A SERIES of important micro-economic reforms in recent years explains the success of the Indian economy, says mmerging markets fund manager Paul Wimborne.
The introduction of a national biometric identification system — the largest of its kind in the world — and the reformation of state-based taxation systems into a single national goods and services tax are paying dividends for both businesses and households.
“These are the kind of reforms you want to look for as an emerging markets investor,” says Wimborne, who co-manages Pendal Global Emerging Markets Opportunities Fund with James Syme.
“These are positive reforms that generate stronger structural growth. India has a very positive story going forward.”
India’s biometric national identity system has allowed hundreds of millions of people to access services like banking that they were previously locked out of due to a lack of documentation.
“In the past, if you were from a rural poor area it was very difficult to prove you existed because you typically did not have identification,” Wimborne says. “Once you can prove you exist you can enter the formal side of the economy like banking and taxation.”
This not only lifts economic activity, but it also cuts down on fraud in government payments.
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Alongside providing documentation to its citizen, India also reformed its taxation system, moving from a series of state-based duties to a single national goods and services tax.
“Until about three years ago, moving goods from one state to another was like crossing an international border with taxes to be paid and customs checks. The national goods and services tax has removed all those inefficiencies,” says Wimborne.
“Rather than having a warehouse in each of the different states, a business can now have a nationwide distribution.”
The combination of a simpler national taxation system and the conversion of undocumented workers into tax-paying citizens has put a rocket under government revenue.
“In the period April to September this year, personal income taxes grew 28.7 per cent compared to the pre-COVID base two years before.
“Corporate tax collections increased by 23.8 per cent over the same period.”
This is allowing the Indian government to spend and top of its shopping list is big ticket capital expenditure aimed at further improving economic growth and quality of life.
“They’re spending on things improving drinking water and sanitation, building roads and railways, and development of rural areas.
“This is all very positive for future growth of India.”
The benefit of the reforms is also protecting the Indian economy against the economic risks facing much of the rest of the world. As strong oil prices and a high US dollar start to drive inflationary pressures in many economies, India is holding up well.
“The growth story is driving strong foreign direct investment which is holding up the currency. That means the imported inflationary pressures are much lower in India.”
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This lowers the likelihood of future interest rate rises, further bolstering the economy.
Investors have been reaping the rewards. While the emerging markets index has been flat in US dollar terms in the year to date, Indian stocks are up 25.7 per cent.
The question for emerging markets investors is what risks are on the horizon.
The biggest risk in India is that valuations have risen, says Wimborne.
“Valuations in India have always traded at a premium to emerging markets and that premium has grown larger over the last year.
“We shouldn’t be surprised in the current global environment where the market has been paying up for growth stories that India is benefiting from that, but valuations are something that needs to be watched.”
Still, right now earnings growth looks to justify the valuations. Indian stocks are trading at 24.1 times the next twelve months’ earnings, while earnings growth is forecast at 25.9 per cent. Over the last few months, earnings forecasts have been revised upwards.
The other risk factor is the oil price. India imports oil and rising energy prices tend to have a negative effect on its economy.
So, what could turn a few years of growth in India into the kind of multi-decade success story the world has long been waiting for?
Wimborne says the key is exports.
“Why don’t emerging markets always carry on and fulfil their potential? The answer is that as you grow, your consumers tend to want to buy more goods which sucks in more imports. You need to be able to pay for those imports.
“The question is whether India’s export side — both goods and services — can generate enough foreign exchange to be able to cover what will be increasing demand for imported goods.”
“If we looked in five or ten years time, that will be a key determinate of how sustainable India’s improvements will be.”
Paul Wimborne is a senior portfolio managers and co-manager of Pendal’s Global Emerging Markets Opportunities Fund with James Syme.
The fund aims to add value through a combination of country allocation and individual stock selection.
The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.
The stock selection process focuses on buying quality growth stocks at attractive valuations.
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