What was the world’s largest economy in the year 1700? The answer may surprise you. It was India. In those pre-industrial revolution times, Mughal India had a 24.4 per cent share of world output compared with 23.3 per cent for the whole of Europe.
There is little doubt India continues to be a country of vast potential. Unlike most other emerging markets, the population is youthful, with half of its citizens less than 28 years old. Many of the young are educated and speak fluent English, enabling them to compete in the global labour market.
The UN estimates that India’s middle class will double to 1.7 billion people in the next five years and here will be unprecedented demand for an array of goods and services in this vast consumer market. India has much potential for further growth. The last four years have seen it strolling along at an average 5.5 per cent growth rate, well below its potential. The conditions are now ripe for the economy to truly take off.
The election of Narendra Modi in May last year was a signal from the country’s vast population they were ready for change after 10 years of stagnant Congress rule under Manmohan Singh. Indeed, Modi’s reign has largely been a success thus far. Since his election, the government has launched initiatives to boost investment in infrastructure and manufacturing. Among other things, it has increased foreign direct investment limits in the defence and insurance sectors (from 26 per cent to 49 per cent) and now allows 100 per cent foreign stakes in railway infrastructure and most large construction projects. It has started to privatise banks and natural resources groups. Fuel subsidies have been abolished and bureaucratic inefficiencies reduced. In an effort to reduce absenteeism, the government has set up a website (attendance.gov.in) which logs whether 51,000 of India’s civil servants come to work – a great move in a country where truancy in the civil service is rife.
But India still faces challenges. The country lacks quality roads and railways in many areas. Private investment is low in some sectors. State ownership, regulation and lack of competition continue to limit the potential of many companies. Landowners hold too much privilege and have the power to stop crucial public works from going ahead. While these problems are widespread, they also represent surmountable hurdles that the government has already started to tackle.
The 2015 Budget, revealed by India’s Minister of Finance Arun Jaitley at the end of last month, showed the government’s commitment to implement reforms that can address these issues and bring about genuine economic and political change. India has chosen to prioritise investment in infrastructure at the expense of fiscal consolidation: its deadline to cut the deficit to 3 per cent has been extended by one year to fiscal year 2018. We think this decision is in India’s best long-term interests.
We particularly liked the following key reforms announced in the Budget:
– Increase in infrastructure spending, particularly on roads and railways, of $11.3bn.
– Implementation of a standard countrywide goods and services tax by April next year.
– Corporate tax rate cut from 30 per cent to 25 per cent to be implemented over the next four years.
– One trillion rupees launch of five “ultra mega power projects” to ease the energy crisis.
– Funding for universal social security schemes for the poor.
There are reasons to be very optimistic. In a country where powers are highly devolved to individual states, Modi’s Bharatiya Janata Party has already succeeded in winning many state officials over.
The BJP won many of the state elections last year following the general election, notably ending the Congress party’s 15-year rule of Maharashtra, the home state of Mumbai. The election of renowned economist Raghuram Rajan as governor of the Reserve Bank of India in September 2013 brought credibility to the institution and its monetary policy. Perhaps most importantly, Modi’s government has disbanded the old Planning Commission and replaced it with the National Institution for Transforming India Aayog. This change from top-down central planning to bottom-up, local decision-making provides an excellent framework for implementation of policy.
The Budget has come at an opportune time for India. As one of the world’s largest net importers, the country has benefited greatly from the recent fall in the oil price. The country’s trade deficit fell from $16.9bn to $9.4bn from November to December 2014 alone. The oil price fall has improved the balance of payments, protected the current and fiscal accounts, and curbed persistently high domestic inflation.
The Indian government should now take advantage of the momentum it has and the current supportive economic environment to implement the reforms and restructuring it has promised.
There will be challenges, including dealing with the complexities of the country’s archaic land laws and ensuring sufficient revenues are raised from taxes to fund the promised investments. However, if Modi and his administration can continue to show genuine commitment to change India will take flight once again.
Hugh Young is head of Asia Pacific equities at Aberdeen Asset Management