During its first-quarter earnings, Apple (NASDAQ:AAPL) reported that sales across the Greater China area, one of its most promising markets, only rose 14% annually. That's a significant slowdown from 99% growth in the previous quarter and 70% growth a year earlier. During the conference call, CEO Tim Cook admitted that although Apple saw "signs of economic softness in Greater China," he remained "very confident about the long-term potential of the China market."

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Image source: Apple.

Investors weren't impressed. Apple's slowdown in China, its anemic 0.4% annual growth in iPhone sales, and its forecast for a year-over-year decline in second-quarter sales caused its stock to tumble nearly 7% on Jan. 27. However, many investors overlooked a bright spot in Apple's earnings report: India.

Why India matters
CFO Luca Maestri stated that Apple's iPhone sales grew 76% annually in India during the first quarter. Maestri didn't disclose how many iPhones were actually sold there, but Counterpoint Research pegs the figure at 800,000. While that would represent just 1% of Apple's iPhone shipments last quarter, that percentage could keep climbing for two reasons.

First, India's middle and upper classes are growing, which is fueling demand for brand-name goods. Euromonitor International estimates that the country's luxury goods market could grow 86% in constant value terms between 2013 and 2018; China's luxury market is only expected to grow 74% during that period. Therefore, demand for Apple products as status symbols could grow in India as it did in China.

Second, India has a billion mobile subscribers, but only 160 million of those users owned smartphones last year, according to Nielsen Informate Mobile Insights. However, that figure is expected to grow at a compound annual growth rate of 26% between 2013 and 2017. eMarketer believes India will overtake the U.S. this year as the world's second largest smartphone market, with over 200 million users. Much of that growth will be fueled by Indians under the age of 25, who account for 63% of smartphone users in the country.

Last August, Counterpoint claimed that Apple controlled 12% of China's smartphone market. If Apple can control just 10% of India's projected smartphone market by the end of 2016, it could theoretically add 20 million iPhones to its annual sales.

Challenges Apple faces in India
Unfortunately for Apple, the vast majority of Indian smartphone users still prefer low-end smartphones instead of premium ones. That's likely because India still has the lowest median per capita income among the four BRIC nations.

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Streets of Mumbai. Image source: Pixabay.

Last August, Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google rebooted its Android One initiative in India after its initial batch of $100 devices failed to make an impression. During the relaunch, Google declared that its OEM partners would focus on $30 to $50 devices instead. Rajan Anandan, Google's VP and managing director of India and Southeast Asia, told the Financial Times that price range represented a "sweet spot" for mass adoption in India.

To gain ground in this market, Apple offered discounts, payment installment plans, and buyback programs for older devices. While this move bolstered sales, many Indian users are still buying older iPhones instead of the latest models. As a result, Apple's hardware base remains fragmented across the country -- Counterpoint reports that in December 2015, shipments of the iPhone 5s accounted for 64% of total shipments, while the iPhone 6 and 6s respectively accounted for just 31% and 5% of that total.

Is this why Apple needs a 4-inch iPhone?
Samsung, Micromax, and Lenovo were the top three smartphone brands in India last year, according to Canalys Mobility. Samsung controlled about a quarter of the market with its low- to mid-range devices, followed by Micromax and Lenovo. Canalys also notes that low-end Chinese players like Xiaomi and Vivo are gradually making inroads into the market.

In this market, Apple's top-tier iPhones remain niche products. This might be the reason Apple is reportedly developing a 4" iPhone, popularly dubbed the iPhone 5se. If the 5se costs significantly less than Apple's top-tier devices, it might tether more Indian users to its ecosystem and pave the way for future hardware upgrades.

Strategy Analytics analyst Neil Mawston recently told Fast Company that smaller and cheaper iPhones could appeal to customers in certain emerging markets like India, Africa, and some Asian countries like Vietnam, which have an abundance of "price-sensitive consumers or first-time smartphone buyers."

A short-term band-aid, not a long-term cure
The Indian market is becoming a new source of iPhone growth for Apple, but those gains could come a steep price. Slashing prices on existing iPhones and trying to gain market share with cheaper iPhones could hurt Apple's margins and dilute its premium appeal. More importantly, expanding into India still doesn't solve Apple's dependence on the iPhone or its glaring lack of promising new revenue streams.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares) and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.