Making India great again

Simon Finch (pictured) is the co-manager of the Ashburton India Equity Opportunities fund.

Narendra Modi’s rise to power draws several parallels to the ascent of President Donald Trump. India’s premier is a leader who promised to chase out the political elite and engaged with dissatisfied voters through social media during his own “Make India Great Again” campaign. The question now is, can the Prime Minister deliver on his campaign promises?

The bull case for India is well established. The world’s fastest growing major economy, India’s 1.3 billion citizens are among the most entrepreneurial on the planet. At the helm of this potential powerhouse is a Prime Minister intent on driving out corruption and pushing through sector-wide reforms to improve the lives of all citizens. The underpinnings of this progressive story is a long history of a stable bureaucracy, supported by a rigorous legal framework.

Despite these indisputable positive factors, Indian equities underperformed the S&P over the past three years since Modi’s general election victory, disappointing foreign investors who rushed to invest in the immediate aftermath of that win. The savvier investors had allocated capital to India in the 2013 taper tantrum pullback, recognising the dire need for a bold new leadership to replace the listless Congress-led coalition government.

However, the reality is Modi and his party are just at the start of a ten to fifteen-year project to reset India’s growth path; ramping up the economy in the short term is not a priority. Earnings reports are beginning to show encouraging signs of improvement, and after six consecutive quarters of ratings downgrades, expectations for a reversal are gaining momentum.

Setting a reformist agenda
Modi shook up pre-conceived ideals within India’s business circles with his demonetisation move in November of last year, which led to the immediate cancellation of 86% of the country’s currency. The impact in the weeks following was devastating, especially given more than 90% of India’s monetary transactions occur in cash.

The rhetoric at the outset was another stepping stone in the government’s clampdown on corruption, with a focus on tax evasion. Following our own on-the-ground research trips in the weeks following the announcement, it is clear the measures have been well supported – even by those suffering directly; which was evident in the landslide state election wins in mid-March.

Building a digital future
Alongside targeting corruption, Modi used the demonetisation process to extol the virtues of moving to a more digital monetary framework. Digital transformation is another weapon in Modi’s armoury of fighting corruption and improving upon the income tax take of less than 3% of the population.

Since 2012, more than one billion Indians have signed up for identity controls, which has allowed for the rapid provision of 270 million bank accounts within the last two years’ expansion of financial inclusion. India is setting the foundations to collectively embrace technology, financial services, and e-commerce.

The shift to digitisation and extending bank accounts across the demographic enables smarter targeted distribution of subsidies, supported by a reduction in leakages, which have plagued the system historically.

Discretionary spending set to bounce
Since the budget, the messaging has shifted to “remonetisation” following moves from the Reserve Bank of India (RBI) to ease withdrawal limits over the coming months. However, although expectations were that most of the inflows would be swiftly reversed, in fact more than 40% has been retained in the banking system.

Indian investors have been allocating fresh capital into financial products, with domestic equities a leading beneficiary, as well as the debt markets. Anticipation is high across industries that they will see a pickup in demand as liquidity rushes back into the market. Cash, previously left idle, will also become active in the marketplace, thus we expect discretionary consumption to see a bounce in the coming months.

A further stimulus for additional spending is the implementation of the long-awaited Goods & Services Tax (GST), due to launch in July 2017. The introduction of this pan-Indian tax will drive efficiencies for business, curb inflation pressures and increase inter-state trade.

On the flipside, we can also expect small pockets of the economy to be impacted negatively as rates are raised for some goods and services.

Political stability will power investment growth
What does all this mean for growth expectations? The RBI’s February report stated it sees a strong recovery in growth in the coming year, which likely led to its decision to hold interest rates, and move from an accommodative stance to neutral.

Discretionary demand, restricted in the weeks following demonetisation, will return while sectors more reliant on cash transactions, such as retail trade, hospitality and transport should show a sharp rebound, and this has been shown in recent earnings announcements.

Prime Minister Modi’s strong showing in the recent state elections conclusively sets India up for a seven-year period of political stability – a situation unique in emerging markets, and indeed globally. Indian assets were not pricing in this outcome and we expect a positive boost to sentiment to aid both the stock market and the Indian rupee.

The Fund remains closely aligned to the government’s investment path and our overweight positions in industrials, financials, and consumer discretionary stocks, have consistently delivered outperformance. We believe India should remain a favoured emerging market investment destination for the medium to long term.

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