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INDIA: Open for Business
by Jonathan R. Laing, online.barrons.com
May 3rd 2014
In 2008, Narendra Modi sent a text message to Indian mogul Ratan Tata asking him to abandon plans to build his new Nano mini-car at a site in West Bengal, where the project was stymied by red tape and farmer riots. Modi proposed that Tata move the plant construction to Gujarat, the Indian state where Modi was chief minister. Tata agreed, and the first part of his complex was up and operating in Gujarat in less than two years, an extraordinary feat in India.
This and many similar business-friendly initiatives helped Modi turn Gujarat into a fast-growing industrial powerhouse during his 13 years at the helm, following China's model of heavy infrastructure spending on roads, ports, and electric-power generation that, along with generous subsidies, has attracted many modern plants -- and attention. "So many things work properly in Gujarat that it hardly feels like India," noted a newsweekly a few years ago.
The hope is that Modi, 63, can put his pluck and powers of persuasion to work for all of India as its new prime minister. He and his Hindu nationalist Bharatiya Janata Party, or BJP, are the odds-on favorites to win the national election, which will wind up in the second week of May. Their victory would end 10 years of increasingly feckless rule by the Gandhi family-led Congress Party, which has failed to realize India's vast economic potential. Modi's main opponent for prime minister is Rahul Gandhi.
Back in 2006-08, India was mentioned in the same breath as China as one of the globe's most exciting emerging-market growth stories. The gross domestic products of both countries were growing at or near double-digit rates. It was the heyday of the BRIC conceit, that magical lineup of Brazil, Russia, India, and China -- nations destined for economic greatness by dint of their immense resources and increasing embrace of free-market principles.
In India's case, the dream hasn't come true. GDP growth has flagged to less than 5%, while consumer inflation runs above 8% -- in all, a nasty potpourri of stagflation. Last summer, capital flight decimated India's foreign reserves and drove the rupee down 20% in value to a low of 69 rupees to the dollar.
India is unlikely to catch up to China, despite the fact that both in 1990 had similar-size economies. Nowadays, China's GDP is more than four times larger than India's roughly $2 trillion. But, under Modi's energetic, investment-driven leadership, India could start to narrow the gap and transform both its economy and its markets.
THE BJP, OVER THE YEARS, has been more reformist than the Congress Party. And in Modi -- despite controversy he has generated for his alleged involvement in an anti-Muslim pogrom in Gujarat and his ties to big businesses -- the BJP has a standard-bearer with a sterling record in economic development.
Modi's governance style flies in the face of Indian tradition, which has featured backroom business deals in exchange for kickbacks to circumvent the prospect of endless bureaucratic delays. Bidding on government contracts in Gujarat is done on the Internet, not over tea. Modi also has embraced privatization of key sectors like ports, water, and power, which is unusual in most of India's 28 state governments and in Delhi, where a dreamy Congress Party's predilection for socialism still holds sway despite the ideology's many failures in India since independence in 1947.
In recent years, Gujarat has been compared to Guangdong Province, the spearhead of China's economic revival. Since Modi took control, Gujarat has consistently led the nation in GDP growth, accounting for some 16% of India's total industrial output and 22% of its exports, despite having just 5% of the nation's population.
Optimism over India's economic prospects has also been fired by the hard-nosed monetary policies of the head of India's central bank (the Reserve Bank of India, or RBI), Raghuram Rajan. He's an inflation hawk, having raised policy rates three times since he assumed his post in September of last year.
For too long, Indian politicians have allowed inflation and, more importantly, inflationary expectations to wax, rationalizing that they are the natural byproduct of an emerging nation's pursuit of growth. But instead of basing monetary policy on the more forgiving wholesale inflation rate (currently 5.7%), the traditional RBI target, Rajan is paying more attention to consumer inflation, which last month was reported at 8.3%. Already since his appointment, the rupee has strengthened from 68 to about 60 to the dollar, and India's foreign-currency reserves have risen markedly as a result of his policies, giving the nation more of a buffer against a repeat of last summer's capital-flight crisis.
Rajan would be retained by the BJP because of his formidable international stature. He boasts a substantial pedigree, serving as chief economist of the International Monetary Fund from 2003 to 2006. Barron's readers got to know him subsequently when he was a popular author and finance professor at the University of Chicago's Booth School of Business. Rajan foresaw the arrival of the global financial crisis in the middle of the past decade and laid out a pragmatic restructuring strategy to guard against a repeat of the seize-up ("Man With a Plan," July 5, 2010).
Can Modi and Rajan rewrite India's economic story? Perhaps, according to analyst Udith Sikand of Gavekal Dragonomics, who follows India closely from Hong Kong. In a report titled "An Indian Counter-Revolution," Sikand likens Modi to Ronald Reagan as the onetime California governor came to power, inheriting raging inflation, slow growth, and years of budget deficits in 1981. Sikand says Modi even indulges in Reaganesque rhetorical gambits like "government has no business to do business" and "minimum government, maximum governance." Rajan, of course, could be a new Paul Volcker, the Federal Reserve chief whom Reagan retained when he came into office and who was able to finally slay U.S. inflation by brutal monetary tightening. "If Modi and Rajan are successful in packing the one-two punch that Reagan and Volcker did in the early '80s, the implications for growth and long-term investment returns for India are really explosive," says Sikand.
