What is an Emerging Market?

While there is no universally accepted definition for the term ‘emerging market or an emerging economy’, many economists and agencies have defined the term(s) based on certain characteristics which are common to most classifications.

By any measure, an emerging economy will have 3 things:

(i) Rising Gross Domestic Product (GDP) – While countries which start from a low base may report higher GDP growth without much increase in production, the real defining characteristic should be a sustained rise in the GDP for 5-10 years. The rise should be led by a sustained push towards industrialization, more specifically towards building infrastructure and increasing manufacturing. The underlying theme is an improvement in the standard of living and per capita or per person income.

(ii) Higher young (working age) population – The number of working people in the economy should be higher than the non working people. In other words, there should be more hands on the job than off it.

(iii) Opportunities – This final characteristic in a way covers both the points above. It is largely made possible because of higher working age population and results in a rising GDP.

How Emerging is The Indian Market?

It is said that capital flows towards return. That is the very nature of money. It moves wherever it finds an opportunity to grow. For the quarter ended June 2014, FII ownership of S&P BSE Sensex companies was reported at 22.5%*. Why is the world betting big on India? I will list out 10 reasons why India is and will continue to be the pick of all emerging market economies for many years to come:

Before discussing why India’s GDP will continue to rise, let’s look at how GDP is defined.

GDP = C + G + I + NX

Where:

“C” = total private consumption in the country

“G” = total government spending

“I” = total investment made by the country’s businesses

“NX” = net exports (calculated as total exports minus total imports)

Master level degree in economics is not need to understand that the GDP improves with rising economic activity. When a higher number of people start making use of available resources to produce more goods and services, perhaps in an effort to improve their lives and lives of others, more money is earned, more consumption happens (C), and higher exports are made possible (NX).

Further, skilled workforce which is able to produce more goods and services at competitive costs attracts inbound investments (I) which helps a country build its infrastructure and industry.

Working age Population: 65 % of India’s population is below the age of 35, the average median age being 27 years. Further, the current population below the age of 15 is all getting basic education which gives India a huge demographic dividend for the next many decades. A young country that works hard (and earns more), is not only more productive but also aspires for a higher standard of living and for better products. This creates an enormous market potential for makers of all sorts of goods and services.

Opportunity: A pool of skilled working age population not only provides the labor force for industrialization, when it happens in a country with low per capita income like India, businesses around the world see this as an opportunity of gaining competitive advantage. Today, top software companies have set up their research and service centers in India. A lot of money has been invested by these multinational corporations in India and given the potential and the availability of skilled resources which the country offers; this is only likely to increase in the coming years.

The other reason why emerging markets like India present a big opportunity is because there is a lot to do in these countries compared to the developed economies. Even while you travel in the interiors of Europe and the United States, you will find hardly anything left to be done. On the other hand, in India even basic infrastructure like electricity and clean drinking water is missing in a large part of the country. Similarly, basic medication and personal care products have not reached a majority of the country. This presents opportunities across all sectors like infrastructure, engineering, construction, FMCG, pharmaceuticals, automobiles and of course banking.

Evidence of Sustained Interest in India

Since 16 May 2014, when India got its largest majority government in over 30 years, Indian equity markets have been the best performing amongst all of the emerging markets pack.

Further, the corporate earnings (EPS) of the S&P BSE Sensex constituent companies have grown ~ 12-13 % per year over the last 5 years. However over the last 3 quarters corporate earnings have been rising (EPS growth in % for the last 2 quarters – 5% for Q4 2014 and 9% for Q1 2014). Analysts expect corporate earnings to grow anywhere between 15 % for the full financial year 2015 (based on average targets of major domestic and foreign research firms) and expect a 5-7 year EPS growth of anywhere between 16-20 %.

Sometime back, I had done a very detailed research on the PE and EPS levels of the Sensex – you can find that research here.

Given that the Sensex is currently still trading at discounted valuations (see link above), if these projections are correct, then by the year 2020, Sensex should reach 64,000+ level. This is based on the Sensex growing at the rate of growth in corporate earnings. Finally, at least over the last 3 months we have witnessed a sharp bounce back in stock prices every time there is the slightest decline, clearly indicating a bull market.

Growth in Sensex EPS – Past 8 Quarters
Quarter FY 2013 Q1 FY 2013 Q2 FY 2013 Q3 FY 2013 Q4
EPS   1,064.75  1,101.10  1,114.56  1,095.74
Growth % 3.41% 1.22% -1.69%
Quarter FY 2014 Q1 FY 2014 Q2 FY 2014 Q3 FY 2014 Q4 FY 2015 Q1
EPS  1,142.95  1,122.16  1,190.70  1,252.73  1,367.80
Growth % -1.82% 6.11% 5.21% 9.19%

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* Fact check: In the year 2008 -09, the BSE Sensex corrected by over 63.5% (from 21,113 points to 7,697 points) while the NASDAQ fell only 39.23% (from 2,474 points to 1,503 points). Apparently the United States and most of the developed world went into a recession in that year.

Why then did the Indian indices declined more than their western counterparts? This was because FIIs pulled back their money aggressively to meet commitments in their home countries.