Nirvana or not?
MIKE REYNAL 18-Dec-2019
As ever, India remains a conundrum. Rarely has an emerging market opportunity been so tantalizing and frustrating at the same time. On one hand it’s hard to argue with India’s enormous potential: its sheer size makes it the sixth largest economy (and second largest emerging market); it is the second most populous country in the world but with a still-tiny middle class; it boasts an established legal infrastructure and high accounting standards; and the workforce is highly educated. These are all reasons why India ranked as the fourth most attractive destination for business, according to PwC’s most recent annual CEO Survey.
On the other hand, India is home to a notorious bureaucracy with oft-ineffectual government policies and, more recently, a troubled banking system. And although economic growth was approximately 4.5% in the most recent quarter ended September 2019, this represents the slowest growth in six years. Perhaps that’s why Moody’s downgraded its ratings outlook.
The headlines may not seem encouraging, but it’s important to keep perspective. For starters, growth of 4.5%, while slowing, is not insignificant. There are not many places in the world to tap into such growth. Moreover, Prime Minister Narendra Modi’s government appears firmly committed to reforms and stimulus. While I was on a recent research trip to India in September, the government announced a significant—and surprising—corporate tax cut. This is a central piece of the Modi government’s attempt to upturn the growth trajectory. The headline tax rate is being reduced from approximately 34% to 25%, while the effective tax rate may drop slightly lower. In turn, this is likely to inject greater profitability into an array of companies, which could be in line for earnings upgrades.
In addition, the government has announced plans to spur new business creation by further reducing taxes for new enterprises to approximately 15%. This is another dramatic incentive that should be viewed as stimulative, though it is not without controversy since fiscal receipts are projected to decline by $20 billion over the next year or so. A projected rising deficit-to-GDP ratio may be one factor worrying the ratings agencies. Yet on the whole, we believe that new business creation and associated economic activity will more than offset any reduction in tax revenue.
After meeting with the Minister of Finance, it seems clear that the Modi Government intends to introduce additional forms of stimulus and take measures to attract investment capital. Together with a rising middle class we are optimistic about India’s long-term future. Through our bottom-up research we are finding some compelling opportunities across a variety of sectors with the characteristics we seek: superior earnings growth at attractive valuations, with the potential for positive revisions.