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India the last real emerging market

The futuristic architecture and glass towers of Shanghai and Seoul defy old stereotypes about emerging markets. But investors heading into Mumbai from the airport, confronted with searing poverty and pollution, could be forgiven for questioning the talk of Asia’s economic miracle taking root in India. We would encourage them to take a broader view: although corruption and inequality remain endemic, there are signs of profound long-term change.

In this issue of Gemologist, we assess India’s ability to modernise and truly emerge.

Key points

India continues to juxtapose the medieval with the hypermodern. Under the progressive influence of Prime Minister Narendra Modi, promising structural reforms are being introduced that should enable this emerging market to blossom

Administrative, legislative and supply-side reforms are taking place at a national level, but India’s federal system means that progress within states is key. Modi’s attempts to foster ‘co-operative federalism’ to spur state-driven projects are gaining traction

India’s impressive growth is largely being generated through greater investment in agriculture and national and state infrastructure. However, the nation is still constrained by weak industrial production, corporate credit, exports and freight traffic

Progressive India favours well-run, quality companies that are focused on innovation and are exposed to structural trends. Conglomerates relying on subsidies or short-term cyclical drivers may prove to be risky investments as the country emerges.

Neither minnow nor whale

A market which is still emerging, being built on solid foundations

India is no longer a minnow in the sea of global liquidity, but neither is it a whale – yet. The country’s presence is felt in Asia as a strategic counterweight to China and its voice in the G20 is starting to be heard. Although its 8.5% weight in the MSCI Emerging Market Index remains modest, this masks the significance of the many Indian companies that compete globally in reach, quality and management skill.

Although India’s emergence may appear sluggish compared to China’s, a number of factors create the potential for the kind of sustained growth that can make it a true rival to its neighbour, if only in investment terms.

India has an enviably young working-age population and a growing workforce. But unlike China, it is in no danger of getting stuck in the middle-income trap, as it lags significantly in terms of per capita income. Its low levels of urbanisation and industrialisation are potential drivers of growth, as are government initiatives to improve health and education, all of which can benefit from advancing technology.

In a commentary we wrote a year ago evaluating India’s progress under Modi, we concluded that although concrete achievements were modest at the time, the country was on the right path. We highlighted improved trends in governance, inter-state competition, infrastructure investment, rising foreign investment, an intention to level the playing field for businesses and the emergence of start-ups.

Although India has underperformed the emerging markets universe this year and corporate earnings have been disappointing, we think the foundations for a 21st century economy are being built. What follows is our assessment of the on-the-ground reality, reinforced by a recent research trip to the country, and what this means for the Indian stocks in our portfolio.

Politics and development

Progressive reform and co-operative federalism

India has grown steadily over the past 60 years, irrespective of those in power. But policies will determine the pace of that growth from here on, and whether per capita incomes can rise enough in real terms to transform the economy. Without a dynamic push to streamline the legal, fiscal and structural underpinnings of the country, foreign direct investment (FDI) will stagnate, deficits will balloon and interest rates will remain high, discouraging business growth and eroding consumers’ purchasing power. Most importantly for investors, a weak rupee would erode any gains made in the local market.

Up close, politics in India are as rough as anywhere else, but in our view the new policy framework under Modi’s Bharatiya Janata Party (BJP) is strong enough for a vigorous relaunch of economic modernisation, spurring a sustained increase in FDI, greater infrastructure investment and fiscal reform.

The opposition Indian National Congress party remains too weak at the national level to mount a real challenge to Modi’s programme. However, India’s federal system means that many states are governed by parties other than the BJP or Congress. The next major election will be held in early 2017 in Uttar Pradesh (UP), a state which is home to 221m people and is currently led by the socialist Samajwadi Party, which is riven with infighting. While the BJP is unlikely to win, a good showing would not only increase the potential for reform at the state level, but would solidify its national leadership and accelerate its momentum for the national elections in 2019.

