Stuart Parks, Invesco Perpetual’s head of Asian Equities, on his optimism for the Indian growth story
On a recent visit to India, Stuart Parks found many reasons to be optimistic about the impact of Modi’s reform agenda and the outlook for Indian corporate profitability.
My impression on visiting India is that Prime Minister Narendra Modi’s reform agenda is taking shape. Last year, we saw excessive optimism over reforms leading to stretched valuations for Indian equities. This year, the market has drifted as expectations about reforms have become more realistic. My view is that Modi has not been slow in implementing change in India, but rather the task he faces is massive.
Modi is addressing this by putting in place ‘building blocks’ for higher growth one by one. Examples of these blocks are a more efficient tax system, an adequate road network, sufficient access to power, an effective land acquisition process and, critically, a recapitalised banking system. The actions of Modi’s government have led me to be optimistic that some companies’ earnings may surprise on the upside in the next few years.
A significant step is the introduction of a national goods and services tax (GST). India’s indirect tax structure is plagued with multiple layers of taxes levied by governments and local authorities. Companies’ logistic networks are heavily influenced by the tax system, with many companies having subscale distribution centres in a number of Indian states just to reduce their tax bill. With a national GST, there will no longer be any benefit to having inefficient operations and trucks will not be delayed by being checked and taxed each time they cross a state line.
The bill has been passed by the lower house and is expected to be passed by the upper house, after which 50% of the state assemblies will need to agree to put it in place. Since it increases state revenues, it is likely that agreement will be obtained and this could happen as early as April 2016. The managing director of a personal care company claimed “Other things being equal, the implementation of GST will add 2% to the GDP growth rate. This will benefit manufacturing and exports”1.
He also claimed that “This will bring the fast moving consumer goods recovery back on track”. We hesitate in estimating how much this tax will add to India’s GDP growth, but we believe it will have a positive effect within three to four years. The obvious beneficiaries, in our view, are auto manufacturers and consumer companies, many of whom are transporting goods across many different states.
Another area where Modi has certainly delivered successfully has been road building. The central government has allocated Rs850bn for the construction of national highways this year versus Rs300bn last year. In terms of kilometres (km), the National Highway Authority of India (NHAI) aims to award 5,600 km of road construction this year and another 6,000 km in 20172. While more national highways will have a significant effect on incremental growth, rural road building is also important.
The share of rural population living in villages connected by all-weather roads is now at 88%, up from 76% just four years ago3. Interestingly, studies show that a road connecting a village impacts productivity within a three- to four- year period. Better road connectivity in India should reduce transport costs, dampen food price inflation and boost rural productivity and consumption. All of these, I believe, will help lift the sustainable growth rate of the economy.
A major block to economic growth in India has always been the shortage of power. This is partly due to insufficient coal supply and inadequate transport links. The Coal Mines (amendment) Bill in March was a striking reform step to address this issue. It allows coal blocks to be auctioned off to the private sector which should increase coal supply.
Furthermore, the government is now aiming to double the production of Coal India Limited to 1 billion tons by 2020, which demonstrates its ambition to address the lack of coal supply.
Modi is successfully encouraging the ministries for coal and rail to work more closely to improve transportation too. In recent months, joint ventures have formed between ‘cash strapped’ Indian Railways and ‘cash rich’ Coal India Limited. Also, the insolvent state-owned generators may be positively impacted by a recently introduced Strategic Debt Restructuring Scheme.
This scheme is forcing companies that default on their debts to swap equity for debt with the banks, or sell assets. While this may reduce the level of debt of the state-owned generators eventually, few assets have changed hands to date as insolvent assets are unattractive.