For India to reach its peak potential, the consumption story of its youthful middle-class was never going to be enough. The services sector, currently commanding 54 per cent of India’s economy, is incapable of absorbing the teeming graduates emerging each year, a fact painfully underscored by the pandemic. The obvious solution, long understood, has been to pivot to manufacturing and exports. However, despite the structural reforms of the Modi government, the singular lack of capital formation over the past decade has stymied India’s promise.
But then came Donald Trump & coronavirus, the two inadvertent catalysts for a dramatic resurrection of India’s fortunes. Trump’s anti-China rhetoric converged global angst on China’s continued disregard for global order and human rights. This triggered a geopolitical push to position India as the balancing factor in South Asia. Covid-linked disruption of global manufacturing and shipping has only served to emphasize the need to reduce dependency on China.
India has three primary assets in its favour: the potential for significant domestic demand, government’s drive to encourage manufacturing and a distinct demographic edge – Shifting Global Value Chains, White Paper by World Economic Forum & Kearney, Jun’21.
China Plus One
Western democracies and multinational companies prize a rule-based international order and China’s resolute refusal to play by the rules has rattled them. Enforcement of a fascist security law in Hong Kong, militarist control over South China Sea, economic imperialism through the Belt Road Initiative, human rights violations in Xinjiang province, crackdown over its tech giants in a bid to control citizen-data and now embracing of Taliban in Afghanistan are all actions not befitting a responsible superpower.
Suitably spooked, global companies are actively de-risking their businesses from China’s dominance. Japan became the first major country to offer subsidies to its companies to move production out of China into other South Asian countries. Bilateral and multilateral partnerships have emerged to counter China, like the Quad aligning Japan, US, Australia and India. Another such policy measure is the Supply Chain Resilience Initiative (SCRI) by India, Japan and Australia to hedge against China. (Source : UNCTAD, World Investment Report 2021)
The entire South Asia region has benefitted from the ensuing gradual shift of supply chains. India has gained materially in sectors like pharmaceuticals, machinery, speciality chemicals and automobile components. In 2020, India received $64 billion in foreign direct investment, the fifth largest inflows in the world, according to the World Investment Report 2021 by UNCTAD. Despite a weak global investment climate due to the pandemic, in the first five months of 2021, gross FDI inflows to India exceeded $31 billion. These trends signal that India’s star is rising on the global investment landscape as the two-decade-long romance with China loses some steam.
The rapid rise of the Asian Tiger economies in the 1990s was catalysed by high levels of domestic savings being channelled into gross capital formation. The backdrop of a geopolitical environment conducive to export-oriented industrialization helped immensely. India could have adopted the same template but the scale of the country, diversity of its peoples and the complexity of its democracy have been crippling. India’s exports have languished even though India’s labour costs have always been meaningfully lower than those of China. The combination of a beleaguered banking sector, absence of state funding and poor logistics infrastructure has traditionally rendered Indian exports uncompetitive.
However, of late, the Indian government has acquired a strategic focus on export-led growth. Its production-linked incentive scheme (PLI), instituted for sectors like electronics-manufacturing, food processing, battery storage, automobile components and specialty steel, has gained traction over the past year. While it was designed to boost domestic manufacturing it has had a pleasant ramification in the export arena.
India’s merchandise exports rose for the eighth straight month in July to $35 billion, up nearly 50 per cent from a year earlier. Despite the low base effect, India is benefiting from a favourable global trade growth outlook. For 2021, North America is set to see a major import growth of 11.4 per cent and Europe 8.4 per cent. The surprise addition this year, to India’s export basket has been agricultural produce like organic millet, red rice, grapes and cherries which have been a big draw for customers in Europe.
India’s trade with China has also witnessed an uptick with India exporting iron ore, petroleum products, organic chemicals and spices to China. India has set a target of $2 trillion annual exports by 2030, which translates to about 22 per cent contribution to a projected $9 trillion GDP, up from the current 12 per cent levels.
Foreign vs Domestic Managers
Long distance relationships are precarious, whether with people or equities. It pays to be locally present particularly when it comes to managing the complexities of emerging markets. According to a recent study by Bloomberg Intelligence, foreign managers of Indian equities have disappointed as compared to domestic Indian managers. In the period since the Global Financial Crisis of 2008, the performance lag is nearly 5 per cent, as seen in Chart 1. The difference emanates largely from the failure of foreign teams to sidestep companies with governance issues. Tainted companies like Cox & Kings, Zee Learn and PC Jeweller were consistently shunned by local fund managers but inexplicably found widespread support amongst those running Indian equity portfolios from New York, London and Singapore. Vakrangee, a technology company was a constituent of MSCI India and almost exclusively held by foreign investors. This proves yet again, that local knowledge will continue to deliver superior risk-adjusted returns in emerging markets.
India is at an inflection point as the world searches for a new equilibrium in a rules-based order. This hunt for a new normal has positioned India in the sweet spot of global consumption and manufacturing. The reform-orientated Modi government is capable of unleashing a manufacturing and export-led growth model to sustain the momentum of rising incomes and consumption. This structural change will result in a multi-year equity rally and investors should participate in this by soliciting local investment practitioners.
(Praveen Jagwani is CEO, UTI International. Views are his own)