They say that idealists don’t care about the short run, while cynics don’t care about the long run. We like to think of ourselves as realists who believe that what you do in the short run determines the long run. This is how we look at India.
India faces short-term headwinds, as we laid out in our recent blog post. Modi’s surprise decision in November to replace 85% of India’s currency in circulation is having a marked impact on growth. Two and a half months later cash in circulation is still 40% below pre-reform levels, the service PMI remains in contractionary territory and two-wheeler sales are down 38%. In addition, India’s banking sector is undercapitalised which weighs heavily on credit and investment.
On the other hand, India’s medium-term prospects remain bright. To begin with, India is a large closed economy with an underdeveloped manufacturing sector that should be relatively immune to Trump’s protectionist agenda. As a natural rival to China it is also on the right side of Trump’s geopolitical agenda.
Secondly, with the exception of public debt, India has no macro imbalances to speak off — the current account balance is close to zero and external debt is low and falling. Fiscal consolidation remains broadly on track with a FY18 budget that prioritises capital spending. Monetary policy adheres to international best practices with an independent central bank that targets 4% inflation.
Finally, progress on structural reform has been impressive as shown in the above table. India adopted a goods and service tax, introduced a bankruptcy law, liberalised FDI, and cut fuel subsidies. Modi’s reform zeal was displayed again with the recent currency reform. While far from perfect — the impact on growth was probably underestimated and less black market money than hoped was eliminated — the reform’s medium-term impact on tax collections should be positive.
In all, India faces short-term headwinds, but sound fundamentals and a strong reform agenda make it a convincing long-term investment in our view.