India: Ready for a China-style take-off?

We assess India’s prospects of emulating the recent rapid growth trajectory of China.

Key points

• India’s growth has suffered in recent history from high levels of bureaucracy, inefficiency, state influence and informality.
• In our view, 2014 to 2020 will be looked back upon as the period in which the stage was set for India’s economic blossoming.
• India is rapidly improving its ranking in the ease of doing business index. The government aims for India to be in the top 25 by March 2024.
• The real-estate market has huge potential to grow from a low base, driven by affordable house prices, low mortgage rates, rapid urbanisation, and a young population increasingly forming nuclear families.

It is easy to see the long-term potential for India. It is a country of 1.4 billion people that can grow from a very low base. Income per capita currently stands at around US$2,000, and household debt-to-GDP at just 13%, while two thirds of the population is under the age of 35.

However, for most investors, India has long been simply a story of potential. By some estimates, India was the largest global economy at the turn of the 17^th century, comprising over a quarter of global GDP. By 1990, this had fallen to a roughly 1% (nominal) or a 3% (purchasing power parity (PPP)-adjusted) share. In 1978, economist Raj Krishna coined the phrase “Hindu rate of growth”, to describe the slow pace of India’s economic growth in the post-war period.

Much progress has been achieved since then, especially following the liberalisation reforms that were embarked upon in the early 1990s by the then Finance Minister Manmohan Singh. And the stock market has delivered healthy returns, especially for those exposed to new-breed private-sector companies. However, India has been overshadowed by its neighbour to the northeast – China. Over the last 30 years, China’s income per capita went from being less than India’s to being almost six times larger; is it now India’s turn to shine?

Bureaucracy and inefficiency

India’s growth has suffered in recent history from high levels of bureaucracy, inefficiency, state influence and informality. Furthermore, significant protection for domestic companies against foreign investment and disruptors has hampered the urgency for innovation and progress. India has not been an easy place to start a new venture or to grow your business. However, reforms and initiatives have been implemented since 2014 that attack many of these impediments to progress, and have the scope to unleash India’s true potential.

Some examples of such reforms and initiatives include:

• The introduction of a pan-India goods and services tax (GST) that unifies the country under one system. This provides much better oversight of commerce across India, and pushes all businesses to formalise their accounts and abide by the rules. Importantly, it addresses inefficiencies in transporting good across India, where previously, it was not uncommon for vehicles to be parked along state lines for several days as cargo crossed from one sales tax jurisdiction to another. India suffers from a very low tax take relative to GDP, at around 10-11% over the last three years, and the new GST system might also help to address this.

• The introduction of the Real Estate Act (RERA) in 2016 required higher standards from property developers, which, in turn, provided clearer safeguards for homebuyers and incentivised the faster development of projects. RERA requires the majority of cash pre-sales from a project to be set aside into a reserve account for the completion of that specified project. While RERA has been difficult for developers to implement, it should put the industry on a stronger footing and instil greater confidence in homebuyers to buy housing off-plan.

• The introduction of the Bankruptcy Code in 2016 helped to clarify bankruptcy proceedings and, in turn, to make company promoters more accountable to their lenders. Better clarity and accountability offered to lenders should promote a more efficient system of capital allocation for productive purposes, as well encourage better behaviour from companies.

• The proliferation of feature phones and smartphones, and people’s access to cheap mobile data services. This trend has been enhanced since the introduction of a 4G network across India in 2016, and we may see over 700 million smartphone users in India this year.[1] This, in turn, unleashes all sorts of other initiatives around e-commerce, media and communications, ‘bankarisation’ (access to financial and banking services) and online payments.

• In 2014, the Pradhan Mantri Jan Dhan Yojana (PMJDY) bankarisation scheme was introduced to open bank accounts for the underserved. Over 400 million such bank accounts have now been opened, in a process made easier by the prior government’s Aadhaar scheme, whereby all Indian citizens are given a 12-digit unique digital identification. Almost all adults in India now have a formal bank account or money wallet. The demonetisation shock in November 2016, as painful as it was, helped to jump-start this new bankarisation apparatus. New payments and fintech initiatives have met with significant success as a result of this backdrop of high smartphone and bank account penetration. India’s Unified Payments Interface (UPI), which is a real-time payment system facilitating free inter-bank transactions, saw 2.4bn transactions worth US$58 billion in the month of December 2020 alone.

• There have been many other progress-oriented initiatives, covering a range of areas including urban and rural housing, electrification, roads and sanitation.

Some of these initiatives have been stimulative or painless. But several have been very painful to implement. You can envisage this by putting yourself in the shoes of an informal entrepreneur with interests in many areas, including real-estate development, who (like many peers) does not pay all their taxes and conducts a lot of their business in cash. The combination of GST, RERA and demonetisation would completely blindside any such enterprise. This pain was further exacerbated by the stresses in the financial system sparked by the default of a large infrastructure business in 2018, which caused reverberations through the non-bank financial sector, money-market funds and the real-estate industry.

Final stages of reform implementation

However, we believe that we are now in the final stages of the reform implementation phase, and ready to start enjoying the fruits that will be borne. In our view, 2014 to 2020 will be looked back upon as the period in which the stage was set for India’s economic blossoming. There are still many obstacles ahead, but we can see the signs that give us confidence for the years ahead.

Housing affordability, on a price-to-income basis, is now about as good as it has ever been. But India also has very low mortgage rates, and much healthier housing inventory levels. The total size of the real-estate market is only roughly US$50 billion, according to one of India’s biggest real-estate developers, and has the potential to grow much larger on the basis of rapid urbanisation and a young population increasingly forming nuclear families.

Perhaps most importantly, India is improving its ranking in the ease of doing business index at breakneck speed – from 139^th position in 2010 to 63rd place in 2019. The government aims for India to be in the top 25 by March 2024. This is extremely powerful in the context of a very competitive labour force (income per capita at US$2,000), and a very competitive currency (PPP conversion factor of roughly 0.25-3). As a result, we are seeing traction from India’s production-linked incentive (PLI) scheme, which offers perks to companies relocating production to India. Many leading global electronics manufacturers have already announced plans for investment in India.

Consumption growth opportunity

All of the enhanced productivity, prosperity and connectivity will help to drive much higher levels of consumption. And this is with a backdrop of extreme under-penetration of certain products and services. For example, only 2.5% of the population currently own private vehicles, which is the ownership level in the US roughly 100 years ago. You need to go back to the 19^th century in the US to find equivalent urbanisation levels to India, at one third of the population. Mortgage loans relative to GDP stand at just 10%, the same level as the US in 1950. Per-capita annual paint consumption in India stands at 4kg, roughly a quarter of the level in the US. There are, of course, many more eye-catching data points to corroborate the underpenetrated consumption growth opportunity in India.

India will no doubt follow a very different path to China. But we have confidence that it is now very well positioned to enjoy some of the spectacular growth rates that China has experienced over the last 30 years.

[1] Source: Statista.com, February 2021.

Authors

Newton emerging markets & Asia equities team

The team who manage our emerging & Asian equity strategies