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COMMENTARY

Solid fundamentals, growth drivers make strong case for investing in India

IN THE lead-up to Indian general elections, we've come to expect an increase in populist rhetoric from the political parties vying for power.

This year is no exception. The general election is due to take place in April and May 2019, and we've already seen a number of manifesto promises designed to appeal to India's large rural community, including farm loan waivers, subsidies, and a reduction in the Goods and Services Tax (GST) and unemployment allowances.

A number of these measures could have significant fiscal implications for India's economy and have raised eyebrows among many investors.

Some 800 million voters are expected to cast a vote using one of India's 1.6 million voting machines, which can only take a maximum of 2,000 votes each. For areas without electricity, these machines can also run on batteries.

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However, we take a more pragmatic view. We believe India's growth path, underpinned by policies put in place since 2014 by Prime Minister Narendra Modi, is well-enough established to withstand any short-term challenges.

These policies - including the introduction of the GST, a revamped bankruptcy code, bank recapitalisation and increasing foreign direct investment limits across sectors, as well as the "Make in India" initiative - helped India become the fastest-growing major emerging-market economy in 2018, at 7.3 per cent GDP growth.

GLOBAL MANUFACTURER VISION FROM 'MAKE IN INDIA' SCHEME

Partly in response to Modi's "Make in India" initiative and India's growing middle-class population, we've seen an increase in demand for locally manufactured products. Consequently, a number of original equipment manufacturers (OEMs) have opened factories closer to where their goods are sold and used.

That trend has extended to include the manufacture of components used in other products. For example, one of the world's largest air conditioning (AC) compressor companies has announced plans to move manufacturing to India in 2021 to cater to rising demand for AC units from the country's expanding middle class.

In a few years, we think most personal AC units sold in India will include domestically manufactured compressors.

Whatever the outcome of the election, we believe, there is little scope for any new government to implement radical, populist policies, due to the set-up between the government and its dependency on the Reserve Bank of India to balance its budget deficit. So, in our view, it's unlikely we'll see any major changes to legislation whoever forms the new government.

If Mr Modi is re-elected, we don't expect many material changes to India's economic path.

Even if Mr Modi doesn't win outright, we think it's likely his Bharatiya Janata Party (BJP) will still play some role in forming the new government, possibly as part of a coalition.

REASONS TO BE OPTIMISTIC

We think we're at a turning point for earnings growth. The last few years for earnings growth have been challenging, due to the effects of demonetisation, implementation of GST and the impact of negative headlines from non-performing loans. We think it's likely we'll see a gradual improvement in earnings growth, which would be supportive for equities.

In the longer run, we believe the case for investing in India remains strong as fundamentals appear solid and long-term growth drivers give us reason to look at India in a positive light. Projected gross domestic product growth for 2019 remains relatively robust at 7.5 per cent, and is estimated at 7.7 per cent in 2020. By comparison, China's economy is forecast to grow at a slower rate of 6.2 per cent this year and in 2020.

India continues to benefit from secular growth drivers such as favourable demographics, infrastructure investment, urban consumption growth and increasing income levels. At present, we think consumption should partly aid India's development going forward, with domestic consumption set to become a US$6 trillion opportunity by 2030.

A prudent combination of less tax and increase in government spending, along with an increase in private sector capital expenditure (capex), should likely further sustain growth.

In summary, despite some risk-off sentiment we've seen towards Indian equities in the lead-up to the election, we believe there's still a case for investing in India. Even if there was a surprise election result, we believe the impact from uncertainty would be felt in the short term, because fundamentals remain intact.

  • The writer is Senior Managing Director, Franklin Templeton Emerging Markets Equity