is the reason why most decisions that our corporate make is driven by profit maximization. We have a decent framework to protect the property rights of private citizens and corporate. Our corporate’ return on equity are higher than almost all the emerging markets - across time frames. A median Indian corporate, amongst the top 100 that you are likely to invest in, earns a return on equity (ROE) of 16%, distributes about 30% as dividend and grows at 11%. A median corporate in US is likely to earn about 2% less and grow at 3% less. Do you know that China’s listed firms ROE will be less than10%? No wonder why our stocks are always more expensive.

Our inflation has been 7.70% for past 50 years, 6.50% over 20 years and 6% over 10 years. Only when our economy is depressed, we get to 4%. Why is our inflation higher than many Asian counterparts? No one knows the exact answer, but my speculation is that its due to high public debt. There is no country as young & poor that has had such high public debt- a near 90% of our GDP. Our high debt is not because of legacy of distributing a lot of goodies. We don’t have a welfare state as many would make you believe it. Instead it’s because of the legacy of rather good governance and big state even when we were terribly poor a few decades ago. India was not supposed to survive for long- most professed when we embraced our freedom. We were supposed to have riots and infinite mutinies, famines and mass hunger. Nothing of that sort happened. A rarest of rare thing in this part of the world- a decent nation emerged. All of that meant - bigger government, higher public debt and therefore rather high inflation. Perhaps.

If you know nothing else about our economy, you will still not be too much off the mark in saying that our GDP will grow at 6% over next few years. Our system can’t deliver growth of East Asians as that requires state capitalism, financial and consumer repression and wild booms & busts. Our people and polity aren’t ready for it. Our state is distributed & democratic and is in pursuit of optimizing individual’s good than that of the whole. Its been our tradition, where we keep self at the center of affairs not the community. That’s why our heroes are Buddha, Krishna and Mahavir. Not Confucius.

Our country has western enlightenment institutions (democracy, rule of law, citizen rights) and her own cultural ones (sacred geography, spiritual tradition and polytheism), both of which are not perfectly aligned yet have coexisted successfully over 3/4th of the century. Ours is a peaceful society, as for its level of income, the homicides and other such brutal crimes are far fewer.

We have lots of people, 1.4 billion, populating a small peninsula. Historically too, we have been a geography to accommodate most people in the world. Fertile land, regular monsoons and rivers must be thanked for it. In recent decades, our population growth has slowed remarkably without state enforced policies. We have fewer imbalances than many places like China, with as many girls and decent population structure. Our population may be same by the end of the century whereas China’s would have halved.

Ours is a young population, with an average age less than 30. So not yet confronting the ageing problems of most of the big economies. Our labor force is increasing by 1.5 million every year. Highest in the world. For a such a poor economy to be saturated with very good talent pool is a blessing. Power of more people at work here but alongside, the long tradition of investing in higher education has helped too. Most metrics of know-how place our country at a decent level that will secure it sustained growth over next many decades.

Our country has great geography. Food security is in place. And though the dependence on external oil is a big problem, its access to the sources is more secured than most other big economic blocks like Europe and East Asia. It’s got abundant sun light and wind, which could very well become the source of energy in the times to come.

It’s not very difficult to trust us because we have never waged a war to occupy others’ territories. But that hasn’t stopped others to attack us through out last two millennia. In current times, insecure, inimical and wanna be hegemon China is our biggest headache. Fall of India is the single biggest project China may be running. As we are likely to be the only peer competitor to them in 22nd century. I hope our administration knows Chinese motives. I think they do. Our country aligned with western democracies which are likely to be more formidable force than China-Russia coalition. Though there are arguments against it, we have taken this irreversible call nonetheless.

Many of us understand English and that gives us a lot of leverage. English is a language of our government and much of the technical education, making it easy for our students to access global knowledge & education and helping it plug its workforce into the western world easily. We are more likely to become an office space for the world than factory of it.

