Having won a decisive victory at the Indian election in May, Narendra Modi’s Bharatiya Janata Party will use its majority to press ahead with policies to drive economic growth, argues Aaron Armstrong.
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It was the biggest democratic exercise in history. Around 600 million people participated in the Indian election, which culminated in a decisive victory for the incumbent Bharatiya Janata Party (BJP) in May. The result handed BJP leader Narendra Modi a strong mandate for his second term as prime minister of the world’s most populous democracy.
So what can we expect from Modi’s administration over the next five years? His record in office is mixed. During his first term, he implemented much-needed economic reforms such as the Goods and Services Tax (GST), which streamlined India’s labyrinthine system of state levies and freed up the movement of people and capital.
Other measures, such as the ‘demonetisation’ drive, designed to cut off the black market and bring the rural poor into the formal financial system, caused much short-term disruption but may pay off over the longer term. And there are lingering concerns over Modi’s divisive brand of Hindu nationalism and bilateral relations with Pakistan, following India’s tense stand-off with its neighbour earlier this year.
The enthusiastic market reaction to the election result (see chart) suggests investors are optimistic Modi will use his increased majority to bring in policies to spur growth and attract foreign capital. In this Q&A, Aaron Armstrong, emerging market equities fund manager at Aviva Investors, explores the implications of Modi’s win.
How do you view India’s election in the context of the wider EM election cycle this year?
In the context of the elections across the emerging world, India really does stand out a mile. In Indonesia, President Joko Widodo has won a second term and we can expect some further progress on reform, if perhaps nothing transformational. But the Indian election was truly a once-in-a-generation event. Narendra Modi is making tangible progress on economic reforms and bringing in ground-breaking legislation to empower a country of over a billion people – it’s a story unmatched anywhere else in emerging markets.
Was the scale of the BJP victory unexpected?
Early in 2019, the Indian market experienced outflows from foreign investors amid concerns about whether this government would survive. Many analysts thought it would likely only remain in power with the help of coalition partners that would potentially have compromised the policy agenda. But in the event the BJP won 303 seats on its own and the leading opposition party, the Indian National Congress, which ruled the country for most of the post-Independence era, only won 52 seats. This represents a truly landslide victory and sets the stage for further reforms during Modi’s second term.
Modi and the BJP were accused of running a hugely divisive campaign and exploiting geopolitical tensions with Pakistan. Did this play a role in its election win?
Modi benefited from the stand-off with Pakistan, which accentuated his ‘strongman’ image, and the tensions coincided with an increase in his popularity. But I don’t think this government has a particular agenda in terms of being hostile towards its neighbours.
As was the case in 2014, Modi ran a somewhat divisive campaign. While many commentators have highlighted the Hindu nationalist tone of parts of his rhetoric, Modi did make efforts to appeal to minority and disadvantaged groups with the promise of inclusive economic development. Given the magnitude of Modi’s victory, these promises of job creation and rising income standards were clearly sufficient to engage voters from all backgrounds and secure their support at the polls.
What will be top of Modi’s to-do list for his second term?
The first priority has to be generating employment. India has one million new workers joining the workforce every month; that means it must create 12 million jobs every year just to make sure the unemployment level stands still. Over the last five years the government has been largely unsuccessful in this. Going forward, it its likely to go back to basics and focus its reforms on the underlying basic factors of production in the economy: labour and land.
Land is one of the most difficult commodities to acquire effectively in India, so a new land acquisition law is necessary. This would make it easier for companies to buy land from farmers and local governments, enabling new infrastructure projects and more foreign direct investment. Second, Modi is likely to try making hiring and firing easier, including a focus on bringing down the costs of taking on new workers. That could have a transformational impact on employment, particularly in labour-intensive industries such as low-end manufacturing.
Modi has come under criticism for replacing the governor of the Reserve Bank of India (RBI), casting doubt on its independence. How might central bank policy shift under the new administration?
Modi’s replacement of RBI governor Urjit Patel can be seen as an interventionist move as the new governor, Shaktikanta Das, is more politically aligned with the government. Under Patel, the bank was focused on hitting inflation targets, whereas Das is likely to be more interested in bringing about a balance between inflation and growth. On June 6, the RBI cut the benchmark interest rate by 25 basis points to 5.75 per cent, its lowest level since 2010.
Das will also have to look at recapitalising certain public sector banks. State-owned banks have dominated the system since the 1970s, when India nationalised its banks. Unfortunately, many of these institutions have been improperly run and have problems with credit quality, non-performing assets and inefficient cost structures. This means they are chronically undercapitalised and don’t have enough capital to lend out to fund the kind of growth rates of eight or nine per cent of GDP Modi wants to see. The RBI is also likely to look at moves to regulate the shadow banking system more closely to reduce the level of systemic risk across India’s financial sector.
Where do you see opportunities in India?
We’re looking at stock-picking opportunities in three key areas over the medium to long term: infrastructure, financials and consumer discretionary. India is likely to undertake a huge level of infrastructure investment over the next five years, and companies in the construction sector could benefit.
Second, we see attractive cyclical opportunities within financials. Private sector banks are now focused on gathering low-cost deposits and deploying them, so we are likely to see faster loan growth especially on the retail side. Third is the consumer story: when you have rising income per capita, particularly as India crosses the threshold of $2,000 per capita – which has been an inflection point for consumption in other countries – and movement from rural areas into towns and cities, that kind of discretionary consumption in the household budget comes more into the picture.
How are Indian companies taking advantage of the rise in consumer spending?
Indian retail is primed for a period of dynamism and disruption. Retail is currently dominated by ‘unorganised’ retail – such as market stalls – which account for around 90 per cent of the industry. This means there is an opportunity for organised retailers to grow rapidly, particularly in the fashion sector, where economies of scale, range of stock and returns infrastructure are particularly important. A number of smaller retailers are coming to the equity market with plans for growth: we’re currently speaking to a company with less than 200 stores that could scale up to 2,000 outlets in the long term, such is the size of the addressable market in the county. It’s rare to see a market with such a wealth of well-run companies with such scope for growth.
Where are the key risks for equity investors in India?
India has a fairly high incidence of companies that perform poorly on environmental, social and governance (ESG) metrics, which can manifest itself in poor share price performance. On a medium- to long-term horizon, we would encourage investors to position themselves in the best-governed companies with good ESG practices and to avoid companies with poor corporate governance behaviour.