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Modi momentum: India’s reform challenge continues

Anthony Fensom  |  11 Sep 2019Text size  Decrease  Increase  |  
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Indian Prime Minister Narendra Modi’s sweeping re-election victory cheered investors and spurred hopes for further reform in the world’s fifth-largest economy.

But with growth subsequently slowing and with challenges at home and abroad, ensuring India achieves its apparent destiny will be far from easy.

Voters in the world’s most populous democracy delivered Modi’s nationalist Bharatiya Janata Party (BJP) another landslide victory in the May poll, with the BJP securing 303 of the 542 seats available in the first back-to-back majority for a single party since 1984.

Together we grow. Together we prosper. Together we will build a strong and inclusive India. India wins yet again!” Modi declared on his Twitter account.

Financial markets reacted positively to the result, with Indian stocks and its currency rallying. Yet ahead of the first 100 days in office of the second Modi government, the economic news has been less encouraging.

June quarter gross domestic product data released on 30 August came in well below market expectations, with the 5 per cent GDP rise the lowest in 25 quarters and the second straight quarter below 6 per cent. Private consumption sagged, with key sectors such as automobiles posting sales declines of more than 20 per cent.

“India's economy remains sluggish on account of a combination of factors, including weak hiring, financial distress among rural households, and tighter financing conditions due to stress among nonbank financial institutions,” Moody’s Investors Service said.

The credit-rating agency cut its projection for India’s 2019 GDP growth to 6.2 per cent from an earlier estimate of 6.8 per cent.

India’s benchmark S&P BSE Sensex index has also slipped by nearly 8 per cent from its post-election high following a proposed tax hike on wealthy investors, including foreigners, which was later dropped.

Critics have urged the government to enact further structural reforms, such as for labour, land and capital, to achieve its ambitious target of a US$5 trillion economy by fiscal 2025. High fiscal and current account deficits are also seen as vulnerabilities amid an uncertain global economic outlook.

“India has among the world's most rigid labour laws, while buying land to set up factories is onerous, expensive and time-consuming. It is no wonder that the Philippines, Vietnam and Bangladesh have gained more from factories relocating out of China,” columnist T.N. Ninan wrote in the Nikkei Asian Review.

Reform credentials

Yet other analysts point to the significant measures enacted during Modi’s first term in office as indicative of his reform credentials. These have included demonetisation, the introduction of a national identity card and implementation of a national goods and services tax.

“Frankly, when the Modi government came to power five years ago we thought it was tough to implement the GST. India is a land of many states, each with their own demands and it was difficult to obtain consensus, but Modi pushed it through and this has led to the formalisation of the economy,” said Anuja Munde, lead portfolio manager at Nikko Asset Management.

“The second key reform is the introduction of an identity card based on each individual’s biometric identity, which has been issued to more than 1 billion Indians. The government has used this to improve financial inclusion and reduce leakages in the public transfer systems,” she said.

“Social spending in India is high at over 10 per cent of GDP and this direct benefit transfer has improved the effectiveness of social schemes while reducing corruption and leakages. This will improve government finances, reducing the fiscal deficit and allow for higher spending on healthcare and infrastructure”.

Indian prime minister Narendra Modi

Key Modi reforms include demonetisation, the introduction of a national identity card and implementation of a national goods and services tax

Demonetisation, another key reform introduced by Modi, has also led to a “significant increase” in the number of income tax filers, curbing corruption and improving compliance in a nation where the “informal” sector accounts for almost 40 per cent of GDP.

The formalisation of the economy could increase gross financial savings by three times through to 2025 as Indians shift savings from physical assets such as gold into financial assets.

“As the financial market becomes larger with more diverse financial offerings, it will become easier to invest, making it easier to fund investment,” Munde said.

Asked the next priorities for Modi’s government, the analyst suggested land, labour and agricultural reforms, since “some of the rules and regulations are archaic”.

Nevertheless, Munde points to India’s positive fundamentals, including its demographic dividend from having more than half its population aged below 25 years, together with rising urbanisation (a key growth factor for China) and increasing per capita income.

Only 34 per cent of India’s population lived in urban centres as at 2018, compared to 60 per cent in China and 55 per cent globally, according to United Nations data.

Meanwhile, the International Monetary Fund sees India’s GDP expanding at an average annual rate of 7.6 per cent through to 2024, ahead of China’s 5.9 per cent and the 1.7 per cent average for advanced economies.

“India’s per capita income is at an inflection point and is expected to almost double in the next six to seven years. Higher per capita income, along with premiumisation will drive strong growth in everything from cars, to cosmetics to travel,” Munde said.

Stock ideas to seize on

India’s stock market has “shot the lights out” since June 2008, with an annualised return through to August 2019 of 12 per cent for the Solactive India Quality Select index versus 6.7 per cent for the MSCI All Country World index, according to BetaShares.

For Australian investors, Indian equities also offer a low correlation compared to global markets due to their domestic focus, while India’s traditional “price to book” valuation premium has recently narrowed compared to world equities.

Boosting the outlook, BetaShares chief economist David Bassanese has pointed to scope for further interest rate cuts by the Reserve Bank of India, thanks to inflation being contained at slightly over 3 per cent.

The exchange-traded fund manager recently launched the BetaShares India Quality ETF (ASX:IIND), which aims to provide exposure to a “diversified portfolio of high-quality Indian companies”. Another recent offering on the Australian bourse is the ETFS Reliance India Nifty 50 ETF (ASX:NDIA), which seeks to track the performance of India’s blue-chip Nifty50 index.

Can Modi put India on an “accelerated” structural reform path that offers a higher growth trajectory? After the milestones of his first term, the 68-year-old leader is now under pressure to deliver even more to satisfy heightened expectations. 

is a Morningstar contributor.

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