India’s Modi Still Has To Deliver On Reform

It seems the only emerging market on investors’ radar currently is India. And with good reason…

In the spring of 2014, reform-minded Prime Minister Narendra Modi was elected.

Under his stewardship, India has become the world’s fastest-growing economy. Last quarter, India’s GDP came in at 7.4%. In 2016, growth in India’s GDP should come in around 7.6%.

India Prime Minsiter Modi Still Has to Deliver on Reform

Cooling inflation also allowed the Reserve Bank of India to support the country’s economic growth. Led by Raghuram Rajan, the Bank has lowered interest rates by 1.25% to 6.75%. Some have even compared Rajan to America’s Paul Volcker for his inflation-fighting efforts.

But as with all economies, India’s has both good and bad factors at work.

The Good

First, there’s no doubt having a prime minister focused on reform is a huge plus. That alone has attracted big investors, such as the Canada Pension Plan Investment Board. It pledged to invest $6 billion by 2022 in the country.

India has also been one of the biggest beneficiaries of collapsing oil prices. Oil is the second-largest source of energy (behind coal) in India. And the country is expected to become the world’s third-largest guzzler of oil – at 4.1 million barrels per day – trailing only China and the United States.

Falling oil prices have helped push down inflation, making Rajan’s job at the central bank easier, as well as boosting the government’s efforts in stimulating growth. Falling oil also solved the once-precarious current account problem.

India is also blessed with youthful demographics, which bodes well for future economic growth. The median age in India is 27. That compares favorably with both neighboring China and the United States, where the median ages are 36.8 and 37.8, respectively.

Demographics are especially important when you consider that 70% of the country’s GDP is domestically driven.

India’s youth is also reflected in the fact that India will have the second-largest base of internet users by year-end, overtaking the United States. India’s 400 million-plus internet users only trail China’s 650 million.

And most of those internet users are using smartphones. In 2017, the country will overtake the United States as the second-largest smartphone market, again only trailing China.

The Bad

Mahatma Gandhi wrote: “I know the path: It is straight and narrow. It is like the edge of a sword. I rejoice to walk on it. I weep when I slip.”

Prime Minister Narendra Modi is trying to walk a straight and narrow path to reform. But several obstacles are hindering his progress:

  • His economic plans are sometimes pushed out of the headlines by Hindu nationalist groups’ intolerance of other faiths. There’s often talk of India’s social fabric unraveling, instead of economic reform as opposition politicians work to slow his reform agenda.
  • Government employees and retired civil servants look to blow a hole in Modi’s budget with a 23% rise in salaries and pensions, starting in January. To meet those demands, Modi will have to either raise taxes or cut back on infrastructure spending. Neither option is what India needs right now.
  • Despite all the rhetoric, total capital expenditures by Indian companies this year nosedived. According to ratings agency Fitch, spending is down to levels not seen since 2010. In a Catch-22, Indian companies are waiting for demand to pick up before investing. But demand likely won’t rise until they invest and employ more people.
  • Part of the reason behind the lack of spending may still be strangling regulations in India. The World Bank rated it at 130 out of 189 countries for regulatory burdens on small companies.
  • As in China, bad loans in the Indian banking system are likely higher than reported. Credit Suisse says 17% of bank loans are stressed compared with the central bank’s estimate of 11%. India’s non-performing bank assets are the highest of any large Asian economy. This will hold back the creation of new loans for businesses.

The Outlook

Despite all the problems Modi faces, he is the right man at the right time for India.

IMF Managing Director Christine Lagarde calls India a “bright spot” in a slowing global economy.

And I agree. Despite doubts about how India now calculates its GDP, India will be the fastest-growing large economy in 2016. And any reforms Modi does achieve will be a plus.

So how can U.S. investors play India? Unfortunately, the list of Indian stocks trading on U.S. exchanges is quite thin, and I don’t care for any of them.

Two exchange-traded funds did catch my eye, however: the Powershares India ETF (PIN) and the EGShares India Consumer ETF (INCO). Also of interest are two mutual funds: the Matthews India Fund (MINDX) and the Wasatch Emerging India Fund (WAINX).

Indian economic outperformance should continue pushing these investments up.

Disclosure: None.

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