Modi is also awarding more funding to the ‘higher growth’ states in an attempt to encourage local governments to recapitalise the heavily leveraged state-owned electricity distribution companies. While these measures to reduce debt, lessens the risk of power shortages, the coal auctions present a significant change but we are expecting some improvement in power availability over the next few years.
A critical step in Modi’s reform agenda is the recapitalisation of India’s state banks. Modi may have hoped that the Indian stock market recovery would allow them to raise capital and increase lending. Since this has not happened, the government is injecting $3bn (€2.7bn) into the state banks in 2016, and a further $6bn (€5.4bn) in 2017. However, the banks will also need to issue equity to support a higher level of loan growth. A solution could be to ring fence non-performing loans, but the government as yet has not made any steps in this direction.
A much talked about step in Modi’s agenda is the Land Acquisition Bill (2015). Land purchasing by the private sector is a protracted process due to a legal requirement that 70-80% of the landowners agree to the sale. This bill will dilute this provision but faces resistance in the upper house. As Modi’s government would hold a majority in a combined session of the upper and lower houses, such a session can be organised, so it is likely that the bill will pass.
Since land acquisition for public use and many other activities are exempt from this provision, we believe that GST reform, the road programme and the recapitalisation of the banks are more significant for growth.
Finally, a number of Indian companies we met have mentioned that the government is approving projects quickly and the local bureaucratic form filling processes are more efficient. Interestingly, the environmental minister claimed last March that there was no backlog of environmental clearances for projects to be approved. Also, many states are now utilising a clause in the constitution that allows them to have different labour laws than those mandated by the central government, if the central government permits it. Some states have already tweaked their laws, making them more business friendly in terms of easier hiring/ firing.
How are our portfolios positioned to potentially benefit from incremental economic growth?
We expect that real GDP growth in India will gradually trend towards 6%, from the trough of 4.5%. There are signs that India’s capex may finally be turning around, with government spending being a key contributor. Before my visit, I was concerned about the downgrades we have seen on earnings this year, but I came back from my visit very much relieved. I am cautiously optimistic about the companies we are already invested in, and have found others we may consider, depending on their valuation multiples.
We expect that the consumer staples companies should benefit from higher economic growth and reforms such as a common tax. A good example is a large personal care company whose earnings are driven by the increasing demand for personal care products which is underpinned by the rising affluence of the growing middle class.
Similarly, we believe some of the satellite TV and broadcasting companies within our portfolios are also well positioned to benefit from an economic revival. Companies may be willing to spend on advertising, while consumers with higher disposable income may also be willing to pay for subscription channels. This combined with the increasing wealth of the middle class and young demographics provide, in my view, a positive outlook for these companies.
Finally, we are positive about our portfolios’ banking exposure. Since state banks are hampered by stretched balance sheets, private banking exposure is where we look for opportunities as faster economic growth should improve the outlook for their loan books. Importantly, these banks can gain additional growth by taking market share from the undercapitalised and constrained state banks.
I expect the Indian reforms will have a marked effect on growth in India within the next two to three years. I was impressed with the company management I met during my visit, and although the infrastructure is still weak, any small improvement should be influential in stimulating growth. In addition, the country’s cheap labour costs, low consumer debt-to-GDP levels, its edge in the IT industry and favourable demographics should continue to play a positive role.
The CNX Nifty Index, representing the largest 50 listed Indian companies, is currently trading on a 12-month forward price/ earnings ratio of around 18 times, just above its historical average over the last 10 years, and is forecast to deliver 16% and 20% earnings growth on consensus figures for FY2016 and FY20174. We believe there are attractive opportunities to invest in companies which should benefit from a higher sustainable economic growth rate. India can have a leap in growth, if Modi continues to do the ‘the right thing’.
1Times of India, “GST rollout to boost GDP growth by 2%: Godrej”, 17 February 2015.
2India Infrastructure: Road Sector, Credit Suisse, 20 May 2015.
3Indian Market Strategy, Credit Suisse, 19 June 2015.
4IBES, Thomson Reuters, 22 July 2015.