Stronger mandate for Modi bodes well for Indian reforms

Stronger mandate for Modi bodes well for Indian reforms

02-07-2019 | Insight

India needs jobs, infrastructure and renewed economic growth. Modi’s previous term in office resulted in several significant reforms, which are a step towards those goals. The stronger mandate he was given with last month’s elections is an opportunity for him to move further along in that direction.

  • Nimesh  Chandan
    Head Investments, Equities, at Canara Robeco
  • Abhinav  Khandelwal
    Fund Manager at Canara Robeco

Speed read

  • Political uncertainty is gone, which paves the way for further reform progress
  • Macro picture favorable, yet further reform needed to support growth
  • Strong earnings growth trajectory likely after subdued growth of the last five years

As one of the fastest-growing large economies in the world, with a market capitalization of USD 2.2 trillion, India has some undeniably favorable structural trends. For example, a median age of 25 and an expanding working-age population gives the country a strong demographic advantage compared to other emerging and developed markets. 

India is also well-positioned on the balance sheet front. The average emerging market debt-to-GDP ratio is 195%, compared with the 283% average for developed markets, based on Morgan Stanley Research data. India’s debt is at only 134% of GDP. 

India is also relatively insulated from the ongoing US-China trade friction. Its economy is quite diversified as it has a whole host of sectors that contribute to earnings within the MSCI Index.

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Source: Investec Research

Taken together, these favorable trends are supportive for equity markets. Yet government reform needs to progress further in order to support long-term growth and to bring about improvement in the business environment.

Likely near-term policy agenda and what it means for investors

It was anticipated that the ruling coalition of National Democratic Alliance, or NDA,  would emerge from the May 2019 elections with a reduced majority. Instead, it took a larger-than-expected majority, winning 353 seats out of 543, with Modi’s Bharatiya Janata Party alone gaining more than 303 seats. Prime Minister Modi will continue with an absolute majority, which gives leverage for further, much-needed reforms.  

Our view is that the immediate priority of the government is to revive economic growth and boost jobs creation. India has seen some economic slowdown during the last year, particularly in consumer expenditure. Growth is expected to pick up again in the next year. 

GDP (%YoY)

Source: CEIC, Kotak Institutional Research

One of the steps in that direction is to bolster foreign direct investment (FDI), particularly in the manufacturing area, and increase employment in that sector. FDI restrictions remain in sectors such as ecommerce, yet they have already been eased in many areas, including agriculture and construction.

Another priority is the increase in public infrastructure spending, which has stagnated since 2012. India’s infrastructure spending has fallen from 11% of GDP in 2012 to 8% in 2018, according to CEIC Data.

Recent steps to improve the ease of doing business

The Indian government has taken a number of successful steps to improve the business climate. These range from the reform of the taxation system to a new bankruptcy code and a financial inclusion program. As a result of these steps, India has jumped 23 places in the World Bank Ease of Doing Business Index, to reach a rank of 77.

The new Goods and Services Tax (GST) has completely changed the indirect tax structure and made trade smoother. As a result, India moved up in ease-of-paying-taxes rankings, which measure the amount of time and paperwork required in order to file taxes. GST has also formalized the rules of trade with the adoption of E-Way bills – documents for movement of goods that apply across the entire territory of India and enable them to move across state borders. This step has unified the country’s national market and lowered internal barriers to trade.

The new Bankruptcy Code created a clearer framework for debt recovery. It enhanced the timeliness of bankruptcy proceedings and created incentives for debt negotiation and resolution as opposed to bankruptcy and liquidation.

Finally, the Jan Dhan policy gave a boost to financial inclusion by providing a large part of the population with bank accounts that carry no minimal balance requirement. The related Aadhar policy created a database for biometric information via which citizens received a unique 12-digit ID in order to digitalize government services. With this increased availability of financial services comes a boost to economic growth, particularly from rural markets.

High earnings growth, favorable macro picture and demographics

Indian equity markets are a combination of high earnings growth, high GDP growth and positive demographics. Taken together, these factors make it an attractive destination for investors.

Indian returns have exceeded those of the MSCI EM index by 14% in 2018, the biggest outperformance since 2014 and the second best in about a decade, according to Bloomberg data. This makes India the country with one of the highest rates of earnings growth.

Corporate earnings are expected to be up 22% in 2019 and up 20% in 2020. This compares favorably to earnings growth of just 3% in 2019 and 10% in 2020 for MXAPJ. Indian equity markets have significantly outperformed other emerging markets, particularly in the period starting from 2014. They responded positively to Modi reforms and related low policy uncertainty, and macro stability.

MSCI India has outperformed MSCI Emerging Markets on a 10-year basis.

Source: Bloomberg

Portfolio positioning

Our biggest bets in the Indian market are structural growth themes that are supported by trends such as urbanization, digitalization, a rising middle class, growing financial inclusion, and increasing consumer spending. In our portfolio we give preference to Financials, IT, and Consumer Discretionary. We also like Industrials as they are expected to be supported by an increased infrastructure spending.

Source of all economic data: Bloomberg, unless otherwise noted. Nothing in here should be read as an indication or advice to invest in any specific companies

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