The Indian election may have led to a surprising result, but ‘competitive capitalism’ is already well ingrained in the system.
Is the India growth story going to be derailed? This is the question occupying investors following the shock general election result. The BJP and its allies captured 293 Lok Sabha seats, well short of Narendra Modi’s predictions of 400 plus.
Despite the BJP losing its parliamentary majority for the first time since 2014, the short answer to our question is no. India is rising and remains the best structurally-driven multi-year growth story in Asia, with three reasons behind this.
Firstly, this is more than a cyclical upswing. Mr Modi’s far-reaching reforms have permanently changed the game, how India does business and competes internationally. Centralised control is out, competitive federalism and capitalism in. The state has transformed from growth driver to growth enabler, creating incentives to crowd in private investment.
The reforms, starting in 2016, responded to the bust of the last credit-fuelled investment super cycle, which led to the bad debt crisis embracing public banks and private corporates. The Insolvency and Bankruptcy Code in particular, forced corporate India to restructure, consolidate and unwind excess capacity.
The introduction of goods and services tax (GST ) on July 1 2017 and the September 2019 corporate tax reform, slashing the rate from 30 to 22 per cent, in line with regional peers, were critical. In 2019 and 2020, parliament passed four codes consolidating 44 existing labour laws.
From March 2020, the Production Linked Incentive scheme encouraged foreign and domestic investors buying into 14 critical industries, including advanced manufacturing, electronic vehicles, renewables and high tech. Digitalisation has been adopted enthusiastically and effectively, transforming tax returns and business licensing. Establishment of web-based one stop shops for permits and project approvals has reduced red tape and corruption.
A decade of steady structural reforms, along with the government’s huge public infrastructure investment drive, has reshaped the business landscape. India’s World Bank Ease of Doing Business score has improved dramatically, overall (71.1) and across key metrics (Figure 1), well above the east Asia and Pacific average (63.3)
Underleveraged corporates
Secondly, bank and corporate balance sheets are in rude health, strongly positioned for growth (Figure 2). Bank non-performing loans are at an 11-year low, capital adequacy ratios well above Reserve Bank of India (RBI) regulatory requirements, NPL provisioning ratios at 75 per cent and profitability strong.
Banks can and are lending. Borrowers are able to take on debt. Corporates and households are underleveraged. The corporate sector has fully recovered from the debt crisis, with balance sheets repaired, profitability restored and the corporate profit cycle in upswing. Cash flow, free cash flow and retained earnings are above the pre-pandemic seven-year average.
Key industrial sectors – cement, airlines, steel and telecom – have consolidated. Large firms continued to pay down rather than pile on debt through the pandemic, when the RBI introduced emergency credit facilities. Despite rising policy interest rates, cost of capital remains appropriately priced to support lending and investment.
Thirdly, the much-delayed investment upcycle is now firmly entrenched, with corporates and mortgage borrowers increasingly taking over the lead from government. Figure 3 shows the investment to GDP ratio rising, and proportion of fiscal resources directed towards building roads, railways and ports – also rising sharply.
Trains, boats and planes
There are 48 per cent more kilometres of national highway today than in 2015. Over the same period, cargo traffic at major ports has increased 24 per cent and kilometres of electrified rail route 127 per cent. Numbers of airports have doubled, while aircraft movement measured in million tonnes is up 56 per cent.
Investors are understandably worried about land reforms being placed permanently on the backburner, and about fiscal slippage. Election results highlighted cohorts of disgruntled farmers, rural voters and unemployed youth. Rising income inequality and pace of job creation – with unemployment for the 15-29 age group running at more than double the national average – were two contributory factors to the BJP’s poor ballot box performance.
But failure to reform land acquisition laws will not derail India’s economic story. The most critical structural impediments to growth have already been addressed. There should be a new focus on delivering more equitable growth, with cyclical buoyancy of tax revenues allowing government to increase spending, without compromising fiscal responsibility.
Pertinently for investors, the government’s pro-business, pro-growth policy stance as a primary means of delivering jobs and prosperity is unlikely to change, even with the BJP alliance’s reduced parliamentary majority. India has left behind the days of unfunded fiscal spending to drive growth. Neither federal nor state governments can afford this. Crucially, the mindset has changed.
Investors should stay overweight India, for she is rising. Any dips in the stock and bond markets will provide opportunities to increase exposure.
Sharmila Whelan, global macro strategist, Westbourne Research Services
