India Warms to Reform: Part 1 of 3

The May parliamentary elections in India resulted in a very strong mandate for the BJP, also known as the Indian People’s Party, and for newly-elected Prime Minister Narendra Modi. With 336 parliament seats won by the BJP-led coalition, this was the strongest expression of voting preference by India’s electorate since the 1984 Congress Party victory; it was, in effect, a vote for change.

With Prime Minister Modi in office, expectations are running high for an economic recovery after three years of stagnant growth.  A cyclical upswing is widely expected and already underway. The question, however, is whether the new government can create conditions for sustainable economic growth after years of sub-par performance.

Over a series of three posts, we’ll discuss six economic drivers that have the potential to accelerate economic growth in India over the next few years, and we’ll give an overview of our expectations for Indian equities.

Increased Political Efficiency
Prime Minister Modi has already appointed his cabinet team, which has been notably reduced from 70 ministers to 45, and several ministries have been consolidated to ensure efficiency. A smaller cabinet makes it easier for the prime minster to remain hands-on, one of Modi’s key strengths during his tenure as Chief Minister of the State of Gujarat. Better execution and centralized decision making will go a long way to address the perennial foot-dragging and public-sector inefficiency in India. The country badly needs strong leadership and decisive reforms.  Prime Minister Modi stands on a very solid foundation and has the experience to deliver on both.

Job Growth

We believe that Prime Minister Modi’s priorities will be to generate investment-led economic growth through reforms and to focus on creating urban jobs – a positive shift from the rural subsidy-oriented policies of the previous Congress Party government. This is a political imperative, given the young population and the rising middle class. We expect growth of urban incomes to gradually accelerate relative to rural incomes. This bodes well for urban discretionary consumption, which has stagnated over recent years. India’s GDP is predominantly consumption driven and should benefit from such a recovery.

Industrial Sector Revitalization

Industrial output growth is at a five-year low.  Stalled infrastructure developments and other investment projects caused by red tape, government inefficiencies, or flawed pricing structures are at levels last seen in the mid-1990s and currently amount to a full 8% of GDP. Most of these stalled projects are in the power sector, with others in the steel, coal, oil and gas, and roads sectors. These projects can be re-launched in a relatively short time, given that the process had already started under the previous administration.  This will make tied-up capital productive again, generate higher returns and cash flows, and provide a welcome relief to many corporate balance sheets.

Related, private investments have all but dried up over the past couple of years as private businesses have been waiting for more clarity and fewer regulatory hurdles before putting money to work. We expect a recovery in private investments now that the new government in place, but clearing bureaucratic and other regulatory hurdles would provide a further boost to capital deployment. The country badly needs better infrastructure and the investment opportunities are substantial.

In our next post, we’ll look at three other economic drivers that will guide economic progress in India, including a shift in lending, fiscal reforms, and growth of foreign direct investment. Check back later this week!

Mohammed Zaidi, portfolio manager for Principal Global Equities, contributed to this article.

Follow Principal Global Investors on LinkedIn

_________________________________________________________

The information in this article has been derived from sources believed to be accurate as of June 2014. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity.

The information in this article contains general information only on investment matters and should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The general information it contains does not take account of any investor’s investment objectives, particular needs or financial situation, nor should it be relied upon in any way as a forecast or guarantee of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice.

Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions in this article. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security.

Links contained in some blog posts may take you to third-party sites and Principal Global Investors makes no guarantees to the accuracy of the information provided.