National reforms can only paint part of the picture, as India is a union of states in which each wields its own power. Inter-state competition for investment was one of the key trends we highlighted last year, and we are encouraged to see further progress in this regard. The World Bank and India’s Department of Industrial Policy and Promotion (DIPP) announced recently that 17 states have implemented just over 50% of national business reforms – only seven had attained this same level last year – with 16 now past the 75% mark. Moreover, a 340-point business reform plan is being implemented at the state level, with ease of doing business a priority. Of course, some states are lagging and India is still ranked a lowly 130 by the World Bank for overall ease of doing business – up only one place from last year. But the recent passage of the bankruptcy law and the national goods and services tax (GST) should improve India’s position.


Interestingly, while seven of the top 10 states ranked by the World Bank are administered by the BJP, the top two are not, indicating that states are rising above political infighting to pursue a development agenda. One example is the recently opened 302km-long six-lane Agra-Lucknow expressway – which was completed in an astonishingly narrow timeframe of less than two years – in a non-BJP controlled state.


The BJP’s current broad-based reforms can be categorised as administrative, legislative and supply-side programmes:

1) Administrative
Bureaucratic reform to expedite approvals for businesses, combat corruption and improve transparency, digitise processes and enable
government delivery of online services

2) Legislative
Opening up business sectors to private investment, liberalising FDI, updating bankruptcy laws and driving through tax reforms including the nation-wide GST

3) Supply side
Investment in physical infrastructure – including roads, railways, power transmission, rural infrastructure, warehousing and ports – and a gradual reduction of subsidies

Here we delve into each of these reform areas, highlighting specific policies that should help modernise India’s economy.


The level of informality in the Indian economy is as high as 85%, and associated corruption and tax collection problems remain extreme, but measures to address this are reaping rewards. These include:„„

  • Issuing 1bn unique identity cards
  • Opening 200m online bank accounts to formalize more business transactions
  • „„Cancelling 35m fake accounts
  • Direct paying of subsidies on LPG and kerosene to beneficiaries’ accounts
  • Planned digitalising of 500,000 ration shops for food subsidies by March 2017, and
  • Demonetising 500 and 1000 rupee notes

Targeted stimulus

No-one knows for sure if India is really growing at 7.5%, although an analysis of individual factors like industrial, electricity and steel production, corporate credit, exports, real corporate sales and freight traffic all imply a considerably slower rate of growth. Offsetting these constraints is rising agricultural production, national and state pay hikes, and an increase in government spending on infrastructure, which aims to crowd-in private sector investment. The real estate and construction sectors are very weak, with as much as four years of inventory accrued in cities other than Mumbai and Chennai. But tractor manufacturers and motorcycle makers like Hero MotoCorp, and auto-parts suppliers like Motherson Sumi Systems, are starting to enjoy a recovery in demand.

Motherson Sumi Systems

Motherson Sumi Systems, a holding in our portfolio, is a leader in automobile wiring, which is well placed to benefit from the ongoing electrification of cars. Since 2008, the company has grown its European business by acquiring distressed but strategic tier-one vendors to original equipment manufacturers (OEMs) like Volkswagen, Audi and Daimler, usually at their behest in return for attractive long-term contracts.

With the turnaround of acquired companies largely complete, Motherson Sumi has expanded its global footprint by adding 17 factories recently, and it is prepared to address its €12bn order book. Since the company earns 50% of its profits from its Indian operations, road-building and a more comprehensive national 4G mobile network (and, in time, 5G) will steadily improve traffic flow, allowing more cars on the road.


Public-sector banks provide about 75% of total credit in India, but remain undercapitalised and suffer from levels of non-performing loans that may be as high as 20%. Meanwhile, capital spending has slumped as a consequence of excess industrial capacity and commercial banks’ focus on resolving legacy stress through recoveries instead of evergreening their loan portfolios. The new bankruptcy law is giving the banks powers to repossess collateral, enabling them to repair balance sheets.


Opinions differ, but most commentators expect it to be several years before public-sector banks resume lending. While the Indian government has limited funding with which to recapitalise the banks and is not keen to do so, they are unlikely to let public sector banks fail. In contrast, most private-sector banks are in better shape, as illustrated by the following stock examples.

