Even before landing in New Delhi, I got a first-hand experience of the inadequate infrastructure and bureaucratic red tape in India during a recent research trip. My flight was rerouted to Ahmedabad due to thunderstorm activity, where we sat for a few hours on the tarmac waiting for paperwork to be filled out only to find out that the plane ahead of us presumably took all the fuel. A 14-hour flight turned into a 21-hour affair. I like flying, but trust me, 21 hours in the same plane is a long time.
Will things really change under newly-elected Prime Minister Modi? Has India's era finally arrived? These were the questions that I was trying to answer as I met politicians, statisticians, government officials and company managements during the last week of May. Given the rally in equities since the beginning of the year, how much of “Modi-hype” is already priced in? I think a lot has been, which means the newly-elected Bharatiya Janata Party (BJP), or “Modi-party” (given his personal popularity and charisma), has very little room for policy errors in the initial stages. The good news is that this is fully understood.
From an investor's perspective, the BJP is talking the talk. Its take on the problems that have plagued India for more than a decade is spot on. The solutions offered by the BJP government are realistic, and its belief in the efficiencies of the market is refreshing. The expected pace of change is conforming to Indian realities. No wonder investor, both foreigners, who are easier to fool, and locals who are generally more skeptical of local politics, bought into the Modi-hope. Even Indian retail investors are slowly returning to equities after shunning the asset class for years. The mood amongst investors and corporates varies from cautionary optimism to full-blow Indian bulls. I find myself somewhere in the middle of this group – not fully giving the new government the benefit of the doubt but at the same time recognizing the immense opportunity to unlock some of India’s potential. Given the sheer size of this country (1.2 billion people and the world’s third largest economy according to the World Bank), improvements in India would provide significant investment opportunities.
Implementation risks remain high, especially since we have been here before with lofty political promises failing to get any traction. On the other hand, Modi now commands a majority in the lower house – the first majority government in three decades. Also, this overwhelming victory was based on a campaign focusing on economics (growth) and transparency (a more efficient government with less corruption). All indications suggest he is taking this mandate seriously and will use his election success to get the 29 states to pass legislation. His implicit message to state politicians should be clear: "Want to get re-elected? Improve growth. I can help with that". Bear in mind, Modi was a four-time elected Chief Minister of one of the fastest growing states, Gujurat, between 2001 and 2014. He should know how to deal with the states, which is often a major hurdle in the implementation of central government policies.
We should expect the following from Modi and his team from an economic perspective – faster privatization or commercialization of state-owned enterprises; more private sector participation on major projects; big infrastructure spend (e.g. power, roads, rail, IT); subsidy reforms; and fiscal consolidation. Also, in line with his campaign promises, expect more transparency and efficiency.
Granted, the BJP will not be able to change things overnight. Reforms take a long time to work through to the real economy but there are a number of low hanging fruits that could yield results much earlier than the expected 12-18 month period, starting by laying out a solid framework of fiscal policies in the next month or two. The announcement of a much smaller cabinet at the end of May was a good start.
Although the pick-up in economic growth is expected to be slow during the initial phases, investors are already starting to look beyond 2014 and at the longer-term potential of India. Thus, even though equity valuations might look slightly expensive from a historical perspective, Indian equities will offer meaningful value should companies start guiding earnings higher on the back of a structural uplift in growth.
Acknowledging the caveats and potential pitfalls, including social and religious issues, we think there is a fair chance that Modi will deliver enough in the first 100 days, and beyond, to keep the hope alive that India is indeed entering into a new, higher growth period.
What are the implications of this outlook on allocations in the Signature portfolios? We have been increasing our exposure to India slowly throughout 2013 and the early part of 2014, having moved from aggressively underweight to marginally underweight. We will continue to increase this weight as opportunities arise and visibility improves.