India - Moving ahead despite the government
Prime Minister Manmohan Singh’s announcements in September of a group of reforms - a cut in diesel subsidies and opening up the retail and aviation industries to foreign investment, jolted sentiment towards India, after getting on years of negative news around corruption and indecisiveness on instigating any reforms at all.
G. Pradeepkumar, the CEO of Union KBC Asset Management, declares: “People were wondering whether the government had the political will for reform. This really showed that the government has a sense of purpose.”
In early October, it was announced that the government had approved increasing the limit on Foreign Direct Investment in the insurance sector from 26% to 49% and allowed 26% FDI in the pension sector (with the roadmap of taking to 49% in future). “These are very positive and long overdue steps but still need to be passed in the parliament. Political opposition is quite likely and one cannot be sure if they will all be passed. However, it has further lifted the sentiment in the capital markets and among the business community. I am sure foreign investors would also be hugely encouraged by this newfound resolve in the government.”
But there is still much to be done to move the GDP growth rate above its current 5.5% or so. There appears to be little prospect of any new legislation coming through before the next elections that would tackle areas such as banking liberalisation, levelling the playing field for foreign lenders, improving the allocation of land for development and clarifying the operation of mines, leaving aside the question of labour market reform. Only 10% of the workforce actually enjoy the protection offered by the formal employment law which mitigates against the hiring of new workers. The majority of the workforce may benefit from a more pragmatic framework that would encourage labour mobility within formal employment.
Foreign investors comparing India with China often say that in China, the economy is driven by government policies so you need to invest in those sectors that have high government influence. In India by contrast, the economy grows despite the actions of government, so investment is best undertaken in those areas where there is least government influence.
Shekhar Gupta writing earlier this year in the Indian Express said: “If you draw a simple chart of the large companies that have lost the most value on the stock markets over the past three years, you’d notice that almost all of these were doing business on the same cusp of politics, finance and natural resources. To that extent, you have to admit that the market has been the first to sense the rot and has applied a stunning self-correction, severely punishing those responsible for it.”
Ajay Shah, a Professor at the National Institute for Public Finance and Policy, New Delhi, is relatively optimistic about the prospects for India irrespective of government actions: “Enforcement does not have to be 100% perfect for it to impact on the decision making of investors. Even if there is only a 10% chance of getting caught and thus getting -80% returns, that is a big risk from the viewpoint of the investor. From the viewpoint of the investor: Why take the risk? Why not make a thorough analysis of the ethical standards of a company one element of the security selection process?”
As he points out, the best people are avoiding rotten companies: “Putting these together, the bad guys are finding it difficult to obtain both capital and labour, which are seeking out better firms.”
Perhaps it is not surprising that Union KBC itself is underweight infrastructure related sectors along with oil, automobiles and power.
Manmohan Singh’s September reforms were not major and as Pradeepkumar says, major political reforms are not really possible within the current political set up. But progress of a fashion can still be made through administrative steps without the requirement for primary legislation. India may not yet be a separate investment destination for international investors, but its importance will only grow: “As investors allocate more to emerging markets, the differences between countries such as India and China become more apparent. Moreover, India has an independent central bank, and the whole market mechanism in terms of regulators, and so on is superb, and second to none including developed countries!”
With a population greater than a billion and rising living standards, it is not surprising that, like China, many foreign fund managers have set up joint ventures in India or attempted to go it alone to tackle the domestic market. But it has not been easy. Fidelity gave up the struggle and sold its Indian operations to a subsidiary of Indian engineering conglomerate Larsen & Toubro Ltd earlier this year, driven by growing competition, weaker markets and regulatory changes such as the removal of the entry load, or a commission charged by a mutual fund distributor for selling a product.
But while international firms may find their standard business models do not work well in the Indian environment, Pradeepkumar is happy with the progress of Union KBC, which has grown to around $600m of assets under management within 18 months. It is often said that the Indian mutual fund market is just too competitive for new players with 43 or so in existence, but what that fails to acknowledge is that the marketplace is growing and the key to success is to find new investors who have reached the level of prosperity where it can make sense to save on a regular basis: “There is space for everyone and I don’t have to eat anyone else’s business,” says Pradeepkumar.
Union KBC’s approach for example, is to create systematic savings plans for the client base of its Indian joint venture partner, Union Bank. For most of these clients, many in smaller Indian cities, this would be their first foray into equity related investments. “We have about 63,000 investor folios (accounts) with us and about 75% of them are first time investors in mutual funds” declares Pradeepkumar.
One example was close to home: “I had a driver who asked for a pay rise. I said OK but suggested he start up a savings plan with us with the extra income. He did that and after a couple of years, he had saved enough together with a loan for a downpayment on a car of his own and he left me to set himself up as a taxi driver!”
The opportunities in India’s domestic savings market are immense but the key is effective distribution. The government sponsored New Pension Scheme (NPS) has effectively hit a brick wall, despite being a very cost effective and efficient scheme for participants, because no one has an incentive to popularise it. Yet recent reforms in the financial services sector introduced by SEBI are creating incentives for fund managers to reach out to new investors. India may be frustrating for many investors and potential participants in financial services, but it does appear to be heading in the right direction so potential investors and market participants should not lose all hope!