Cash in on India’s ‘mind-blowing’ potential

India’s stock market has soared by 20% this year, the best performance of any emerging market. It’s all down to one man: the new prime minister, Narendra Modi. Modi revived the Indian state of Gujarat with his business-friendly policies – now voters hope he can do the same for the whole country.

A decade ago, India’s annual growth was heading to 10%. Now it’s half that level. Yes, the global economy has been weak in general, but most of India’s problems are home-grown.

The government spends too much on fuel and food subsidies, while taking in too little tax – only 3% of Indians pay income tax. The subsidies have discouraged private-sector investment and also driven up inflation, which in turn has pushed up interest rates.

“A mixture of bureaucracy… incompetence and corruption” has also deterred investment, says The Economist. As a result, India’s infrastructure is “decades behind China’s, hampering overall growth and also causing bottlenecks, making inflation worse”. There has also been little progress on opening the economy to foreign money.

Has the budget helped?

Given this backdrop, investors were expecting a comprehensive reform programme when the new government presented its first budget last week. They didn’t get it, which is why India’s benchmark Sensex index has fallen by around 2% in the past few days. Still, while it “was not a big bang”, as RBS puts it, it did “hit all the right touch points”.

Finance minister Arun Jaitley said that defence and e-commerce will be open to greater foreign investment. And the tax code will no longer be changed retrospectively, which has proved a major irritant for foreign investors. A federal sales tax will also replace various local levies and cut subsidies, though there was no detail on when and how.

Overall spending will rise by 13%, and will focus on infrastructure such as roads, ports, and warehouses, to revitalise growth. The hope is that this boost for infrastructure, to be funded by a sell-off of state assets, will attract more private investment.

The government has only been in office for a few weeks, so expecting exhaustive reforms may have been unrealistic. In the near term, says Andy Mukherjee on Breakingviews, markets will judge the government on its ability to revive investment, in turn bolstering jobs, growth and consumption. “The budget has done just enough to keep those hopes alive.”

A compelling long-term story

Investors get frustrated by Indian politics, says Anup Bagchi of ICICI Securities. But Indian stocks have never worried them as much. “Managements are very good” and Indian companies have long been prized for their high profitability and their strong presence in services such as IT and pharmaceuticals, as well as high-tech manufacturing.

Note too that India’s population is second only to China’s in size, says Liam Halligan in The Daily Telegraph. And it’s young too – half of its citizens are below 28, providing a rapidly growing workforce, which will be a major source of growth over the next few decades.

Meanwhile, the middle class is growing fast as millions move from subsistence agriculture to manufacturing and service jobs in cities. Between 1971 and 2003, income per head rose from $100 to $500. Just five years later, it had doubled again.

According to the OECD think tank, the middle class could swell from 10% of the population today to 90% by 2040 – akin to the industrial revolution in Europe. All this implies “an awful lot of demand for cars, washing machines, processed food and services”.

In short, India’s potential is “mind-blowing”, says Halligan. Our favourite India play, Aberdeen’s New India investment Trust (LSE: NII), is on an 11% discount to net asset value.