THE BULL THESIS on India is already beginning to play out. Foreign investor money that fled the always bipolar Indian stock market last summer has returned this year with a vengeance, to the tune of $5 billion. The S&P BSE Sensex Index of major Indian stocks has jumped 10% since last September when Modi became the BJP's prime minister candidate. It's now trading near all-time highs.
Of course, it's what happens with the dynamic duo in charge that matters most for the nation's economic growth and, of course, Indian stock prices. Ruchir Sharma, chief of emerging markets at Morgan Stanley Investment Management and author of the well-received emerging-market tome Breakout Nations, thinks India has a real chance to surprise many observers on the upside. "Look, it would take massive restructuring for India to catch up to China, and that's likely beyond India's current capability," says Sharma. "But India has some advantages over China -- India operates off a much lower economic base and has far fewer credit problems -- that give it a 50-50 chance of surprising on the upside."
One bull on India is David Nadel, who manages The Royce Funds' $54 million International Smaller-Companies fund (ticker: RYGSX) and is Royce's international research director. As implied by the name, Nadel fancies smaller and mid-cap stocks in India, impressed by the number of companies in that sector that are both shareholder friendly and notching gaudy returns on capital and equity of 20% or more. They also haven't rebounded to record highs, as have the 30 big-cap stocks in the Sensex Index, with the S&P BSE Small-Cap index still some 46% below its 2008 peak. (For more on Nadel's picks, see "Where to Invest in India").
Beyond the chances of fundamental reform coming, Nadel is counting on other secular changes in the years ahead. It's a familiar if somewhat overlooked list. A rapidly growing middle class and the world's third-largest economy based on purchasing power parity are just two of them. "In eight years, India will have as many households with disposable income of $10,000 or more as the U.S. or the euro zone," Nadel tells Barron's. "And the nation is rapidly integrating into the global economy in such fields as pharmaceuticals (half of the world's FDA-approved pharmaceutical facilities are in India) and high-value-added information technology."
To be sure, some 70% of India's population is still trapped in rural areas and missing out on the productivity revolution that China has experienced by moving population from the farms to urban-area factory floors. But, Nadel contends, a "rural revolution" is taking place, which has seen incomes in India's dusty nondescript villages and towns rise smartly in recent years. This is a result of various government food and fertilizer-subsidy programs and an ambitious government make-work project guaranteeing poor rural residents 100 days of annual guaranteed wages. The result of all this is that rural land values have risen markedly, giving the poor population that owns land a jump in wealth.
The upside is likely to be a surge in consumption per capita in both goods and discretionary services like health care and private education, according to Nadel. He cites a 2012 International Monetary Fund report showing that as of 2011, India had the lowest private consumption rate per capita among the world's 10 most populous countries, trailing even Pakistan, the Philippines, and Indonesia.
"You have to just look at the uptake in mobile-phone adoption in India, where subscriptions have jumped from practically zero at the beginning of the millennium to over 900 million, to see the potential," he points out. According to a local Indian brokerage-house report, the penetration rate for cars, computers, laptops, and air conditioners is less than 5%, and for refrigerators, washing machines, and motorbikes, below 15%. (See chart).
India's laggard economic performance since independence in 1947 can largely be laid at the feet of the state's founder and leader Jawaharlal Nehru and his descendants, who have dominated politics through the National Congress Party for most of the 67 years since. The charismatic Nehru, a well-meaning socialist, embraced some of the worst alternatives to free-market development, including avid nationalization of industry, incompetent Soviet-style central planning, fortress protectionism, and stifling bureaucracy.
Until a spasm of reform in 1991, a system contemptuously known as the License Raj reigned supreme, under which private businesses had to run a formidable gauntlet to be licensed and then were subject to strict regulatory oversight of the goods they produced, the markets they served, and the wages and personnel decisions they made. The regime resulted in prodigious red tape and corruption, both of which bedevil India to this day.
ON THE CAMPAIGN TRAIL, Modi promised voters cheaper goods and 100 new "smart cities" loaded with the latest technology, to start to bridge the yawning wealth gap between cities and rural areas. The BJP election manifesto also trumpeted big plans to improve India's ramshackle intercity roadway system and creaky railroads by introducing bullet trains.
But significant obstacles face the Modi-BJP reform plans. It remains to be seen exactly how the elections turn out, and whether the BJP to reach a majority will have to form a coalition with MPs from states that have their own self-serving, parochial agendas.
