It has been a frustrating couple of years for India. Political stability and the undoubted momentum surrounding reforms have propelled India to the top of the many emerging market (EM) lists. However, one key ingredient has remained stubbornly missing – a sustainable recovery in economic growth.
Closely linked to the lack of growth, we have yet to see a revival of the investment cycle and a return of corporate earnings growth. This is hopefully now changing, with the government unveiling the most significant measures yet to deal with India’s growth malaise.
The Finance Minister surprised everyone late last month, announcing a sizeable recapitalisation (circa US$32bn) of the public sector banks (PSU), crucial in improving access to credit for small businesses. He also approved the largest ever highway development investment of more than US$120bn over the next five years. These efforts show Prime Minister Modi is advancing a pro-growth agenda in the run up to the national elections in 2019.
The strong multiplier of recapitalisation
In relation to the recapitalisation, the government is trying to address the ongoing fallout from the non-performing loans (NPL) generated since the mid-2000s that have been weighing down India’s financial system, particularly the public sector banks. Weak PSUs have been unable to properly clean up the NPL mess, which has acted as a brake on the recovery.
While the finer details remain sketchy, and a small proportion of this money is actually not new, we believe the recapitalisation will act as a fiscal stimulus – due to the strong multiplier impact it will have. The infusion should meet nearly 70 per cent of the capital requirements to deal with the NPL issue of the PSUs – enabling these banks to provide capital to key government focus areas of housing and infrastructure.
For a variety of reasons, we have chosen to avoid any investment in the PSUs for more than four years. Our focus has been on private sector banks, where efficiencies in management practices are more transparent and cost effectiveness is more measurable. We have also had an overweight to the non-banking financial corporations, where access to management teams is greater and allows for more detailed analysis and assessment of the potential opportunity.
Expect further job-creative initiatives
Modi recognises the importance of delivering jobs, particularly in the period running up to the election. Road building is hugely labour intensive and we expect Modi to continue rolling out highly job-creative plans in the coming quarters.
Housing construction is another area that will benefit greatly from further investment, leading to greater employment. We are invested in stocks tied into this theme.
Our exposure to infrastructure-related companies, including leading road builder Ashoka Buildcon, supports our conviction around infrastructure. These groups will equally benefit from the recapitalisation, as funding becomes available for future projects. Secondary investment opportunities are likely to be the more fruitful method to invest in the latest announcements.
A clearer growth path for India
While the Indian credit cycle has been lacklustre for an extended period, this announcement will aid the improvement that began earlier this year and quicken the recovery. The Reserve Bank of India has been critical of the slowness in banks writing off bad loans and the latest initiative should encourage lending once more.
Modi has made it abundantly clear re-election is his main goal for the next 18 months. This task will be made easier through job creation exercises, such as the road investment plan. Expectations for further announcements are high, which is likely to be reflected in the market direction from here.
India’s growth path is clearer after this announcement. We have a reformist government that is not afraid to take big decisions and introduce supportive policies to ensure opportunities are captured across sectors. India remains at the forefront of global growth and is capitalising on its opportunity.
Simon Finch is manager of Ashburton India Equity Opportunities Fund.
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