ICICI Bank and HDFC Bank
ICICI Bank, a holding in our portfolio, has a relatively high level of non-performing loans among private-sector banks, though we believe these are peaking. The sale of Essar Oil to Rosneft should help lower its volume of stressed assets over the next few quarters, and ICICI is prioritising loan quality over quantity with an increased focus on retail borrowers, whose balance sheets are in good shape.

HDFC Bank, another holding, remains untroubled by bad loans and continues to compound earnings at 20% a year. Prudent lending, unencumbered by a requirement to finance the pet projects of local governments, accounts for the majority of the difference in credit quality between private- and public-sector banks. Meanwhile, technology is increasingly important for Indian lenders. ICICI is implementing ‘software robotics’ in more than 200 business processes, while HDFC has been a pioneer in leveraging technology to expand its franchise in the vast but nascent customer base of rural India.


Modi’s government has brought a significant, and welcome, change in the focus of federal spending, moving from benefits and subsidies to investment in long-term assets – particularly infrastructure.

In a move that is emblematic of Modi’s intent, competent ministers have been appointed to oversee a significant increase in road, rail and energy-infrastructure spending. All road transportation, highway and shipping projects have been consolidated under one minister and coal, power and renewable energy initiatives under another. This is helping to offset sluggish industrial orders and credit creation, although at some point domestic and foreign private-sector investors will need to pick up the baton. Rules limiting FDI have been relaxed; there is little evidence as yet of substantial foreign investment in real estate or defence projects, but there is keen foreign interest.

After peaking in the 2008-09 financial year, the combination of policy paralysis, complacency and implementation headaches led to a yearon-year decline in new infrastructure and private investment projects, persisting until the current administration took charge. The downward trend has since reversed and the pace of project completions is rising too (see figures 4 and 5). Nevertheless, unfavourable market conditions and the lack of private-sector interest are preventing the investment cycle from achieving its full potential, which is a common theme worldwide (and one also likely to constrain infrastructure plans in the US).

The scope of the projects being undertaken is expansive. Here we highlight key infrastructure initiatives that should benefit India’s economy in the long term:


Less than $65bn has been invested in the rail sector in the past decade. Modi’s government plans to double that figure in less than half that time to $130bn by 2020, with the first phase of high-speed rail construction due to start in March 2017. Meanwhile, a programme to privatise 400 railway stations has begun alongside a $6bn locomotive manufacturing facility being built by General Electric.


The rail investment programme’s flagship development is the Western Dedicated Freight Corridor (WDFC), which is on track for completion in 2019. As well as quadrupling available freight capacity, the WDFC should win back industrial customers who had avoided India’s previously unreliable rail transport in favour of trucks.

Container Corporation

Container Corporation (Concor), one of our holdings, is a prime beneficiary of the WDFC, setting up multi-modal logistic parks (MMLPs) along the length of the corridor to serve as hubs for customer storage, customs clearance, cargo aggregation and disaggregation, and intermodal transfers. The MMLPs will also provide value-added services such as packing, re-packing and supply-chain services, with the ability to handle specialised cargos such as liquids, automobiles and cement.

Concor is also likely to benefit from the GST, which is due to be implemented in 2017. This will eliminate the cascading duty payments of the current indirect tax regime and thereby increase the attractiveness of a third-party logistics business model. Concor customers have shown interest in scalable logistic facilities and are considering outsourcing some of their supply chain functions to the business.


Road construction in India is currently growing at 8% per year, reaching 22km per day in Q2, up from 11.9km per day in 2014-15, but still well short of the targeted 41km per day. Accompanying this progress, the number of stalled projects has dropped from 384 in the 2014 financial year to only 15 today. Contracts for 25,000km of new highways are expected to be awarded this year, with plans to connect 178,000 villages by March 2019, although it remains to be seen if this target is realistic.


The unloading of goods and connectivity remain the key problems for ports. However, overall performance is rapidly improving, accompanied by a steady rise in operating profit. Container volumes at India’s major ports rose 6.3% year-on-year in the first half of this fiscal year. Ship turnaround time at Mumbai has dropped from 2.85 days to 2.01, while average output per ship berth day was 10% higher from April to September 2016 compared to the same period last year.


