Why India is worth it

It also helped India's two main stock indices - BSE Sensex and Nifty 50 - fall more than 6 per cent the following day. And it resulted in severe cash shortages for several weeks as 86 per cent of the country's cash in circulation had been wiped out, meaning people had to queue for hours to exchange their money for newly printed 500 and 1,000 rupee notes.

But four months on, the picture is starting to look rosier, argues David Cornell, chief investment officer of Ocean Dial Asset Management, a London-based asset manager that specialises in India. Ocean Dial runs funds including India Capital Growth Fund (IGC), which primarily invests in listed mid and small-cap Indian companies.

"Gross domestic product (GDP) for the last three months of 2016 was 7 per cent, compared with 7.4 per cent in the prior quarter - a much better outcome than was forecast following November's demonetisation," explains Mr Cornell.

India's equity markets have also rallied on the back of a fiscally sound federal budget and better-than-expected corporate results since demonetisation. And they have been buoyed by recent victories in state elections for the ruling Bharatiya Janata Party, particularly in Uttar Pradesh, one of the country's poorest and most populous states.

"The people most affected by demonetisation were the poor," says Mr Cornell. "[Yet] India's poorest chose to abandon caste-based and entitlement politics to endorse a reform drive and pro-growth agenda - a vote for Modi as leader."

The results raise the likelihood that Mr Modi and his party will be re-elected in 2019 with a mandate to continue their reform agenda. And Mr Cornell believes this will, in turn, support increased foreign investment in India. In February, after four consecutive months of selling, foreign institutions turned net buyers to the tune of $1.6bn (£1.28bn).

"Modi is very focused on stability to attract foreign direct investment and that seems to be working," says Mr Cornell.

And smaller increases in US interest rates should help create a risk-on trade in the global market - whereby investors feel more optimistic and are more willing to back riskier assets - which should benefit emerging markets in general, he adds.

But the risks remain. A stronger US dollar could make emerging market debt more expensive to finance, or a faster-than-expected upward move in US interest rates could see investors pull funds away.

But Mr Cornell thinks India stands out among emerging markets. Unlike commodity-driven economies such as Brazil and Russia, it has a broader range of industry sectors.

And growth is expected to remain robust. Whereas China is starting to experience an ageing population, India's population is one of the world's youngest and this is likely to give it a labour advantage over the world until 2050. This, in turn, should further fuel the growth of the middle class. "India is where China used to be," asserts Mr Cornell.

Consumer discretionary spending is one of the sectors experiencing most growth. This area had been dominated by the unorganised, informal economy, but over the past five years India has witnessed the development of several high-quality businesses. These include one of India Capital Growth's top 10 holdings, Kajaria Ceramics (KAJARIACER:NSI), the market leader in tile manufacturing in India, which has compounded profits at 30 per cent over five years.

Another area where Mr Cornell and his team are finding opportunities is financials, the trust's largest sector exposure. Mr Cornell says banking and financial services is a highly underpenetrated market in India and could benefit from further economic growth and the government's demonetisation measures. The trust's largest and third-largest holdings are Yes Bank (YESBANK:NSI) and Federal Bank (FEDERALBNK:NSI).

But he admits that valuations now look expensive. "India is trading at a trailing 12-month rolling price/earnings (PE) ratio of 21.3 and a forward PE of 19.6," he says. "In absolute terms, the multiple is higher than the long-term average, but this has been affected in the short term by the impact of demonetisation, so distorting growth."

However, he adds that the PE ratio is currently lower than the long term average premium over MSCI Emerging Markets index which is 40 per cent.

"We believe Indian market earnings will be in the region of 12 to 15 per cent for the fiscal year starting in March 2017," he says. "And the premium is justified by the size of the opportunity, the breadth of investible sectors and the quality of the management teams on the ground."