Can investors in India capitalise on economic reform?

India’s stock market rose by more than 11% during the first half of the year¹, buoyed by the landslide election victory² achieved by Narendra Modi’s Bharatiya Janata Party (BJP) in May. Many analysts argue that the prime minister has a mandate to reinvigorate his modernisation agenda – creating further opportunities for investors.

Priyanka Kishore, Head of India and South East Asia Economics at the think tank economic consultancy Oxford Economics, warns significant further progress may be challenging, given that Mr Modi’s most ambitious reforms will be difficult to get through the Upper House of Parliament, where the BJP lacks a majority. Nevertheless, she expects to see more change. “We think Mr Modi will focus on reviving short-term growth and addressing concerns about jobs, while following less contentious plans to address supply-side bottlenecks,” she says.

The potential now, given the BJP’s larger majority, is to press ahead with reforms that boost the private sector – the power sector, for example, would benefit from rural electrification, while labour market liberalisation would improve the competitiveness of Indian exporters. Investors in such businesses have good reason to be optimistic.

That’s an exciting development in a country that also boasts remarkable demographic potential. The World Economic Forum predicts that by 2030, 80% of households in India will be middle income, up from 50% today³. In a country with a population of close to 1.4 billion, including 665 million 25-to-64-year-olds and 625 million under-25s, that’s a market of astonishing size⁴.

“Investors are rightly excited about the long-term potential of an economy that has access to a huge population of young workers and a market of middle-class consumers growing very rapidly, says Narayan Shroff, Investment Director at Barclays Private Bank.

“The economy is still in a transit mode in adjusting to these big reforms, that include fiscal prudence (including subsidies), formalisation and financialisation of the economy, tax reforms, digitisation and financial inclusion of rural economy, focus on startups and MSMEs, banking system clean up, new debt resolution processes and real estate sector regulations,” Shroff adds. “If the near term (mostly cyclical) challenges, including credit and consumption slowdown and delayed pick up in private investments, are handled well, the opportunities for investors will be attractive and wide-ranging.”

Potential for economic growth

At a macro level, the economic prospects for India are encouraging. The World Bank predicts India’s economy will grow by 7.5% over the 2019-20 fiscal year, which would represent a bounce back from the 5.8% annualised rate of growth seen during the first quarter of the year⁵.

It expects consumer spending in particular to benefit from relaxed monetary policy; with inflation currently below the Reserve Bank of India’s target, the central bank has been able to reduce interest rates three times in 2019 to support the economy⁶.

Meanwhile, the Government’s micro reforms are already boosting the private sector. Modi's efforts to cut through red tape have already helped move India to the 77th spot in the World Bank’s 2019 Doing Business ranking, upon its previous 134th place⁷.

The prime minister’s priorities, Oxford Economics’ Priyanka Kishore anticipates, will include measures to increase the productivity of the agriculture sector, support for small and medium-sized enterprises, further spending on infrastructure and liberalisation of regulation on foreign investment in India.

Opportunities for investors

Modi’s campaign pledges included a commitment to spend $1.44 trillion upgrading the nation’s roads, railways and other critical networks⁸. But the prime minister is also looking to increase private sector businesses’ investment in infrastructure significantly.

The Indian Government’s analysis is that infrastructure spending needs to reach $4.5 trillion by 2040, of which it is looking for $526bn from the private sector; in return it is offering new investment vehicles and financing models, striving to streamline regulatory clarity and investigating how to reduce execution risk⁹. Already, leading companies in India’s construction and transport sectors have seen their share prices lifted by the BJP’s victory.

It’s important to note that Modi is not only focused on physical infrastructure; digital networks are an important priority too. By some assessments, the right level of investment in digital technology has the potential to add $1 trillion of economic value in India, to the benefit of companies in the digital sector, as well as to the broader economy¹⁰.

Matt Clifford, co-founder of UK-based accelerator Entrepreneur First, which recently started operating in India, suggests India today has the biggest pool of technical talent anywhere in the world: ”The start-up eco-system is only just getting going, but the rhetoric is now changing,” Clifford says. “Where established career paths with large companies offered the prestige, the very public and positive support for entrepreneurialism from politicians and other opinion formers really matters.”