Municipal investment includes improvements to water supply, sewers and local roads. Also, nine metro networks are currently being built with a total of 30 cities scheduled to have metro rail by 2025. All but three of these projects are publicly funded.


Plant-load factors, which measure capacity utilisation, are low and have scope to rise, while coal availability has improved and national transmission networks have increased the availability of power. Although there is an overall power surplus, this does not result in continuous power for all Indians and a third of rural households are yet to be connected to the grid. Under Modi, electrification has accelerated and is well on the way to linking the targeted 12,000 new villages by 2018. Across India, electricity generation is 7% higher so far this year.

Leakage from power lines has been an acute problem for India’s power grid for decades. More than 20 states have signed up to the government’s Distribution Company (Discom) Assurance Scheme, which transfers 75% of the Discom debt to the budgets of the individual states and makes them accountable for reform. The Discom Assurance Scheme is critical to improving the distribution system, which is currently leaking $15bn in electricity each year.

Only eight of these states have recorded declines in lost electricity. State-level dynamics have implications for the programme, and thus the results are mixed. But there have been some noteworthy improvements. The state of UP has reduced the gap between electricity-generation costs and sales revenue by 65% for the year ending March 2016, while Jharkhand saw commercial losses halved in Q2 2016 compared with Q2 2015. Another recently launched initiative, the Power Development Scheme, targets underground cabling, end-to end metering and IT-enabled energy accounting in order to stop future leakage. Thus progress is being made to stop energy wastage, but there is still a long way to go.

Renewable energy is another area of focus. India currently generates 42.6GW, or 14% of its total energy capacity, from clean sources. This is not bad by global standards, but by 2022 the government aims for about 220GW to be generated from renewables. India’s solar capacity was only 3.7GW as at the end of March 2015, but by 2020, 32 new solar parks in 20 states are planned, adding 20GW and increasing capacity six-fold.

Power Grid Corporation of India

We hold Power Grid Corporation of India, a company tasked with the expansion and strengthening of India’s inter-state transmission networks, in our portfolio. Its work is essential in connecting states
with power surpluses or deficits. The company has an order backlog of $20bn, which it will act on over the next four-to-five years. Interestingly, the creation of what Power Grid describes as ‘renewable energy corridors’ in north-west and south India aim to ensure that standalone projects can transmit electricity without a thermal power plant to providing baseload energy.


Despite India’s vast territory, the lack of available land for business has been a key hurdle for new investment and projects. However, having failed to convince parliament to rationalise the Central Land Laws, the national government opted to give states freedom to modify land laws at the local level with approval from the centre. Consequently, between the 2014 and 2016 financial years, the citing of land availability as a reason for stalled projects has halved from 16% to 8%.

A project to digitise national land records was launched in 2008 and was recently merged into the wider Digital India programme with a two-fold increase in budget. The use of aerial surveying, satellite imagery and drones should help to complete the project by 2021. At the same time, existing land records are being verified, linked to landowners and disclosed online. This will provide clear records of title, which should simplify disputes and expedite transactions. Similarly, processes for environmental and forest approvals have moved online, providing a barrier against corruption and enabling quicker response times.

New terminal, Mumbai Chatrapati Shivaji

Is Mumbai’s Chhatrapati Shivaji International Airport a harbinger of the quality of Indian infrastructure currently being planned and built?


Labour laws have proved to be another stubborn roadblock to new investment. Change is happening at the state level and, as competition between states increases, the ability to do business should ease. New initiatives designed to streamline paperwork and minimise red tape include the digitalisation of labour-law compliance and selfcertification for companies. Meanwhile, the government plans to reform wage and industrial relations laws, aiming to facilitate the ability of businesses to expand and contract.

