India's Achilles' Heel - Market Analysis for Apr 27th, 2019

India is one of the most exciting markets for long-term growth over the next 20 years. The population is massive, but just as importantly, it is also young and growing. It is expected to become the world’s most populous country in the mid 2020’s, surpassing China.

According to many projections, the U.S. GDP is expected to increase by about 50% from now until 2030, while India’s is expected to quadruple on a PPP-basis by then. If this turns out to be true, this would make India the second largest economy in the world as measured by purchasing power parity behind China and ahead of the United States sometime in the late 2020’s.

But India’s big weakness is that it is heavily reliant on energy imports. The country doesn’t produce nearly enough oil and gas to support itself, and thus relies on major imports from other countries. Many nations are in this situation, but for India it is worse because the country is still poor on a GDP per capita basis, which makes oil imports comparatively very expensive.

To put it into perspective, India imports about 5 million bpd, which is more than half as much as China imports. Oil is priced globally in dollars, and in dollar terms India’s nominal GDP is only about 20% as big as China’s nominal GDP. As a result, India’s reliance on oil imports as a percentage of its nominal GDP is huge.

India is working to combat this with ambitious solar energy installation goals. As an intermediate-term goal, the country is aiming to have 100 GW of installed solar capacity by 2022. Right now it is approximately 25 GW. This goal of 100 GW by 2022 is expected to be comprised of 40% rooftop and 60% utility-scale and super-scale projects.

India’s total grid-connected electric generation capacity is growing by 4-5% per year. Last year, renewable sources of energy made up about 75% of new capacity installed. And as electric cars become more common in the future, India can further reduce its reliance on oil by focusing on continually expanding its solar generation capacity and using that energy for both the grid and for cars.

The ironic problem, though, is that India imports a lot of solar panels, mostly from China, and this contributes to a trade deficit with China. India’s government has imposed tariffs on these imports to reduce their competitiveness compared to domestic producers, but this may result in India coming short of its 100 GW goal as some analysts expect.

So the two-edged challenge facing India is that as they grow, they are increasingly reliant on oil and gas imports, and in order to reduce that reliance they want to increase installed solar capacity while also building out their own competitive solar manufacturing capability so as to avoid reliance on solar panel imports. That’s a problem that will take many years to solve.   

Impact on the Indian Rupee

This dependence on energy imports manifests primarily in currency weakness.

India has a competitive business environment by emerging market standards, has a well-educated workforce in the software industry, and overall is doing a lot of things right to build out its economy. In most contexts, a country like this would have a positive trade balance and current account, resulting in a relatively strong currency.

However, India’s reliance on energy imports puts a big anchor on their trade balance and current account. As a result, both their trade balance and their current account are consistently negative and also sensitive to the price of oil.

The price of brent crude hit a major bottom in early 2016, and was fairly cheap during a multi-year period in 2015-2017. India’s current account improved during that time but began to deteriorate again from 2016-onward as oil gradually rebounded in price:

India Current Account 

As long as India continues to have a structural trade deficit and negative current account, investors can expect its currency to be one of the weaker ones globally over the long term. If India can ramp up its exports and solar industry, it may eventually overcome this problem and strengthen its currency. 

To quantify this issue, here is the performance of the MSCI India index:

India’s market by MSCI standards in local currency increased 7x over the past 15 years, and gave a compounded annual return of 11.27% since 1994.

However, in dollar terms, this performance was diminished:

In dollar terms, India’s MSCI index only multiplied by about 4.5x over the past 15 years (still better than the United States market over that time), and compounded at a 7.52% annual rate from 1994. So, India’s currency depreciation has been a -3.75% long term drag on annual performance in dollars.

Hedging Strategy

If you are bullish on India for the next two decades as I am, but want to mitigate this reliance on oil and gas imports and negative sensitivity to the price of oil, then going long oil can generally hedge India’s performance in your portfolio.

One way I like to do this is by being long Russia. While growth is slow and sanctions and corruption weigh on performance, Russia’s market is extremely cheap and their fundamentals in many ways are strong. Russia is a big oil and gas exporter, has a consistently positive trade balance and current account, and has one of the lowest levels of debt as a percentage of GDP compared to other countries. They benefit from higher energy prices.

As such, I like to be long both Russia (RSX, RSXJ, etc) and India (INDA, SMIN, IFN, etc) to neutralize my exposure to the price of oil.

Another way is to buy oil producers or an ETF that tracks them. I like Occidental Petroleum, as one example. Kirk Spano in particular sorts through a lot of oil and gas stocks to give investors more insight into which ones to buy or avoid.