What happens next?
We expect reforms to continue as the government will not likely need much external support from parties outside the alliance led by the BJP. Key initiatives include:
- Labour reform: most of the groundwork is complete and we expect the government to begin implementing the reform in the next term
- Farm sector reform: this is an Achilles heel for the Indian economy, as 60% of the population depends on the farming sector, which is not profitable and therefore drags on national income. A comprehensive farming-sector reform is expected. This would also include a focus on urbanisation, housing and e-agri markets so that surplus labour shifts from farming and the primary producers receive better value
- Institutional reform: most developed economies have strong institutions that are independent but responsible to the country for their actions. In India, several world-class institutions exist but, over time, have become detached from the reality on the ground and are not accountable for their actions. We expect several institutions to be reformed over the next few years, with the RBI and the Judiciary being prime candidates. The process of reforming the RBI is already underway, and the need for a stronger judiciary system is evident in the roughly 33m cases stuck in the system
- GST 2.0: the GST regime started in 2017 and the system is stable. However, it is not perfect and we expect GST 2.0 to be developed at some point. This would include a further rationalisation of the GST rate structure and the possibility that the GST council will retain only two rates, 12% and 18%, under which all goods and services will be taxed. This will further simplify the system. We also expect new features to be added to the GST that will improve the compliance rate, such as invoice matching
We also expect that the next five years will see an emergence of universal basic income (UBI) for the poor and vulnerable. A UBI with a limited scope was launched last year for small and marginal farmers. In addition, a universal healthcare scheme was also launched last year. We expect these programmes to grow in scope and size at some point. The government spends about $30bn each year on various subsidies and schemes already and a DBT-based UBI is likely to be a better option as it solves the problem of fund leakage.
We believe that manufacturing is also likely to receive a major boost as the economy is sound and provides a foundation for a manufacturing-led economy. We expect a number of large defence contracts to be announced in the BJP’s next term that will likely have significant transfer-of-technology conditions and a requirement for local manufacturing offset. Global defence companies have already set up joint ventures and subsidiaries in India and the initial work has begun. Defence projects have the potential to create a manufacturing ecosystem that will complement the existing automotive, software, chemical and industrial capabilities in the country.
Banking on opportunities
Modi’s victory lifts a cloud of uncertainty for the economy and the market. However, the government has a few immediate challenges to overcome. For instance, resolving the Non-Banking Financial Companies (NBFCs) funding and liquidity issues, public-sector bank consolidation, the continuation of fiscal consolidation and accelerating the pace of economic expansion despite a challenging external environment, particularly given the escalating economic war between the US and China.
A stable and a strong reform-minded government is important and it will be seen as a positive by foreign strategic investors. A number of reforms initiated over the last five years will be institutionalised as it is important for the country to not revert to the old ways of doing business.
In our view, domestic sectors are the most attractive from an investment perspective. Most public-sector banks and NBFCs are out of action, which provides well-run private banks with an opportunity to grow faster. Private banks and insurance companies demonstrate strong earnings visibility even though the economy has not completely recovered from the disruption of GST implementation and the NBFC liquidity crisis. They are experiencing credit growth of over 13% driven by retail customers and a modest recovery in industrial business. Additionally, we expect the private sector capex recovery to be a major theme over the next five years.