Likewise, state-government wrangling over land-acquisition issues has accounted for about 55% of the nation's delayed capital projects that would constitute some 5% of India's GDP, according to a recent JPMorgan report by Sajjid Chinoy and Toshi Jain. Most notoriously, it took Korean steel giant Posco PKX +0.20% POSCO ADS U.S.: NYSE $73.91 +0.15 +0.20% May 2, 2014 4:02 pm Volume (Delayed 15m) : 127,815 AFTER HOURS $73.48 -0.43 -0.59% April 30, 2014 4:10 pm Volume (Delayed 15m): 3,385 P/E Ratio 22.13 Market Cap $25.81 Billion Dividend Yield N/A Rev. per Employee $3,374,600 03/20/14 Australia's Richest Person Sec... More quote details and news » PKX in Your Value Your Change Short position (PKX) nine years to gain approval to build a $12.5 billion steel complex in Orissa state, while ArcelorMittal MT +0.12% ArcelorMittal ADS U.S.: NYSE $16.24 +0.02 +0.12% May 2, 2014 4:00 pm Volume (Delayed 15m) : 4.53M AFTER HOURS $16.25 +0.01 +0.06% May 2, 2014 5:44 pm Volume (Delayed 15m): 43,731 P/E Ratio N/A Market Cap $27.14 Billion Dividend Yield 4.93% Rev. per Employee $342,647 04/27/14 NTT DoCoMo to exit India with ... 04/17/14 Blackstone Irons Out Views on ... 04/17/14 Japan Steel Giant To Sell 'Wor... More quote details and news » MT in Your Value Your Change Short position (MT) scrapped similar plans to put up an $8.5 billion steel mill in the same state last year. Clearly, the License Raj lives on in a country starved for investment spending.
Finally, tight money policies and a central-government budget deficit -- estimated for the recently completed fiscal year (ended on March 31) at 4.6% of GDP -- won't give Modi much immediate opportunity to ramp up stimulus spending. Unless the budget deficit that peaked in fiscal 2010 at 6.5% keeps contracting, credit-rating agencies have threatened to drop India's sovereign debt to junk status.
Still, Modi and the BJP do have some wiggle room on reforms. The JPMorgan analysts expect them to revamp India's power sector, chronically subject to grid crashes and electricity interruptions, through deregulation of pricing. The BJP likewise seems open to increasing foreign ownership in industries like defense and insurance.
Government revenue should improve if the long-stalled goods and service tax is implemented, replacing a hodge-podge of value-added central and state government sales taxes. Finally, a Modi administration would rein in the growth of various India-wide subsidies for everything from fertilizer and food for the rural poor to gas- and diesel-fuel prices. The food-subsidy program has been particularly problematic, according to Gavekal's Sikand, because rather than helping the 300 million or so of India's population who clearly need the support, it entitles about 750 million folks to food subsidies at the expense of the government exchequer.
MODI AND RAJAN make a somewhat incongruous pair atop the Indian economy. Rajan, the son of an Indian diplomat, had a worldly and cosmopolitan upbringing. He's emphatically an upper-crust Brahmin, educated at posh schools in India and boasting a Ph.D. in Management from MIT in the U.S.
Modi, on the other hand, is an anomaly for the upper reaches of Indian power structure. He didn't have much schooling and, as a teenager, ran a tea stall for his father near a railroad station in a town in Gujarat. His rise to eminence began in his youth when he joined the Rashtriya Swayamsevak Sangh, a Hindu nationalist paramilitary organization that ultimately was absorbed into the BJP. A mesmerizing speaker and adept organizer, Modi quickly rose through the ranks of the RSS and later the BJP.
His stock in trade were anti-Muslim harangues, which made him controversial among the secular, urban elite. Yet, if truth be told, their disdain for Modi might also have arisen from his lower-caste origins.
But controversy over his hypersectarian views continues to dog him. Much of it stems from a bloody anti-Muslim riot that occurred in Gujarat in 2002, in which more than 1,000 people, mostly Muslims, were slaughtered in a three-day rampage in response to the incineration of a train in the city of Godhra that killed 59 Hindu pilgrims and activists. Modi had become Gujarat's chief minister just months before the riot.
Though Indian courts absolved him of complicity, many observers claim the investigations were a whitewash. Among other things, they point to the fact that Modi subsequently appointed a gynecologist as his minister of women and child development who was later convicted of murder in the riots. She received a 28-year jail sentence.
In recent years and during the campaign, Modi has toned down his hypernationalistic rhetoric, preferring to focus on reform and the economic renewal of India that will uplift the lot of Hindus and Muslims alike. Nonetheless, both the U.S. and European Union have refused to grant him diplomatic visas, though in the case of the EU, that boycott has recently been lifted.
Likewise, Modi was accused during the campaign of cozying up to Indian billionaires like Gautam Adani with sweetheart land deals and large subsidies to spur development in Gujarat. But the charges seem to have gained little purchase in light of several megacorruption scandals that have dogged the Congress Party in recent years.
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