There is the widely held opinion that India grows in spite of its politics and not because of it, says David Cornell, Ocean Dial Asset Management’s CIO for the India Capital Growth Fund.
Over the past 50 years, the country has experienced strong successes despite battling with structural inefficiencies and corruption. Recent years have been characterised by a slowdown in growth, but we are optimistic about the future of the Indian economy and its capacity to recover.
Within developing democracies, coming to a decision can be a slow process. In India, consider the complexity that the diversity of each State brings. Passing from one to another, you will not only be greeted with a new (often more than one) language, but a different landscape, cuisine, religion, set of values.
Consequentially, regional parliaments are representing incredibly diverse groups of people and as such, development can be slow.
Steps taken
It is clear that economic problems cannot be painted away with one stroke of a brush and Modi’s government has already taken steps to tackle this issue of inefficient centralisation.
Now, a higher percentage of government revenues and greater decision-making powers have been delegated to State parliaments to help improve the process.
While this will certainly help to improve the country’s efficiency, it is important to remember that, even before this, India was, and still is, a ‘high frequency’ economy.
Over the past 15 years, the BSE Sensex Index has compounded at a rate of 9.3% in US Dollar terms, outshining other emerging markets such as China, which compounded at 6.3% over the same period.
Although there is no doubt that the Chinese economy has seen impressive growth, it has done so in a pro-growth, pro-business environment, bolstered by the successful implementation of government reforms.
In spite of government
India, in contrast, has achieved this against a backdrop of volatility and uncertainty. China has thrived because of the government, India has done so in spite of it.
However, we have seen encouraging moves in Modi’s first and second terms as he launched a pro-business reform agenda. Demonetisation, the Insolvency & Bankruptcy Code, and the Goods & Services Tax have helped to tackle corruption and improve complex as well as inefficient systems.
While implementation has brought with it short-term setbacks, we are starting to see these roll into long-term structural improvements.
Crucial to India’s continued development will be the presence of Foreign Direct Investment, and the Corporate Tax Rate cut in September 2019 demonstrates Modi’s intent to attract this.
The biggest tax reform that this generation has seen brings India’s tax rates in line with its Emerging Markets peers. Further to this, a simplification in labour laws, reducing the existing 44 to just four, makes India a significantly more attractive destination for FDIs.
Whilst we these reforms bed in, we are already seeing encouraging moves in the World Bank’s Ease of Doing Business rankings where India has leapt from 141st in 2014 to 63rd today.
As Modi offers corporate India the necessary framework to flourish, it is equally important to remember that, in India, earnings power is not driven by politics.
In my 6 February analysis for NRI Adviser, I looked at how the country is benefitting from a reverse brain drain, welcoming an influx of entrepreneurial and business-focused talent.
With an already high management bench strength, this migration is helping to further strengthen corporate governance and best practice. Companies are aware of the significant impact that this can have on their share price performance and reacting accordingly.
With this in mind, in India a preoccupation with the macro can easily lead to overreaction, and in turn cause investors to miss out on exciting opportunities. Against the current backdrop of market volatility and divergence investors have sought safety in a small handful of large cap companies. For bottom-up stock pickers such as ourselves, this is opening up mispriced opportunities.
Our focus is on identifying companies with high quality management and strong balance sheets that offer long-term growth potential. As India cultivates an increasingly business-friendly environment, and as management teams become more aware than ever of the importance of sound corporate governance, we are seeing a huge amount of potential at rock bottom valuations.
Well positioned macro scenario
The foundations are there, and despite the recent slowdown and nervousness surrounding the market, India’s macro environment is well positioned to support a pick-up in growth. Inflation remains low and stable, forex reserves are at an all-time high, interest rates have come down. There are inevitably elements of the economy that still need to be addressed but as investor confidence grows, a recovery can happen very quickly.
While there is no clear time horizon here, we would encourage investors to gain exposure early to avoid missing out on the growth potential. Equally important is selecting a manager that will maximise on the opportunities available. An active approach is essential in identifying value in the market, particularly in the small and mid-cap space where we see maximum upside potential.
However, while these approaches will position you well to maximise returns, the greatest mistake would be to take no exposure at all. Since India gained independence in 1947, long-term investors have enjoyed significant periods of strong returns irrespective of the political situation, and will continue to do so.
By David Cornell, CIO, India Capital Growth Fund, Ocean Dial Asset Management
