Investors were heartened by 2012’s burst of reform in India, but Joseph Mariathasan writes that this is an unexpected bonus in a market where the dynamism comes from the private sector

After years of negative news on corruption and the indecisiveness of the authorities
around instigating any reforms at all in India, foreign investors’ sentiment was jolted in September 2012. Prime minister Manmohan Singh announced of a round of measures, including a controversial cut in diesel subsidies and an opening up of the retail and aviation industries to foreign capital.

“People were wondering whether the government had the political will for reform,” says G. Pradeepkumar, the CEO of Union KBC Asset Management. “This really showed that the government has a sense of purpose.”

The focus of global growth may be centred on China, but George Hoguet, global investment strategist at State Street Global Advisors, probably reflects the views of many when he sees India as offering the better long-term returns from equity markets.
India bulls observe that, even before the September reforms, the stock market had gone down so low that there was potential for upside, and that India’s interest rates are among the highest in the world.

But there are still many roadblocks to reform, and even the opening up of the retail sector only happened because a lot of local companies realised that they needed foreign capital to be able to expand, according to Andrew Holland, CEO of Nikko Asset Management’s Indian joint venture, Ambit Investment Advisors.

“There were vested interests in preventing the likes of Tesco and Carrefour from competing in the Indian market,” he says. “There is less noise from locals now. If India is to grow, getting from farm to fork needs not only stores, but a whole new infrastructure in terms of cold stores, and so on.”

Further liberalisation is certainly happening but progress is still slow. “To fully exploit potential areas for co-operation between our two countries, we need to make special efforts to bring our private sectors closer together,” Singh told a joint session of the US Congress. But that was back in 2005 – in October 2012 the government finally announced that it had increased the limit on foreign direct investment in the insurance sector from 26% to 49%, and allowed 26% FDI in the pension sector (with a view to take that to 49% in future).

“These are very positive and long overdue steps, but still need to be passed in the parliament,” says Pradeepkumar. “Political opposition is quite likely and one cannot be sure if they will all be passed. But 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.”

There is still much to be done to move the GDP growth rate above its current 5.5%. 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 workers actually benefit from the protection of the formal employment law that 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.
Still, some progress can 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,” says Pradeepkumar. One legacy of India’s history in the British Empire was the creation of institutions that provide the framework for well-functioning capital markets. “India has an independent central bank and the whole market mechanism is superb, second-to-none – including developed countries.”

There is also another trend that is fundamental to the India story. Ajay Shah, a professor at the National Institute for Public Finance and Policy, New Delhi, points out that while 31% of India’s labour force is still in agriculture, the agricultural workforce is greying and the new worlds of industry and services are disproportionately manned by the young.

“When the shift of a worker into services or industry is accompanied by migration, it adds up to a powerful engine of social and economic modernisation. It is a powerful mega-trend that is reshaping India today,” he says. China, of course, has seen that urbanisation on a massive scale. Shah argues that by 2012, China had reached a point where there is relatively little upside for GDP growth by getting workers out of agriculture. His view is that the Indian evidence for 2012 looks similar to China of 2004, so India is perhaps 10 years away from this loss of upside in GDP growth. Perhaps another reason for favouring Indian equities over Chinese?