“To turn an oil tanker’s direction takes time”
As 100 days had passed since the BJP’s overwhelming election victory, it seemed an opportune time for the investment managers of the India Equity Opportunities Fund to head to India to understand what the government had in store for the future. Simon Finch used his time on the ground to meet with some of the companies they invest in, as well as to speak with members of the bureaucracy in Delhi to gain a greater insight into the changing face of Indian politics and the impact on the economy.
While the support for the Modi-led BJP began in earnest in December 2013, election results in India are never a foregone conclusion. The landslide victory had echoes back to the 1980s; the last time a political party had such a clear margin of victory. The equity market had cautiously begun pricing in a Modi victory through the early stages of this year; however, Modi himself knows that May was only just the start of the challenge to reset India back on its path to growth.
The outgoing government had faced increasing criticism of their inability to pass any law bills, whilst project bottlenecks were witnessed across a number of industries, increasing the frustration at corporates, as well as investors both domestic and foreign. Capital expenditure was stalled as the bureaucratic malaise reached a pinnacle. All this helped pave the way for a redeeming personality such as Modi, with India’s GDP figures languishing around 4% to reignite the India growth story.
Modi’s success as governor in Gujarat was repeatedly heralded as a model for what he could achieve across the entire Indian sub-continent. To replicate that success across the diversities that intersects Indians at every level, from religion, to culture, to climate and ultimately individual wealth discrepancies is a huge challenge. We travelled to India with the knowledge that the first 100 days have gone much like most other global leaders’ first 100 days; a period of euphoria, followed by a rushed set of announcements on budgets and ministries followed by a lull when impatient investors decry that promises have yet again been broken. However, whilst some disappointment naturally occurs, our recent visit emboldened our belief in the Indian growth story rebirth.
Structural success stories
Amongst Modi’s priorities is that of financial inclusion; ensuring that people have access to a variety of suitable financial services. The Unique Identification scheme (UID) is one such example of ensuring that every Indian has the potential to access financial services of one kind or other. Modi has promised that those with a UID will be able to open a bank account, be given a debit card with INR100,000 associated insurance for the poor. This opening up of financial services to every Indian forms one of the structural stories within the Fund called Capital First. Jonathan first met with Capital First, a finance provider to micro, small and medium enterprises (MSME) in spring 2014, which led to an investment within the Fund. In our discussions with this relatively new company, we noted how quickly they have taken market share (c.10%) from their nearest competitor, which previously had more than 90% of the market. As with all the investments in the portfolio, we meet with company management on a regular basis to ensure the management strategy is consistent with our initial understanding and that they are delivering consistent performance under strong governance. Capital First have a growing reputation for smaller ticket size lending to MSME participants, with an extremely low default rate. Through their proprietary credit scoring process and strong client relationships they have grown their loan book more than tenfold since 2010, whilst retaining their tightly managed risk profile. Lending in this low value segment is critical to engage India’s rural population in the growth story through financial inclusion. In fact the MSME sector currently contributes 15%1 to India’s GDP, which is why Modi is so keen to promote this type of lending.
Borrowing at this level can be for items such as a sewing machine, which can enable a cottage industry worker. Other items include small farm machinery items, or two-wheeler motor bikes. These loans are seen as stepping stones towards greater financial inclusivity and will ultimately lead to consumer durable loans, as well as home loans. This is intertwined with another of our structural stories, that of the increasingly sophisticated Indian consumer.
Whirlpool, the global white good manufacturer, has an Indian listing that has been held in the Fund since inception more than two years ago. Whirlpool will be a direct beneficiary of lenders such as Capital First, as Indians across the country transition to using appliances for jobs that were traditionally done by hand such as laundry.
The rise of e-commerce
During the trip and our interactions with various people, it became evident that consumers were using technology more and more in their daily lives, which was corroborated in our meeting with Gateway Distriparks, a freight and cold chain logistics operator which is owned in the Fund, In a break from a more developed market retail model, a rapidly growing number of Indian consumers are buying their groceries online, with dedicated delivery times and with supermarket topping quality. This could be a huge blow for those foreign chains that were lining up India to deliver the growth element to their western earnings profile. We have access to these types of services in developed markets, however, the traditional, asset heavy supermarkets also co-exist. However, India has the opportunity to bypass the costly store infrastructure model and transact directly with the consumer, delivering straight to their front door. This is one area that companies such as Gateway Distriparks and their subsidiary Snowman Logistics, which was recently listed, are anticipating as growth drivers moving forwards.
Strengthening foreign relations
Other companies visited during the week highlighted Modi’s push in September to attract foreign investment with visits to Japan and the US and a visit from Chinese leader Xi. At the start of the month Japan committed c.$50bn for a variety of projects, including rail and infrastructure, whilst China agreed it will initiate deals worth close to $30bn. Post the India trip Modi visited the US, which received an abundance of media coverage, documenting meetings with President Obama and CEOs of the country’s leading organisations across a number of industries. Modi knows that education and job creation is critical to the success of his tenure, and with significant foreign investment he can certainly achieve his milestones.
Signs of change
Some market commentators have questioned what has actually changed since the election result, and there are certainly some reasons to feel frustrated. However, we found that generally the people and companies we spoke with acknowledge that “to turn an oil tanker’s direction takes time”. 100 days is certainly a short period of time to break down layers of bureaucracy that stymied the previous government’s efforts to push India forward. A reduced number of ministers have been working harder than ever, with all twelve2 bills presented being passed, (previous government presented 14 bills combined in their two second sessions) and hours clocked by the ministers ratcheted up as Modi’s workaholic culture takes root.
The September launch of the “MakeinIndia” campaign is just one measure the new government is using to create greater transparency, engage both domestic companies as well as generating increased foreign inward investment. Our meetings highlighted the will of the companies to implement a Goods & Sales Tax (GST). Commentators and market participants that we met stated this could be India’s defining moment, and has previously been suggested as being much like China’s accession into the WTO in 2001. We were told that GST would harmonise inter-state trade, lower restrictions and stamp out cartels, which should ultimately ease the inflationary burden, allowing the Reserve Bank of India greater policy flexibility and improve the household budgets across the country. Whilst in opposition the BJP were opponents of the proposal. However, now they are in power management of the companies we met expect them to push through with GST, with its introduction likely to be in 2016.
What next?
With regards the near term, one overriding sentiment from the trip was that people were expectant of Modi to push more aggressively with reforms once the October elections in Haryana and Maharashtra states had taken place. And post those results, which were positive for the BJP, we have seen just that. Modi has announced a relaxation of some of the labour laws, which should allow organisations to be more flexible and competitive. Fuel subsidies have finally been abolished, which unties the hands of energy companies, bringing fuel costs in line with true market values. Finally, Modi has taken the lead in ensuring the coal block licence auction process commences promptly and does not stymie the efforts of the energy and power industries to ensure India has a consistent and cost effective power supply.
Now that these election “distractions” are out of the way Modi can focus on his plan of “minimum government – maximum governance”. Through the removal of needless bureaucratic layers that have only been a hindrance to Indian economic growth Modi can finally release India’s economic tiger.
