Important economic reform is underway in India, which has the potential to solve the nation’s long-term structural problems and transform its economy into a modern place to do business, says Kunjal Gala, Senior Analyst, Hermes Emerging Markets.
We have been frequent visitors to India in recent quarters, taking the pulse of both the business and political environments in what we consider to be one of the most compelling long-term investment opportunities in emerging markets. The hope and excitement following the BJP’s election victory in May 2014 has evolved into a cautious optimism given the slow pace of reform. Earlier this month we travelled to some of the country’s larger states, meeting the officials charged with implementing reforms and projects, in order to gain an on-the-ground view of the change taking place. We had plenty of questions: beyond the soaring rhetoric, was the “New India” actually being built? Are local leaders investing for growth, are train tracks being laid and is manufacturing prowess being developed, amounting to the economic transformation that Prime Minister Narendra Modi promised to his people?
After visiting companies and officials in Mumbai, Ahmedabad, Neemrana, Jaipur, Greater Noida, and Delhi, we can confirm that positive changes are happening but are not yet broadly embedded. Amid the subdued global business environment, we returned with the view that the Indian economy is on the right path, encouraged that the Modi Government is focused on solving structural problems in the economy rather than applying an immediate, cosmetic fix in order to temporarily boost growth.
The route to a reformed India
We identified several new, positive and secular trends that are emerging in the political and business spheres of India:
- Governance: the central Modi Government and several states are introducing technology to slash approval times. The Digital India initiative, launched in July to ensure that all government services are available to citizens through improved online infrastructure and connectivity, is indicative of this. Improved governance at the official level is seen as the foundation of all the reforms, and India’s progress is recognised by its 16-position rise on the World Economic Forum’s competitiveness index to rank 55th.
- Inter-state competition: in most of the states that we visited, officials were focused on the ‘ease of doing business’. This is spurring healthy competition between states across India as they seek to attract foreign businesses. For instance, states offer packages including land, connecting amenities and infrastructure to companies aiming to establish a presence in India. Improving governance among officials ensures a more level playing field.
- Infrastructure and modernisation: improving infrastructure – roads, railways, power, water supply and sewage – is another priority for states. At the national level, the Prime Minister’s office is directly monitoring several large projects, most importantly the Dedicated Freight Corridor, whose two routes will substantially increase railway capacity by linking Punjab with West Bengal and Mumbai with Delhi and should help attract private and foreign capital to certain projects. In addition, the government’s aim to create 100 ‘smart cities’, modern satellite cities or hubs of further development – like the Gujarat International Finance Tec-City, which we visited – shows the scope of Modi’s vision. The development of roads, expansion of railway capacity and power transmission were highlighted as priorities, with a lot of activity expected to take place. Land acquisition, once perceived as an insurmountable obstacle, is being navigated by states that are adopting unique methods to build these new urban developments.
- Urbanisation: infrastructure development is not happening in isolation. India is not building roads to nowhere, but is linking industrial clusters with commercial towns and the modern, ‘smart cities’ that are considered to be engines of future growth and development. A key project is the Delhi-Mumbai Industrial Corridor (DMIC), being built to attract global manufacturers and foreign companies to cities and logistics hubs along the 1,483km high-capacity freight railway between the political and business capitals of India.
- Rising foreign interest: India has emerged as the principal global destination for FDI so far this year, attracting $31bn versus the $28bn directed to China and $27bn into the US1 Foreign businesses are increasingly seeing opportunities to invest and expand their production capacity in India, notably Foxconn, General Motors, L’Oréal and Ikea, and are beginning to unlock India’s potential to become both a regional and global export hub.
- Skills: our meetings revealed the mammoth task undertaken by the government to train or retrain more than 90m people over the next seven-to-eight years across a broad spectrum of industries, in technical and non-technical vocations.
- New business v old business: officials we met with highlighted the need for Indian businesses to accelerate their adoption of technology, become more efficient and competitive to counter foreign entrants. The playing field for domestic and foreign businesses is fast becoming level. For some, the presence of foreign businesses will intensify competition; for others, it will provide important partnership opportunities.
- Start-ups: promoting start ups and micro, small and medium-sized enterprises is emerging as a key part of the government’s job-creation strategy. India has over taken Israel to become the third-largest start-up market in the world, with more than 4,000 of the businesses growing at over 40% throughout 20142 The sector attracts funding through several sources, including the India Aspiration Fund, launched by the Government of India, the India Innovation Fund, which is supported by a group of business-backed research and trade associations, and private investors, with Softbank, Warburg Pincus, Sequoia Capital and Alibaba showing interest.
These reform efforts should drive sustainable, long-term growth in India, but their impact will be limited if some of the country’s legacy issues are not resolved. These include:
- Stalled projects: recent data shows that the stock of stalled projects in the country has risen to 7.6% of GDP, many of which are likely to be economically unviable3.
- Legislative reform: the proposed goods and services tax bill remains stuck in the upper house and a means of resolution remains unclear. Its failure may jeopardise efforts to promote large-scale manufacturing. Similarly, more needs to be done to reform the country's labour laws.
- Strength of the corporate sector: the weak global environment is a drag on growth, though clearly beyond government control. Overcapacity and excessive leverage in the power, steel and property sectors are greater obstacles, but collaboration between states and the central government to facilitate debt restructuring for the state electricity boards and the infusion of equity in select road infrastructure projects has set a positive precedent. Reviving private sector interest in such projects is important, as the government cannot shoulder the country’s investment needs alone.
- Health of the consumer: consumer spending in rural areas is muted. However, rising levels of investment in infrastructure, construction, manufacturing and skills should, in time, produce an income effect that increases the ability and propensity to spend.
The destination rewards the journey
India remains one of our biggest portfolio allocations, and our belief in the country’s long-term investment potential remains firm. We are confident that the right framework for sustainable growth is being created: stronger governance, healthy inter-state competition, improving the ease of doing business and investment in skills, industry and infrastructure. More work is needed to achieve the proposed GST reform, balance growth between states and to create an effective public-private partnership model. On balance, we view that the potential rewards of investing selectively in Indian stocks outweigh the risks, and maintain our large overweight to the country through exposure to the logistics, manufacturing, software, power transmission and finance sectors.
1 fDi Markets data, reported in the story “India grabs investment league pole position”, published by the Financial Times on 29 September 2015.
2 “Indian start-ups attract $5bn funding: report”, published by The New Indian Express on 13 October 2015.
3 Centre for Monitoring the Indian Economy