"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

India, the sleeping giant awakes

India, the sleeping giant awakes

Dramatic reforms under the new Indian government are expected to re-ignite the country’s equity market and attract a flood of foreign investors

Long considered the sleeping giant, India has awakened to the drum beats of its new Prime Minister, Narendra Modi of the Bharatiya Janata Party (BJP).

Optimism over the new Modi administration has fueled the country’s equity market which is currently one of the best performing in the world. The MSCI India Index was up 23.2% in US$ for the year-to-date period ending October 3, 2014, compared to the broad MSCI Emerging Markets Index which made a loss of 0.5%.

Narendra Modi’s victory in the last general elections which concluded on May 16, the largest for any single Indian party in 30 years, is expected to put an end to policy paralysis in the world’s largest democracy, which has inhibited the country from achieving its true economic potential.

Widely favoured by the business community, Modi is expected to implement policies that will improve India’s macroeconomic framework, including a lower current account deficit, stable interest rates, and a stronger currency. It is also anticipated that he will bring greater stability to India in an environment of increased transparency and open the doors to foreign investors.

Budget sets stage

The Modi administration’s first budget, tabled on July 10, included several measures aimed at reforming the economy. Among the key measures are: (i) increased infrastructure spending; (ii) reforms to various subsidy programs to improve efficiency and to redistribute the benefits of subsidies; and (iii) revisions to the country’s fragmented tax system to make it more efficient and to generate higher tax revenues.

The budget emphasized infrastructure spending, with emphasis on rural development, including higher outlays for irrigation, housing, roads, railways and related infrastructure. It also took initial steps to fulfill Modi’s election campaign promise to create 100 new smart cities across India.

Existing subsidies were also redistributed with the overall aim of increasing the efficiency of allocation and to reduce the budget deficit over time.  The fertilizer subsidy will remain flat year over the year while the oil subsidy will decline by 25%.  On the other hand, the subsidy on food will increase by 25%, offsetting savings in oil.  The overall effect of the redistribution of subsidies is that the combined total of all subsidies is expected to remain flat while GDP continues to rise. As a result, the percentage of total subsidies to GDP will fall.

The budget also laid the groundwork to replace India’s complex tax system with a Goods and Services Tax (GST). The implementation of GST is expected to enhance the efficiency of the tax system; broaden the tax base; increase compliance by facilitating more efficient allocation of factors of production; improve competitiveness of domestic manufacturing; and support GDP growth.

Other budgetary measures focused on controlling inflation which would eventually lead to lower interest rates; the creation of manufacturing zones with tax and duty concessions; the removal of restrictions on foreign ownership of local companies, including banks and insurance companies; increased spending on healthcare and defence; and the development of low cost housing. The budget also proposed the implementation of a National Energy Policy, including the attainment of energy efficiency through renewable projects.

Modi has also taken steps to give banks more freedom to expand credit to the non-government sector and market India as an investment destination.

In the US last week, the business-friendly Modi walked away with promises of agreements on trade, investment and technology. Members of the US-India Business Council also committed to invest over $41 billion in India over three years to help raise the country’s manufacturing capabilities.

Can Narendra Modi maintain his track record?

Modi has a proven track record as Chief Minister for the State of Gujarat which he hopes to bring to the national scene.

Gujarat’s GDP grew at an annualized rate of 10.1% from 2001 to 2012 under Modi, balanced across the agriculture, manufacturing and services sectors. Comprising of 5% of India’s population, Gujarat contributed 7% of India’s GDP, with its manufacturing sector accounting for more than 13% of national output. Gujarat is also recognized as the most urbanized state in India with 43% of its population living in urban areas versus the national urbanization rate of 31%. And in a country which has power supply constraints, Gujarat is one of the few states with surplus electricity.

Demographic dividend on India’s side

As the world’s largest democracy with a population of 1.2 billion and a median age of 27 years, India has youth on its side. Its growing middle class, which is larger than the entire US population, is expected to fuel consumption of discretionary and non-discretionary goods and services, supporting the growth of Indian companies and the economy which is forecasted grow at an average rate of 5.4% over the next three years.

U.S.-based Morgan Stanley & Co. has predicted that India’s gross domestic product (GDP) will rise to US$6 trillion by 2020 from this year’s estimate of US$1.9 trillion, with the acceleration coming from a potent mix of demographic trends, increasing globalization and widespread economic reforms advocated by Modi.

Challenges ahead

Modi’s task will be challenging. While India has the potential for dynamic change and explosive growth it is still mired in old-style economics and crony capitalism. Modi also has to find a way to repair India’s image, damaged by charges of corruption and poor economic management.

 

Dwarka Lakhan

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.


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3 comments

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  1. Avi
    Avi 20 October, 2014, 15:40

    For a plan as ambitious, he’ll need at least 2 terms I think.

    Reply this comment
  2. Deepam Jaylaal
    Deepam Jaylaal 24 November, 2014, 19:39

    Modi has great political capital, and there are incredible expectations for him. The people have projected their hopes and aspirations onto him, myself included.

    Reply this comment
  3. Anil Kappor
    Anil Kappor 24 November, 2014, 19:41

    The big challenge is for India to get its growth mojo back. The time has arrived.

    Reply this comment

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