PERSPECTIVE3-5 min to read

What’s behind India’s post-Covid outperformance, and is it set to continue?

Indian equities have delivered blockbuster returns since the end of 2020 amid superior earnings growth. We ask if these trends can continue.

India post-covid


Nicholas Field
Global Emerging Market Equity Strategist, Emerging Market Equities

India has outperformed emerging markets (EM) over the long-term but has only started to seriously outperform in the last three years. Going back almost 30 years to the end of September 1995 (when our data for valuations, margins, asset turns etc begins ) until the end of 2020, India outperformed by around 2% per year. In price terms (excluding dividends), the outperformance was just over 3%, as India’s dividends are low relative to other markets.

In the period since then to the end of March 2024, India has outperformed EM by a blockbuster 17% a year. This has seen its weight in the MSCI EM index more than double to reach close to 18%, rising to become the second largest market in the index.

What explains this outperformance? Is it valuations, superior returns, or just earnings performance? In this note we disaggregate and assess the drivers of performance.

What has driven India’s outperformance of EM since the end of 2020?

Valuations in India are certainly high, but they have not accelerated in the last few years. Indeed, due to the Covid pandemic-induced global drop in earnings in 2020, valuations were at a high point at the end of 2020. Below is a chart of the trailing price-earnings (P/E) ratio for India and EM, as well as a relative chart of the ratio of the two, just up to the end of 2020.

India post-covid

Valuation was a driver of that modest outperformance in the 25 years up to 2020. Since then, it has actually turned negative, as the next chart illustrates.

India post-coivid

Having dismissed valuation as a driver of outperformance since 2020, this would be a good point to deconstruct returns. The table below breaks down returns into valuation moves (trailing P/E ratio), return on equity (ROE) changes and book value growth (all figures are annualised).

India post-covid

Until 2020, ROE in India was falling. The book value was growing faster than earnings. In the period since that has all reversed.

India post-covid

The pickup in ROE has been much more significant in India than for EM as a whole. The chart below shows the gap between India’s ROE and that of the MSCI EM index.

India post-covid

Until 2020, India’s market ROE was converging down towards the EM index ROE. Since the end of 2020 though, the majority of the country’s outperformance has been driven by a much stronger ROE recovery from the pandemic-induced low than elsewhere.

What has driven this change in ROE for the Indian market?

As a reminder and for clarity, ROE is earnings divided by book value. We can see book growth was actually higher in India in both time periods. So, the difference would appear to be earnings growth. The next chart shows earnings for EM and India indexed at one in 1995.

India post-covid

India is by no means the only EM to have seen strong earnings in the last three years. But it is the best of the large markets. The chart below compares India with South Korea, China, and Taiwan, which together account for over 70% of the MSCI EM index, plus the MSCI EM index itself.

India post-covid

South Korea and Taiwan have both seen earnings tail off as the technology cycle unwound in 2023. Markets in both countries have largely looked through this (in other words valuations have increased). The challenges to Chinese earnings are well documented.

Has there been a sectoral impact?

The majority of sectors in India have had a better earnings trajectory than aggregate EM since the end of 2020. The chart below shows the earnings path for most of the sectors in India.

All sectors on the chart outperformed aggregate EM earnings, so the strong Indian performance was quite general.

India post-covid

So, what is behind the strong earnings in India since 2020?

India had a strong recovery from the Covid pandemic. The chart below shows nominal GDP growth in US dollars since 2020.

India post-covid

India has delivered growth in excess of the US, in nominal US dollar terms. It is by no means the only EM to have performed well - Mexico has managed 50% or so in total - but it is easily the best of the large EM. China, shown for comparison, has not generated any growth in nominal US dollar terms over the past two years.

Economic growth in nominal US dollar terms does not automatically transmit into equity returns, but it can help the topline. The next question is whether margins are also strong.

We know ROE was the dominant driver of India’s strong return. We can disaggregate ROE into margins, asset turn and leverage. It turns out that about 70% of the improvement in ROE was down to an improvement in margins.

What has supported margin improvement for the India market?

India post-covid

There are two factors behind the improvement in margins. The first is the very low point they reached during 2020, and the second is how they improved into 2023, even as margins across EM tailed off.

This second factor is probably due to prices for commodities and basic materials coming off through 2023 from their highs of 2022. India is a commodity importer.

How does this inform our view on the Indian equity market?

The structural case for investing in India is well known, but having been a modest outperformer and a relatively low volatility market, India began to strongly outperform in 2021. As we have shown, earnings started to grow faster than wider EM, which was driven by a more rapid increase in margins.

Fast-forward to today, and nominal US dollar growth is reducing globally after the post Covid surge. This appears to be true in India as well. In our view, it is also doubtful that India can see a further increase in margins as topline growth sees a little more pressure from the falling nominal growth outlook.

The long-term structural outlook for Indian equities remains robust, supported by a positive policy backdrop. However, valuations are expensive, and earnings growth looks set for some deceleration.


Nicholas Field
Global Emerging Market Equity Strategist, Emerging Market Equities


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