“India may be a land of over 100 problems, but it is also a place for a billion solutions” – Kailesh Satyarthi
Changes are afoot in India, changes that will likely raise the sustainable growth rate for the Indian economy. This week, we examine some of the likely effects of these changes and how they might eventually interact with the country’s equity markets.
The black economy…
For some time, the sheer scale of India’s ‘unofficial economy’ has been seen as a key impediment to India’s long-term growth prospects. Estimated by some to represent close to two-thirds of the total economy, the so-called ‘black economy’ generates more income by a distance than agriculture and industry together. Various efforts have been made down the years to bring these dark, untaxable, transactions into the economic light. From Aadhaar (a unique 12-digit number that creates a digital identity for more than 1 billion people, enabling individuals to be rapidly identified using biometric data) to the introduction this year of the Goods and Services Tax (GST) (replacing the patchwork of indirect taxes and duties), these efforts seem to be starting to bear fruit.
By some estimates, this current administration’s recent efforts alone have already increased the number of taxpayers by 20-25% and are thus expected to significantly increase future tax revenues. In a country where the growth prospects have long been blighted by the government’s inability to fund much needed infrastructure, this prospective revenue boost should prove very helpful.
In addition, the rationalisation of the tax regime should lead to improved productivity and lower compliance costs, as interstate supply chains will basically be treated the same as intrastate production. The government’s recent Economic Survey estimated that Indian interstate trade accounted for 54% of GDP, well below that of the US or China, though higher than Canada or Indonesia, which have more challenging geographical barriers to trade. Assuming a convergence with levels of internal trade in the US or China, the GST could provide a further boost to output growth.
Another long-standing impediment to growth has been the parlous state of the state-owned banks’ balance sheets. Bad debt ratios doubled over the last year as the Reserve Bank of India (RBI) concluded an asset quality review that forced some accounting realism onto the banks. However, recognising these losses left banks unprofitable, undercapitalised and unable to lend to the real economy. On 24 October, India’s government bowed to the inevitable and announced that it would inject 2.1 trillion rupees into its state-owned banks.
This bank bailout was cleverly structured to take advantage of the demonetisation experiment, which left the banking system flush with excess liquidity as ‘mattress cash’ was converted into deposits. In the scheme, the RBI will drain excess liquidity from the system, and the government will inject 1.35 trillion rupees into the banks as equity capital. All of this should help to unclog the credit channel, and unleash some of the pent-up investment forces.
As a result of these wide-ranging efforts to restructure and streamline the economy, India has leapt up some 30 places to 100 in the World Bank’s Ease of Doing Business report for 2018. Of the 10 areas covered by the report, India made it easier to conduct business in eight of them, with the biggest improvements being seen in the areas of resolving insolvency, getting credit and paying taxes.
So, the growth outlook is improving, but what does that mean for investors? The link between the growth of a country’s output and the corporate profits quoted on its domestic indices can be muddy as we’ve explored before. Sector composition, government interference and the influence of overseas profits are among the potentially relevant factors. However, in spite of all this, there has been a statistically substantial relationship between the economic performance of India relative to the wider emerging Asia block and relative equity market performance. With India’s long attractive growth prospects now on a more solid footing, we see Indian stocks as a good addition to our emerging markets triumvirate of China, Korea and Taiwan.