Indian reforms re-ignite investors’ interest

When the reticent Indian prime minister Manmohan Singh finally spoke up, markets rallied. The leader, infamously labelled an “underachiever” by a popular magazine, proved his mettle through a series of recent progressive measures. These were reminiscent to the reforms he had undertaken earlier during his tenure as finance minister during liberalisation in 1991, when he lifted India out of a balance of payments crisis.

Over the past six months, the ruling multi-party coalition government in India had been plagued by “policy paralysis” as it favoured populist policies over reforms. However, fears of a potential downgrade of the country’s credit rating to junk status led the Indian government to announce more changes in under 24 hours than it had done previously in eight years.

The reforms included a cut in diesel subsidies, resumed asset sales, reduced taxes on overseas borrowings and plans to raise $2.3bn (€1.7bn) by privatising four state-run firms. Also announced was the opening up of investment of up to 49 per cent by foreign carriers in local airlines. But perhaps the most controversial proved to be allowing investment of up to 51 per cent by foreign investors in India’s $505bn multi-brand retail sector, a move that led to widespread protests by small shopkeepers and withdrawal of support of a coalition partner that would lose the ruling Congress Party its majority.

However, the government’s resolve not to roll back its reforms, as earlier, is restoring investment sentiment in India. As a result, Julius Baer, which had a long-standing underweight recommendation on Indian equities in its Asian and global emerging markets portfolios due to lack of movement in economic reforms has upgraded its stance to neutral.

“Recent news on the plans to open up the retail sector is very significant,” says Stefan Hofer, emerging market equity strategist at Julius Baer. “It is still early days in the reform process, but the signalling impact is very significant and we detect that investor sentiment vis-à-vis India has shifted to the positive.”

Valuations in India are as not as compelling as elsewhere in emerging markets and Asia, he believes. The bank predicts India to continue to show moderate growth, which will not change in the short-term, with or without retail sector reforms.

“Nevertheless, the recent reforms have put Indian equities back into a much more positive light,” Mr Hofer admits.

The policy changes are finding favour, particularly with those companies that are engaged in local logistics, explains Robert Aspin, senior investment strategist of the wealth management group at Standard Chartered, which is overweight equities and neutral on Indian equities. “Valuations are attractive and policy changes are encouraging. We see some excellent stockpicking opportunities in the market,” he says.

The reforms herald a big change from the relatively slow policy reforms over the past two years, feels Tushar Poddar, a Mumbai-based economist at Goldman Sachs. “While there will be opposition to the reforms and implementation issues, they are a big step forward and will be positive for investor sentiment,” he says.

Nevertheless, although the reforms signal a move away from the policy paralysis of the past two years, the immediate benefits may not be forthcoming, believes Manish Bhatia, fund manager of Indian equities at Schroder Investment Management.

“The cut in diesel subsidy will only reduce the deficit by around 0.1 per cent of GDP,” he explains. “With August inflation coming in above expectations at 7.55 per cent year-on-year, the diesel hike looks set to feed into inflation figures later this year and will only exacerbate another headache for Indian  policymakers.”

The fund manager says he is looking for policy action on major bottlenecks that continue to receive little attention. “Land acquisition and labour laws, as well as the power sector, all require major overhauls,” Mr Bhatia says. “If these issues are addressed, we believe the investment cycle can be revived and inflows will start to pick up.”

Though the reforms are sparking interest, he feels foreign direct investment will not pick up substantially as Indian airlines are deep in debt and haemorrhaging money. Also, the fact that foreign supermarkets looking to enter the country as a majority stakeholder will have to go through individual states to set up operations, will be a major hurdle, he says.

Nevertheless, Deepak Lalwani, director of Lalcap, a London-based investment consultancy specialising in India, disagrees that it will pose any challenge. “Most of the states which are opposed to foreign direct investment in retail, such as West Bengal and Bihar, are poorer states, where companies will not have a market anyway,” he says.

“Broadly, these are big-bang reforms, which could be a game-changer,” Mr Lalwani says. “In less than 24 hours, the Indian government has announced more measures to liberalise the economy than it had done in the last eight years.”

“We have the world’s second-largest population, we have a fairly large middle class, so we become an attractive destination for any sort of organised retailing,” agrees Arun Kejriwal, director of Mumbai-based advisory firm Kejriwal Research and Investment Services.

Indian companies, in particular, will benefit from the loosening of rules, as the action could encourage partnerships with international businesses. “Foreign investment will help ease fundraising concerns for Indian companies that have been bleeding money,” says Arvind Singhal, chairman of Technopak Advisors, an Indian retail consultant. He feels the move will also help local industries, as foreign retailers are allowed to enter India only if they invest at least $100m, with half of it going to rural areas to boost infrastructure.

The government is particularly keen on this reform as it may help unclog supply bottlenecks that cause about 35 per cent of fresh food produce to rot before reaching the final consumer, says Lalcap’s Mr Lalwani.

“It is also hoped that global chains will be able to offer farmers better prices by cutting out the middleman,” he says. “At least 30 per cent of the goods will have to be sourced from local small industries. So, this will be positive news for all in the value chain, from farmers to consumers.”

Strong Signal

Meanwhile, the ability and willingness of the government to act despite coalition pressures bodes well for foreign direct investment in other sectors, says Rohini Malkani, an economist at Citigroup. “The reform measures send a strong signal and are likely to reduce threats of a ratings downgrade.”

As fears of a Chinese slowdown worsen, India may be able to replace China as an asset allocation hub for Asia, says Amit Shah, executive director of IIFL Private Wealth Management, a Mumbai-based wealth manager. He believes Indian equities will continue to climb for the next six to 12 months’ times, with stocks of key players in the retail sector, such as Pantaloons, Shoppers Stop and Trent Ltd., which has a franchise agreement with Tesco, likely to rise.

“India represents a large market of $1.2tn, with foreign institutional holdings of $200bn,” he says. “As the government reduces stakes, there will be opportunities for foreign investors to raise asset allocations in India.”

As there is a need of more equity to issued, asset allocations to India are rising, he says.

“India’s weightings are below potential in global indices,” Mr Shah adds.

However, Standard Chartered’s Mr Aspin believes though India may replace China as the latest growth opportunity, the Chinese market is very cheap at present. “A lot of bad news has already been priced in,” he says.

Robert Aspin, Standard Chartered