The government of Narendra Modi is bragging about India’s 7%-plus growth rate.
The popular catchphrase “India Shining” – first coined as the election slogan of Atal Bihari Vajpayee in 2004 – is being used widely.
But, in reality, the output figures are fudged. And in terms of reform enthusiasm and ability, Modi is no Vajpayee.
Yet India uniquely benefited from the decline in oil and commodity prices in the past year. Of the five “BRIC” economies (Brazil, Russia, India, China, and now South Africa) it’s having the best run.
With that in mind, let’s take a look at how to play this market.
The State of Affairs
In retrospect, Vajpayee’s administration from 1998 to 2004 looks even better than it did at the time.
During that time, half a century of a “Hindu rate of growth” of only 2% to 3% per annum, which left Indian citizens in poverty, was replaced by a strong reformist commitment. Under Vajpayee and his Finance Minister Jaswant Singh, the government undertook privatizations, as well as tax and pension reforms, which pushed growth rates up to between 7% and 8% by 2004.
But, in an act of stunning political ingratitude and foolishness, the Indian electorate threw out Vajpayee in 2004. Reform stalled, public expenditure bloated, and growth, after a few good years of living off the effects of Vajpayee’s reforms, once again slowed.
Modi pays lip service to the Vajpayee approach. He even went so far as to name Vajpayee’s birthday, December 25, “Good Government Day” in 2014. But, in practice, Modi hasn’t really followed Vajpayee’s lead.
The Goods and Services Tax (VAT), which was supposed to be supported by both parties and stabilize India’s chaotic finances, still hasn’t made it through Congress. The Vajpayee tradition of following Western norms of good governance was notably violated earlier this year when India attempted to enact a retroactive profits tax on foreign investors, even on those with no operations in India.
After mass protests by international institutional investors, this tax was withdrawn. The 2015–16 budget announced in February made no significant progress toward reducing India’s excessive budget deficit. Although, the abolition of the wealth tax improved the excessive (and largely evaded) taxation of the well-off.
Meanwhile a “reform” of national statistics, also announced in February, increased reported GDP growth from 5% to 7%. This exaggerated the country’s economic progress and enables it to claim faster growth than even China!
Even under the new statistics, second-quarter growth came in at 7%, below forecasts of 7.5%, and suggests that IMF predictions of 7.5% growth in both 2015 and 2016 are too optimistic.
Worse Than Russia
The rupee has declined by 10% against the dollar in the past year, less than many other emerging market currencies. Nevertheless, the fact that a country with such low labor costs and that’s benefiting from the oil price decline should still run a trade deficit of 1.3% of GDP in 2015, on the IMF forecast, indicates that problems remain.
The largest issue is a public sector deficit of 4.1% of GDP, which is excessive when the economy is growing so fast. There’s also the notorious raft of regulations and red tape that the Modi government is slow to remove.
India ranks an appalling 142nd on the World Bank’s “Ease of Doing Business” Index, well below its BRIC partners, Russia, China, Brazil, and South Africa. Modi’s rhetoric about improving far exceeds his government’s actual achievements.
When your business climate is worse than Russia’s, you’re a long way from perfect.
Nevertheless, there’s a fundamental stability about India’s position that suggests rapid growth – whether at 5% or 7% – may continue for some years. The Modi government, while less business-friendly than Vajpayee’s, is committed to at least gradual improvement in India’s business climate and is in power with a solid majority until 2019.
Growth itself can improve the business climate, while India is still so poor that its wages remain highly competitive, even against China’s, for decades to come. Of all the countries to benefit from globalization and improved communications, India is potentially the biggest winner. Fortunately, the government (as distinct from the bureaucracy) is at least no longer a major obstacle to the process.
Why Go for Anything Less?
There are two ETFs that allow you to invest in India, each of which takes a different approach.
The iShares MSCI India Index ETF (INDA) tracks the MSCI India Index, which is weighted towards the larger Indian companies. It’s a $3.3-billion fund with an expense ratio of 0.68%, only a little higher than funds operating in a less difficult environment. With a P/E of 19 times and a yield of only 0.875%, it’s pretty much fully valued.
The Market Vectors India Small-Cap ETF (SCIF) tracks the Market Vectors India Small-Cap Index. It’s a $180-million fund, whose expenses are somewhat higher than INDA at 0.85%. As the name suggests, it tracks Indian small caps in practice with a market capitalization of between $1 billion and $3 billion. This is considerably cheaper than the behemoths, treading on a P/E ratio of only 12 times. Its yield is also slightly higher at 1.07%.
India’s potential is so great, that with the moderately business-friendly government of Narendra Modi it seems madness to overlook it.
But its progress won’t be entirely smooth sailing. I prefer small caps at 12 times earnings to the overall market at 19 times earnings.