And things are getting better in our country. We have grown at more than 6% over past 25 years. Most markers of people’s wellbeing have continued to improve over past decade. Our life expectancy has been rising (near 69.2), general health outcomes improving and infant mortality falling. Our 95% of population is connected with decent roads, and access to water and electricity are improving very rapidly and will perhaps be universal by the end of this decade. Our population is fairly banked and our digital financial infra is world class. Not everything is perfect though. We remain one of the poorest in the world. Our primary education is inferior. The educational outcome in high education isn’t great for most.  Our society is too uneven to risk becoming oligarchical and too diverse to risk becoming communal. We haven’t been able to industrialize. Bit by bit - we are solving it. Too slow for autocratic nations but fast enough for history!

Now you are reading this because you are interested in our markets. I will tell you what our bonds and stocks do.

Our government bonds have no credit risk but they are volatile and at times do not do a job of delivering real return- a return over inflation. You would have earned about 9.5% if you invested in 10-year bond 30 or 40 years ago and rolled over every year. That’s like investing in 10 year Govt bond’ index fund. That would have been about 2% more than inflation. Very different from how it’s been over past 20 years- a period when bonds have been bad investments. Had you invested in the same index fund in 2002 or 2007, you would not have earned any real return - to this date!

Only when you bought at cycle high yields, say in 2008 or 2012 or 2018, you earned reasonable real returns in bonds over next 5-10 years. State loans or AAA PSUs would have given about 30-50 bps extra with negligible excess risk. So remember that bonds are a cyclical investment in our country. Buy them only when they get to 8%, is a sort of a law. Don’t trust low for longer stories! Not just yet.

Now on stocks. They are riskier. We have about 7k firms. Historically, only 1 in 5 firms deliver better than Government bonds. And even worse, near 3 in 5 stocks deliver negative returns over decades. Even top stocks, that big indices are made of- see busts frequently. We see an average of 38% drop in stocks every time there is a bust. But its not same every time. Our indices fell by nearly 50% for 3 times, 40% and 25% for 4 times each since 1986. A fall of 20% in indices, an arbitrary number, is called a bear market. We have nearly one every three years. US has once in a decade- on an average. Risk is not that stocks jiggle. Risk is that they go through these busts too often. Know this so that you don’t end up putting money in stocks when 3 years out you need it for your daughter’s wedding. Stocks are for long term and long term is at least a decade.

Stocks return over bonds is called equity risk premium (ERP). Our equities delivered ERP of 2% since 1992 and 9% since 2002. This tells you that outcome from stocks investing can be very diverse even over very long period. The ongoing boom that began a decade ago has earned investors about 4.5% over bonds and 6.5% over inflation. That's a neat deal. But nowhere close to what you would have earned in go go years of 70s and 80s. Stocks multiplied by 11 times between 75-86, then by 13 times in 1988-92 and by 6 times during 2003-07. Most of your fav bulls, the great story tellers who seem in trans and have faith in the great good of stocks come from that era, when so much money was made and so quickly. We don't and very likely won't have such bull markets. Know it for your money's health. What remains for you is to earn 3-4% over bonds. Unless of course, you know a trick or two to time markets. Mis-time it and patience will do no good to you. And you have been misguided if you think stocks are a sure shot lottery win. Developed markets have delivered about 5.3% over inflation and 3.3% over bonds since 1900. US’s markets delivered somewhat better, at about 6.7% over inflation. But they have been the best times. Returns in previous two centuries were much worse. And in the coming century wont be as good. For them or for us.

And most important thing to remember is- if one buys stocks at cycle peaks, it hurts for decades. Buy in 1992 or 2007 peak and your ERP would be near zero for 10-15 years. Remember ERP- is the return you earn over bonds. Time heals a lot of things but not the one which is born of buying assets at excessive prices. Very likely a similar fate awaits for peak valuation investors, of both bonds and equities of 2021!

To conclude, you are investing in a country which is very likely going to deliver decent returns in both bonds and equities. But beware that typical cycle rules apply here too. We too have booms and busts. A big boom in equities has recently ended. Another will come soon. But only after a bust.

With lots of Love & wishes

Maneesh Dangi

21-May-2022

PS

Our kitchen generally makes good food but not always. No kitchen does it ever. Know it.