Digital India

Digital India, a flagship government programme, reflects Modi’s vision of a digitally empowered society and thriving knowledge-based economy. A recent PwC Strategy1 study concluded that increasing internet access can help bring people out of poverty, and Digital India places greater broadband and mobile connectivity at the core of its vision. Global brands such as Intel, HP, Apple, Microsoft and Google are backing key initiatives, including:

  • „„The construction of broadband highways – Microsoft is bringing low-cost broadband technology to 500,000 villages while RailTel has installed 45,000km of fibre optic cables, which Google will use for connectivity
  • Universal access to mobile internet – 55,000 villages to be connected by 2018
  • Public internet access – Google has partnered with Indian Railways to roll out wi-fi across 100 railway stations
  • Digilocker – a new cloud-based platform for securely storing digital files
  • e-Governance – a unified mobile app for government services will be launched in early 2017
  • „„Electronic delivery of services – an online government marketplace for procurement
  • Electronic manufacturing

Tech Mahindra

India’s fifth largest IT services company, Tech Mahindra, offers technology solutions for healthcare, police, cyber-security and emergency response systems to governments at the state and central level. The company, a holding in our portfolio, is wellpositioned to benefit from the expansion and increased sophistication of digital enterprise and services in India. It helped the nation’s financial-market regulator to digitally transform its processes and end-user experience, and was recently selected by the state government of Jharkhand as a strategic partner to facilitate its digital journey and generate employment through skills development.

The Mumbai Metro began operating in 2014 and the network is expected to be completed in 2021.

Foreign direct investment

According to the DIPP, India received a total of $40bn in FDI this financial year. The services sector accounted for the bulk of this, with only 6% related to manufacturing. Attempts to promote manufacturing through the wide-ranging Make in India programme have achieved some success: Xiaomi, Huawei and Lenovo have all started making smartphones in India, while GM is investing $1bn in a new global auto manufacturing and export hub. Airbus is also setting up a pilot and maintenance training centre and, as previously mentioned, GE has signed a $6bn deal with Indian Railways to manufacture locomotives. While these investments do not represent huge sums, they are indicative of a positive direction of travel.


Defence is an important industry under the Make in India initiative and the sector has been opened up to full foreign ownership. The recent agreement to buy Rafale fighter jets from France will result in up to 50% of the contract value being sourced from India, while discussions are taking place with both Lockheed Martin and Saab to set up a comprehensive manufacturing facility for fighter jets, with the ultimate aim of kick-starting a domestic aircraft industry.

Bharat Forge
The automobile industry is one sector in which India already has world-class companies that are attuned to global developments. Bharat Forge, one of our holdings, is a leading manufacturer of crankshafts for trucks, amid other forged metal components, and one of the few companies in the world with the technology for titanium forging. It has successfully transitioned from manufacturing low-cost auto components to an R&D and innovation-led business providing total solutions for companies in the commercial vehicle, passenger vehicle, railways, aerospace, manufacturing and oil and gas industries. Bharat Forge is now comprehensively upgrading its manufacturing facilities in India, adopting the principles of ‘smart’ industry and the internet of things, including the deployment of sensors, automation and advanced analytics. Bharat Forge’s advanced manufacturing capabilities place it in pole position for supplying parts to India’s growing commercial vehicle, energy and defence industries.

India’s Modinisation

Modi’s long road is still the right one

Modi’s government has made a good start in its effort to underwrite sustainable long-term growth and modernise the country. Its substantive reforms, aiming to fix structural problems in its economy, contrast with the Chinese government’s recent tactic of short-term fixes to temporarily boost growth. Modi’s moves are excellent from a long-term perspective but the evidence from companies suggests that some of the reforms will continue to have an adverse impact on earnings in the near term (see figure 5). Nevertheless, they create solid foundations for longterm sustainable growth driven by higher productivity – and this is what really matters, in economies everywhere.

A new India is emerging, and the space once held by outdated conglomerates from the time of the red-tape ridden ‘license raj’ and the informal economy is being claimed by businesses willing to compete through innovation and efficiency. Investing in India during this transitionary phase is challenging, but identifying companies that will outperform on a long-term basis is key. We believe that well-managed, quality companies with robust financial structures will be able to endure short-term cycles, investing in order to benefit from India’s positive structural trends. These are the businesses which will succeed in the medium to long term, and which will reward patient investors.


  1. 1“Connecting the world,”published by PwC in 2016.

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