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India's second wave has affected the psychology of its middle-class suggests Ocean Dial CIO

Nicholas Earl, 07/07/2021

India’s second wave of Coronavirus cases and deaths during Q2 2021 could have a sustained impact on the consumption patterns of its aspiring middle-class, argues David Cornell, chief investment officer at Ocean Dial Asset Management.

Mr Cornell outlined that the outbreak of the Delta Variant, which has contributed to an increase in deaths from approximately 165,000 at the end of March to nearly 400,000 at the end of July, could result in the country’s middle-class pivoting towards saving money, particularly for healthcare issues. He believed that the pandemic exposed the deficiencies in India’s medical infrastructure - a reality that middle-income earners, living in urban areas with hospitals, would notice.

This shift towards saving could stall India’s economic growth, which has previously been driven by consumption since Prime Minister Narenda Modi took office in 2014.

The chief investment officer said: “Our sense is the second wave of India’s pandemic has had a material impact on the psychology of middle-class India. It may well impact consumption patterns in the near future as families recoil from spending in order to preserve savings for medical emergencies in the future. Or simply because they are not in a position where they feel like treating themselves.”

While it is unclear what the long-term domestic economic consequences will be following the variant driven second wave, data released from Pew Research in March 2021 has revealed that its middle class shrunk by approximately 32 million in 2020 during the first wave alone.

The big picture

Its findings detail that India’s middle-income citizens, defined as earning between $10.01-$20 per day, accounted for over 60 percent of the people worldwide that shifted from middle-income into low-income ($2.01-$10) or poverty (less than $2). Prior to the pandemic, Pew Research anticipated that 99 million people in India would belong to the global middle class in 2020, but recent figures now suggest only 66 million are in this income bracket, while the poverty rose to 9.7 percent.  

Meanwhile, private consumption as a proportion of GDP has declined to 55.4 percent in the fourth quarter of 2020-21 from 56.2 percent during the first quarter of 2018-19.

This situation could become a significant issue for India’s government, which has been encouraging urbanisation and the development of a middle class to support the country’s economic growth and planned fiscal stimulus announced in its budget earlier this year. The emergence of a burgeoning middle class prior to the pandemic was a key aspect of its economic reforms which have otherwise alienated millions of agricultural workers, and also its pledge to create a million jobs a month.

Commenting on the possible problems that could be caused by a reduced middle class with limited spending power, Mr Cornell said: “Every family in India, particularly in urban India which is consumption driven, is going through a very unpleasant time. We are watching very closely between now and December whether consumption patterns do hold up or not. I would say that is one of our biggest concerns."

When it comes to growth, the World Bank remains a source of optimism for India. It has forecast growth at a rate of 8.3 percent for the 2021-22 fiscal year, well ahead of the global average of 5.6 percent. In addition, the United Nations anticipates that India will be the fastest growing economy for the full year of 2022. Its mid-year update on the World Economic Situation and Prospects in May, during the peak period of India’s Covid cases, suggested that it could a 10.1 percent growth figure.

On the vaccine front, India is now inoculating an average of 3.5-4 million a day, with 358 million people vaccinated overall. This is second only China in terms of total numbers, but represents only 21 percent of the population having at least one jab. However, manufacturing momentum has resulted in approximately 60 million vaccines being produced per month. This number is set to increase, with the country anticipating 1.3 billion people being vaccinated with first jabs by the end of the year. This breakthrough could restore consumer confidence and bolster economic growth, however it would not resolve the financial issues already affect its middle income earners.

Investment oppportunities

Even if the future of India’s middle classes remains an open question, Mr Cornell remains positive about the potential in India’s recovery, and has focused particularly on potential investment opportunities in the domestic cyclical recovery. Ocean Dial Asset Management is responsible for the India Capital Growth Fund, a strategy focusing on small and mid-cap opportunities across the country.

Motivated by this ambitious outlook, one of India Capital Growth Fund’s largest holdings is now JK Lakshmi Cement. This is one of three cement holdings in the portfolio.

He explained: “It ties in with the cyclical, economic recovery. It ties in with an infrastructure led push from the government. We are reasonably confident that we're seeing the start of a residential housing recovery of which plays into the cement theme. So, we've got cement with a high exposure in the portfolio.”

He was also targeting consumer discretionary opportunities. This included the acquisition of stocks such as Kajaria Ceramics and Finolex Cables, which are focused on cabling, ceramic tiling, and also appliances like electric heaters and air conditioners. By contrast, Mr Cornell encouraged people to divert from consumer staples even if it seemed appealing in a period of volatility to embrace them.

Mr Cornell said: “The consumer staples sector is where we've been taking a little bit of money off the table. Historically, in times of stress and uncertainty, investors gravitate towards these defensive areas of the market. The valuations in the consumer staples sector in India have historically been very high because of that, they're even higher now. We don't see much value in this area of market, we would rather play a recovery story than a defensive story. So, staples are an obvious place I think to veer away from.”

The fund trades at a discount to net asset value of 12.2 percent and remains behind its benchmark the BSE Mid-Cap TR over a three-to-five year window. However, Mr Cornell notes the fund is 21 percent ahead of the index over the past 12 months and has outperformed the index consistently since his reforms to the fund’s approach last year. He also felt it was in a favourable position compared to potential rival products due to his emphasis on small and mid-cap opportunities to benefit from structural growth in the economy.

Forecasting the fund’s future performance, he concluded: “As India recovers economically, it'll be the mid and small cap area of the market that is likely to do better. The fund is better positioned towards that area of the market than the others.”

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