“The Digital India story is compelling,” argues Shroff. “Some businesses are focused on providing the building blocks of innovation, while others are capitalising on this infrastructure; both groups include companies ranging from start-ups to India’s established technology leaders.”

As well as new industries, the prime minister hopes growth will also come from more traditional sources. In particular, Modi’s Make in India campaign to boost manufacturing, first launched in 2014, is to be rebooted, encouraging overseas businesses to partner with domestic companies.

For investors, this is an alluring opportunity, with potential to back both foreign companies and domestic enterprise. Britain alone now has more than 400 companies with operations in India’s manufacturing sector; in the chemicals industry, for example, British investment in India in recent years has totalled $12bn¹¹.

Indian manufacturers are in increasingly buoyant mood. May saw the fastest growth in the industry so far this year, data shows¹². And new Government support for collaborations between domestic and overseas businesses can help accelerate this trend.

“We have a great ambition to grow manufacturing from 17% of GDP to 20% or 22%,” says Ajit Ranade, President and Chief Economist of the Aditya Birla Group, a manufacturing conglomerate based in Mumbai. “It’s not going to be easy but that’s the way it’s going forward.”

The renewable energy sector is another potential area of opportunity, given Modi’s ambition for India to reach 225 gigawatts of clean energy generation by 2022, which would more than treble its current capacity¹³.

Already, India ranks as the world’s second-best emerging market in BloombergNEF’s annual study of renewable energy leaders¹⁴.

Then there is the financial services sector, where Modi’s government made significant investments during its first term in order to tackle financial exclusion through innovation. The Government says it has created 1.2 billion biometric identities for Indians over the past few years, as well as opening 330 million new bank accounts, opening up the financial system to Indians who previously could not access it¹⁵.

Already, some of India’s new breed of Fintech players are generating accelerated returns. India Fintech unicorn businesses worth more than $1bn include the likes of Policy Bazaar and Paytm Mall.

Varun Dua, Chief Executive of India’s first start-up online insurance company Acko, says policymakers are playing an important part in this growth. “A few years ago, a company like ours wouldn’t even have got a licence, but regulators are opening their minds to the idea that new people, capital and products need to enter the sector.”

Risks to consider

The strong case for investing in India is not to suggest that doing so is risk-free – far from it, even leaving aside the question of whether Modi can deliver his promises of reform. One concern is that the stock market’s recent strong run leaves it over-valued.

Standing at almost 29, the price to trailing earnings ratio on India’s widely-followed Nifty 50 Index, was in June higher than at any time in the past five years¹⁶, though it’s interesting to note that mid-cap and small-cap valuations have eased back from highs seen previously in the year and may therefore offer better value¹⁷.

India is also vulnerable to shifts in global commodify prices. Oil is its biggest single import, accounting for $75bn of expenditure annually – as 85 per cent of the country’s oil needs is imported – which leaves its economy exposed to a rising oil price¹⁸. The country’s own commodity production provides some mitigation, particularly if the Government hits its target of increasing production of minerals by 200 per cent over the next seven years¹⁹, but an upwards trend in the price of oil would nonetheless cause real problems.

Another issue to consider is India’s need to manage its currency volatility. The rupee has gained considerable ground in recent months, outperforming other Asian currencies by some margin²⁰. India’s central bank may be forced to intervene if higher foreign inflows of money continue to push the value of the rupee upwards, jeopardising the competitiveness of Indian exporters.

Nevertheless, Chief Market Strategist at Barclays Private Bank Gerald Moser insists that the medium to long-term opportunity is compelling for investors prepared to accept shorter-term volatility. “No matter which sector you study, the opportunities for investors in India are now intriguing, given the combination of sound fundamentals and political promise,” he says. “If Modi can press home his electoral advantage during his second term and pull off the reforms he has promised, there is every reason to be excited.”

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