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