INDIA: THE LAND OF CONUNDRUMS
Despite an aggressive second wave of COVID-19 and associated lockdowns from April to October 2021, India has continued to weather the storm and has gone from strength to strength in 2021. Foreign Direct Investment (“FDI”) was at its highest ever level (up 10% vs. 2020), the stock market reached new highs, and the INR managed to remain steady.
These achievements were driven by multiple factors. First, notwithstanding news headlines that focused on politics and religion, the Indian government has been working towards making the economy more business friendly. The move to digitization via the Aadhar initiative, the updated SME-friendly Goods and Services Tax (GST) regime, the 2020 National Education Policy, and creditor friendly policies have all contributed to an increasingly favourable macro environment. India has moved up to 62 in 2020 from 142 in 2015 on the World Bank’s “Ease of Doing Business” scale. Moreover, India has become a more credible diversification play for many Asia-focused investors. In the first half of 2021, private equity investments in India reached USD12bn as compared to USD5bn in the same period last year.
REFLECTING ON 2021
What ADM Capital thought was a “one-off” and opportunistic approach to investing in 2020 when COVID-19 first struck has ended up guiding our approach through 2021. Continuing our strategy of investing in digitally disruptive businesses and companies with a cross border presence paid off handsomely, as did a preference for companies with predictable cash flows and access to liquidity. Operationally, our long-standing relationships in India enabled us to effectively use our onshore contacts for deal sourcing and due diligence. We committed USD75m in new loans in India and realized USD20m in exits.
In 2021, the deal pipeline remained strong with a large and diverse pool of inquiries for new financings. As has been the case over the years for our broader Asia Pacific portfolio, we note that the best sources for deals are our existing borrowers where there is mutual familiarity with the borrower’s business operations on one end and ADM Capital’s lending approach on the other. Also, in a crowded market with many borrowers seeking capital, it makes sense to prioritise the underwriting of deals with strong management buy-in and good access to information.
ADM Capital continued to emphasise and refine the integration of ESG and responsible investing into our investment process throughout 2021. In India, we financed companies that provide financial inclusion, digital freight forwarding, consulting services to utilities, and property brokerage services. In a macroeconomic environment that is increasingly demanding climate focused solutions, our investee companies have been inundated with demand for their services. ADM Capital is well positioned to help its borrowers take advantage of this opportunity to create broader social impact. We continue to work with our borrowers to not only meet IFC-recognized ESG standards, but to exceed them via “stretch targets” specific to each borrower’s industry.
ASPIRATIONS FOR 2022
Underpinning our positive views on India is the young, currently underserved population that will continue to generate strong underlying demand for products and services as affordability increases, thereby driving the domestic economy and GDP growth. Infrastructure needs rebuilding and expansion is required, particularly via green and impact-oriented initiatives. Infrastructure activities alone accounted for 13% of 2021 FDI, and the Indian government has pledged USD1.4tn to infrastructure investment and carbon efficiency initiatives for 2022 onwards. The services sector has increased its share of GDP at 54%, while the COVID-19 fallout has accelerated the digitisation of Indian businesses – especially in banking and payments – which has also driven domestic growth. Furthermore, residential sales in 8 cities bounced back to near pre-COVID-19 levels toward the end of 2021, bolstered by low interest rates, a fall in housing prices, and the stimulus provided by various governments. Markets predict the base case GDP growth for 2022 at 9-10%, underpinned by a recovery in the high-contact services sector.
Notwithstanding the bullish market outlook, the conundrum that is India suggests tangible risks. The risk appetite of banks for lending to mid-sized companies remains constrained: loan-to-deposit ratios have fallen to 72% in 2021 vs. 76% in 2020. But even as commercial banks retreat from lending, this has been somewhat offset by the increased participation of domestic registered funds, resulting in overall non-food credit growing by 7.1%. Nonetheless, for the Indian market to produce sustainable growth, regulation needs to keep up with the times and a more receptive approach to foreign investments is required. While capital controls are expected to remain in place and continue to challenge lenders, the relaxation of withholding taxes, investing quotas, interest rate ceilings, and rules on minimum maturity are needed to level the playing field against other more open economies of Asia.
Markets will remain unsettled by the impact of the Omicron variant and other variants yet to come, requiring a flexible investment approach. Inflationary trends may turn into stagflation due to supply chain issues, while higher oil prices could blight manufacturing growth. Simultaneously, the labour participation rate, at a low of 40% by year end 2021 vs. 45% in 2018, could continue its decline due to the persistent jobs skills gap, and the Indian government’s protectionism and tight capital controls may mean India cannot benefit from the trend of foreign firms setting up manufacturing bases in India. In the latter case, other regions may become more interesting for investors.
ADM Capital’s 2022 strategy for India therefore remains positive but cautious. We will continue to invest in the region but will remain attentive to the aforementioned risks by pursuing diversity in our investments, preferring investee companies with high predictability of earnings, or in sectors which are currently in an upcycle and those with enough cushion to absorb FX risks. Most importantly, we will continue to stress-test predictions to make sure we are comfortable with worst-case scenarios; this remains an invaluable approach for unpredictable times.
Given the long-term positive backdrop, India remains a core market for ADM Capital’s secured private credit funds. We have been able to take advantage of inefficiencies and uncertainties in the market due to our long-time presence in the region, and will continue to work with reliable promoters in industries that have been unaffected by the pandemic or have seen COVID-19 driven upside.
Given India’s propensity to abruptly move from normality to crisis mode, we need to remain disciplined and focused on the principles which uphold our investment philosophy.
We look forward to forging ahead in 2022.