Strategy Note /

India: A bad week for nationalists and a challenge for ethical or ESG investors

  • First, a BBC documentary on PM Modi's response to communal riots in 2022 and his policies affecting Muslims

  • Second, a Hindenburg Research report alleging the Adani Group is "pulling the largest con in corporate history"

  • India is a foreign investor favourite, 14% of MSCI EM, but scores poorly on press freedom and corruption metrics

India: A bad week for nationalists and a challenge for ethical or ESG investors
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
26 January 2023
Published byTellimer Research

For Indian nationalists who wish to see their country portrayed in glowing terms internationally, this has been a tough week: a BBC documentary which casts Prime Minister Narendra Modi in a poor light and a Hindenburg Research report which alleges fraud in the Adani Group.

For the vast majority of foreign investors looking at the overall India market, the issues raised are likely to blow over. We remain relatively positive on India.

But for those few investors who claim ethical credentials, are held accountable for this claim, and continue to invest in India, there is a problem.

Democratic deficiencies are not new or unique

The BBC documentary, India: The Modi Question, has portrayed current PM Modi in a poor light for his response to the communal riots, between majority Hindus and minority Muslims, in Gujarat in 2002, during Modi's term as Chief Minister.

The government has responded with a ban on broadcasting the documentary in India or sharing online links to it.

These are not new concerns on India's domestic environment, putting concerns over its foreign policy stance on Russia to one side.

It is just that this week has provided a reminder of both, at a time when India has taken more of the central position in EM.

Deficiencies in democratic freedoms are not unique to India, particularly among emerging market peers – consider the concerns in China or Vietnam, which have not inhibited long periods of outperformance in their cases.

Press Freedom: India well below others in large EM

Corporate scandal does not usually derail the whole market

The Hindendurg Research report, Adani Group: How The World’s 3rd Richest Man Is Pulling The Largest Con In Corporate History, alleges share price manipulation and accounting fraud.

The Adani Group is based in Gujarat and has a market capitalisation, spread over seven publicly listed companies, of over US$50bn (26 January 2023). It activities span coal, logistics, power generation, gas distribution, edible oil, online travel, road construction. Its motto is 'Nation Building' driven by 'Growth with Goodness'.

Its response to Hindenburg has included describing the report as "a malicious combination of selective misinformation and stale, baseless and discredited allegations that have been tested and rejected by India’s highest courts" and considering legal "remedial and punitive action".

Bad behaviour by one corporate, should that prove to be case in this instance, usually does not derail confidence in the entire equity market – consider Satyam Computer Services in India in 2010, or, for that matter, Enron in 2001 in the US, Parmalat in Italy in 2003, or Wirecard in Germany 2020.

Corruption scores: India in the middle of the large EM pack

Ethical investment dilemma

This week in India presents investors who profess an ethical approach, whether under an ESG banner or not, with their latest challenge.

Part of the Indian investment case is predicated on a strong Modi-led BJP majority government, which is both friendly with big business interests and interested in reform – albeit with lower priority on reform than on re-election.

But with that will come moral concerns over the nature of BJP political messaging and policy, particularly over minority rights, and if its relationship with big business involves corruption.

I have written many times about the ESG blind spot of badly behaved countries, both in the emerging and developed markets. Most institutional investors do not even bother screening countries for ethical behaviour.

Those few that do apply stringent ethical criteria in EM, eg the Freedom 100 EM Index from Life + Liberty Indexes, end up with an addressable group of countries that is far too small to support the weight of assets under management in EM equities.

Chile is 23% of this FRDM Index: Chile's GDP and market capitalisation are both under 2% of that in China. China has zero weight in FRDM compared to almost 35% in MSCI EM.

My reports on this theme have consistently been among my least read and engaged with. Several of them are linked below. I have little optimism that they will be read now.

Equity strategy view unchanged, still positive

Our preference for the largest countries in emerging market equities is as follows, in descending order: China, Taiwan, Korea, India, Saudi Arabia, Brazil, South Africa.

India's investment case strengths are relatively stable domestic politics, high growth and the absence of external debt. These features should persist.

Prime Minister Modi and his BJP’s re-election in 2024 appears on track after the resounding victory in the Uttar Pradesh state elections in 2022.

While structural economic reform efforts appear to have stalled in favour of electioneering, eg agricultural reforms were sacrificed to appease protesting farmers, and the protection of minority rights is under stress, large corporates will be more comfortable with a continuation of BJP rule than a change to government run by what remains a fragmented opposition, which is, at best, competitive at the local level and, at worst, hopelessly uncoordinated at the federal level.

Without these structural reforms, India likely does not fully take advantage of the opportunity to grow its manufacturing base, as the only country with the potential scale to match China.

But there is a lot of growth ahead without that by simply managing legacy bad loans in the state-owned banking sector, and allowing the market for private sector lending to corporates and consumers to function relatively freely.

The main risks to the investment case are valuation – which is at a slightly greater premium to the historical average than most peers in large EM – the reliance of economic growth on loose monetary and fiscal policy – with a real interest rate close to zero (currently positive 0.5%) and fiscal deficits close to 10% of GDP – and, the growth of military spend as a percentage of GDP (2.9% in 2020) as India plays a bigger geopolitical role, which inevitably means more friction with China.

For more, see India: Reform and Illiberalism after Modi's BJP state elections success (March 2022) and China and India scuffle in the Himalayas again (December 2022).

Valuation: India slightly more expensive versus history

Related reading and data

India sues Twitter (Jun 2021)

Why India abstained on the Russia vote at the UN (Mar 2022)

When countries behave badly: The tortuous morality of ESG investing (Mar 2022)

ESG needs to focus on countries, not just companies (Oct 2021)

Large EM equity strategy: 2023 outlook (Jan 2023)

EM Country Index update (Dec 2022) – ranks the investment case of 50 emerging and frontier markets and the US, as a developed comparable, with adjustable weighting c30 factors on growth, policy credibility, politics, sanctions, ESG (which includes country-level governance).