Opinion: The new face of emerging markets: India brings both promise and complexity for global investors – The Globe and Mail

The world is undergoing a paradigm shift, both politically and economically. This article is the third in a four-part series that examines several changes, including the opportunity afforded by the energy transition, the evolving dynamics of emerging markets and how North America can leverage its comparative advantages to strengthen its position in the global market.

Seismic alterations in the global economy, brought on by geopolitical developments and pandemic-induced fluctuations, have compelled Western investors to adjust their strategies and reassess their risk appetite for markets and asset classes beyond conventional allocations.

Until very recently, the path forward for those in search of diversification and higher potential returns (with commensurate risk) lay, in large part, in emerging markets. But the new world has made investing in these markets far more complicated, and the retreat from several jurisdictions is likely to endure, illustrated by the growing demand for Asian investment products that exclude China.

Yet, in many respects, emerging markets are even more attractive today than they have been in the past because, unlike in the past decade, they are less likely to track the outcomes of American and European markets. Since there is now less monetary and geopolitical harmony throughout the world, it’s likelier that emerging markets will provide true diversification to portfolios – and we know diversification is the only “free lunch” in investing. At the same time, diversification plans need to be balanced against the inherent risk in emerging markets.

Goldman Sachs economist Jim O’Neill coined the term BRICs (Brazil, Russia, India and China) in 2001 to describe fast-growing countries projected to dominate the global economy by 2050. However, political unrest and a faltering economy in Brazil, tensions between China and the West and Russia’s invasion of Ukraine have severely affected opportunities for investors and raised risk substantially. As it stands, only one “BRIC” remains with the potential to navigate demographic and political headwinds: India.

After recently overtaking China as the world’s most populous country, India poses the strongest macroeconomic promise for massive scale and development, providing opportunities to discover outsized returns and balance risk with the benefit of international diversification. Its demographic trends, geopolitics, sector strengths and domestic economic policies are core factors that globally minded investors should consider as they seek to diversify their portfolios.

It starts with people. India possesses a young, rapidly growing work force that will grow richer before aging sets in. By way of comparison, China’s dependency ratio (the proportion of retirees to working-age people) is expected to increase, giving India a major advantage and providing perhaps the best predictor of long-term economic health.

For foreign investors, India’s demographics promise a growing consumer base that will drive demand in sectors such as technology and consumer goods.

However, the country is not without political challenges. While India has been placed by Canadian, U.S. and other allied governments at the centre of foreign policies in the Asia Pacific, India’s official policy is more complicated. And domestically, growing Hindu nationalism risks setting the country back and unwinding some of its demographic advantages.

Since the Cold War, India has been a leader in the Non-Aligned Movement, which effectively makes it a middleman rather than a participant in any political rivalry. To that end, India has not joined the West in condemning the Russian invasion of Ukraine and continues to be a leading buyer of Russian oil. If the U.S. were to go to war with China over Taiwan, India’s reliability as a partner is hardly predictable, as its trade with China is double that with the U.S.

Despite these challenges, North American businesses and governments see an opportunity to strengthen relations with India. Most recently, Indian Prime Minister Narendra Modi visited the U.S., shoring up defence agreements and seeking out audiences with private-sector heavyweights such as Tesla TSLA-Q owner Elon Musk, enticing them to invest more in his country. All, no doubt, much to Beijing’s chagrin.

To be clear, one should not gloss over significant doubts among foreign investors looking at India. It’s hard to find reliable data on the economy. The size of India’s middle class remains a black box. Many Indians work outside the formal economy, in tax-exempt agricultural roles, or do not earn enough to pay income taxes, forcing analysts to rely on estimates. In the 2021-22 fiscal year, for example, only 54 million individual tax returns were filed.

The country needs to harness its demographic dividend by addressing its shortage of skilled labour, improving income growth and economic opportunities for women, and building infrastructure capable of supporting industries that will thrive in the 21st century. These systemic changes will be critical in convincing foreign investors that the investment risk is worth it in India. The challenge also lies in enhancing export capabilities and fostering a business environment that attracts North American investment.

This is no small feat and will require significant reform to an education system that currently favours a select few. This year, the employment rate for Indian working-age women fell to 24 per cent. For under-25s, it dropped to 12 per cent. If half the population remain outside the labour force, India’s potential will not be realized.

India does excel in technology, agriculture and health, with companies such as Tata and Infosys leading the charge. It also has a famously excellent managerial class, the majority of whom are English-speaking.

With technology in particular, government and businesses are working to leap from an outsourcing relationship with Western partners to one of collaboration. American tech leaders such as Tim Cook have taken note, with the Apple AAPL-Q chief executive recently proclaiming that India presents a “huge opportunity” for continued expansion. Large semiconductor companies such as Micron and Applied Materials also used Mr. Modi’s U.S. visit to announce significant investments in India.

But the controls of key levers of the economy sometimes rest with a handful of well-connected individuals and families (e.g., Ambani, Adani), boxing international investors out of major growth sectors. To access these sectors, institutional investors often turn to private investment, which, like in any market, requires boots on the ground and the right partners.

A US$2-billion tax dispute between the British telecom Vodafone and the Indian government, as well as Walmart’s hurdles in establishing a retail footprint in India, highlight the country’s sometimes unfavourable regulatory environment.

Investing in emerging markets poses immense challenges. India is clearly no exception, sitting on the precipice of unprecedented prospect, balancing inherent challenges with the promise of a sustained economic takeoff. The decisions it makes today, and the global events that follow, will determine whether it emerges as the world’s next great economic power and foreign investment destination.