India’s parliament recently concluded its winter session. As India navigates through its future course of reforms, a lot of emphasis is often placed on key initiatives such as the Goods and Services Tax (GST) Bill, which could simplify taxes and increase mobility of goods and services across the country; a full-fledged bankruptcy code to strengthen recovery mechanisms for the banking system; and a few other key legislative items.
While we stay hopeful for the passage of some of these reforms with time, more importantly I wanted to revisit a key and less spoken about step that government already took a few weeks ago towards improving accessibility of 15 sectors to foreign investments. This is a small but significant step towards providing India with needed capital. I also wanted to stress how it could lead to potential expansion of India’s market cap in emerging markets (EM) indexes and why certain sectors, such as Financials, stand to benefit from increased foreign fund flows.
Sectors Opening Up to Foreign Investments—Financials to Be a Key Beneficiary
In the second week of November, prime minister Narendra Modi’s government relaxed foreign investment norms for 15 sectors, including construction projects, cable networks, agriculture (coffee, rubber, palm oil) and air transportation1, in which the foreign caps have been raised to 100% for foreign direct investment (FDI). Other sectors such as defense and broadcast have been increased to 49% for FDI.
Given India’s socialist past, such big changes show a significant change of mind and a willingness by the current government to liberalize India’s economy. What this means is more foreign money can flow into India, spurring not only growth but also potentially leading to earnings expansion for these sectors.
While this is good news in general, one sector surely deserves special attention, and that is Financials. In July of this year, the cabinet announced it was removing individual caps for foreign institutional investment (FII) and FDI to create a single composite cap of 74%.
While FII is investment in liquidity market instruments such as equities (or bonds, mutual funds, the way our own exchange-traded Funds purchase shares), FDI, on the other hand, is foreign investment in long-term physical capacity such as setting up a factory.
Many investors prefer an investment approach that allows liquidity. For many big financials in India, the FII cap previously was close to being reached, while the FDI cap was largely vacant. The merging of these two thresholds into one created potential for greater FII in these banks.
Fund Flows and Increase of India’s Cap Weights in Benchmark Indexes
A direct effect of this step could be passive flows of foreign money into Indian markets, an increase in weighting of Indian financials in benchmarks tracked by fund investors globally. According to estimates by leading research and brokerage houses in India,2
• India’s weight in the MSCI Emerging Markets Index could go up by 74–100 basis points (bps) from its current level of approximately 8%;
• the weight of financials in the MSCI India Index could increase to 23%–24.5% from its current level of approximately 16%; and
• among big banks, key increases seem to be in YES Bank and Axis Bank.
Below is a detailed breakdown of new investment limits available to foreign investors for large private banks in India.
Merging of FII and FDI Caps to Free Additional FII Investment for Private Banks in India
We have been emphasizing the importance of the Financials sector within India. Current liberalization provides tremendous opportunity for investors to access a sector that’s about 6% of India’s $2.2 trillion gross domestic product (GDP) and is growing fast.
WisdomTree India Earnings Index
It is important to note that the WisdomTree India Earnings Index uses an earnings-weighted approach to allocate to profitable Indian companies. At roughly 25% in financials, it is 8% over-weight compared to the MSCI India Index.3
Some of the biggest beneficiaries of this current announcement—Axis and YES—are currently included in the WisdomTree India Index but are not yet included in the MSCI India Index.
Putting Everything into Perspective
With several caps limiting investment, full participation in Indian markets and economy has traditionally been a challenge for foreign investors. India currently stands at a crossroads of tremendous wealth-generation capacity. With the government’s goal of a GDP growth rate of 7%–8%, India can potentially double its $2.2 trillion economy over the next decade. Recent measures by the government are allowing greater access for foreign investors to participate in the wealth-creation opportunities.
Today, some emerging markets face a host of challenges: falling commodity prices, geopolitical risk, depreciating currencies against the dollar and global headwinds, to name a few. In contrast, India seems to be better positioned. Falling commodity prices have helped cool inflation in India (India is world’s third-largest crude oil importer). Geopolitical risk cannot be denied, but India does have a full majority government and, more importantly, a government that is reform friendly, as evidenced by the above announcements. The rupee, in spite of four consecutive rate cuts by the Reserve Bank of India this year has been one of the better-performing EM currencies in 2015. And finally, a consumption-driven model makes India a much better investment destination to withstand global economic headwinds.
As with any investment, there are risks. However, in the current macro landscape, as accessibility of Indian companies for foreign investors improves, by allocating to fundamentally sound Indian companies, investors have an opportunity to potentially generate significant positive returns. We continue to stay positive on India in an otherwise challenging emerging market landscape.
1Non-scheduled air transportation and ground handling services have been increased to 100%. Regional air transportation service has been allowed up to 49%.
2Sources: Edelweiss, Morgan Stanley and Credit Suisse.
3As of 11/30/2015. Subject to change.
Important Risks Related to this Article
Investments focused in India increase the impact of events and developments associated with the region, which can adversely affect performance.
– See more at: http://www.wisdomtree.com/blog/index.php/india-continues-opening-market-to-foreign-investors/#sthash.CYnf4Gea.dpuf