After some initial volatility, investors are starting to take a more sober look at the impact of Premier Modi’s stumble in the polls and whether it will impact economic reform.

An unexpected election result saw Modi’s Bharatiya Janata Party (BJP) lose its majority. It must now govern in coalition. However, it is unlikely that the election result will substantially derail the economic growth trajectory in India. Modi’s party still has the largest number of seats in parliament – 240. The next largest party – the Indian National Congress – has just 99. It may force Modi to water down some of its ambitions, particularly over land reform and labour reform, but there is likely to be broad continuity.

India still has a significant pathway of growth. GDP per capita is just $2,730. This compares to $13,140 for China or $11,350 for Brazil. On current growth rates, it could become the world’s third largest economy by the decade's end. The government has set the goal of becoming a developed country by 2047. Although definitions vary, this would suggest a GDP per capita of over $20,000, implying sustained and significant growth for India. The International Monetary Fund projects growth of over 6.5% for the next three years, and the recent election does little to disrupt that.

There is a range of factors supporting Indian growth that are above and beyond government initiatives. For example, India is a clear beneficiary of the China plus one phenomenon, which has seen global manufacturing companies diversify their production away from China. The government has played a role in putting incentives in place, but the trend is self-sustaining. There has already been significant success in smartphones with Apple setting up in India, but similar growth has been seen for washing machines, renewable energy components, and the food industry.

Fragilities

Nevertheless, the volatility surrounding the election does expose some fragility in the Indian market. Although it has recovered, it became clear there was a Modi premium in some of the state-owned companies and some family-owned businesses tied to the government agenda. While these businesses may continue to thrive, we prefer not to invest where growth is wholly dependent on the state.

It also shows why investors need to exercise caution regarding valuations. The market is expensive relative to its emerging market peers and is slightly above its long-term average. Given its companies' growth prospects and strong governance, it has always traded at a premium, but some parts of the market are particularly highly valued.

We believe it is important to focus on companies with momentum for growth and visibility on earnings. Plenty of companies are still beating expectations on earnings, which provides comfort for companies to grow into their valuations.

Six structural themes

We believe it is imperative to focus on six structural themes that, in our view, have momentum independent from the government agenda.

Aspirational consumption

Aspirational consumption, for example, is supported by rising GDP per capita. As the economy grows, the middle classes thrive and demand more goods and services.

Premiumisation trend

There is also a premiumisation trend as they move to higher-quality options. A pioneering mixed-use developer and the best mixed-use development company in India is also the country’s leading premium shopping mall operator, which is benefiting from a first-mover advantage as the Indian consumer discovers the mall experience.

Better healthcare

Demand for better healthcare services also increases as wealth rises. Public health experts believe that India’s healthcare system must strike a balance between offering top-notch treatment in upscale urban hospitals and making sure that the vast rural masses have access to suitable medical facilities.

Urbanisation

Our Building India theme incorporates infrastructure development and urbanisation. Some of this depends on government policy but is likely to happen under governments of any kind. Urbanisation is a feature of any fast-growing economy, and India is no exception. For example, we’ve bought into the real estate sector, which is in the early stages of a longer-term recovery. There are also second-order beneficiaries of the housing boom.

Digitalisation

Digitalisation is also a powerful trend. The country has developed a Digital Public Infrastructure network called the India Stack. This unique initiative is designed to help citizens access their data and information online and for government and businesses to provide targeted digital services to India’s vast population underpinned by thumbprint authentication technology.

Power crisis

India continues to suffer from chronic power deficits. In May, the government said it was expecting the country’s biggest power shortfall in June in 14 years. Solar photovoltaic and onshore wind deployment is expected to double in India by 2028, which is also creating a range of investment opportunities.

Final thoughts

The recent turmoil around the election does not derail the Indian growth story, but it has exposed some sectors where valuations have become extended. We avoid those areas with a Modi premium and look for companies with self-sustaining momentum. There are plenty to be found, regardless of where power lies.