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Is The Indian Economy Poised For A New Phase Of Growth?

By Knowledge Wharton. Originally published at ValueWalk.

The Indian economy is at a crossroads with major structural reforms underway, such as a unified Goods and Services Tax (GST) that rolled out on July 1 and an Insolvency and Bankruptcy Code that was enacted last year. The GST would dramatically “formalize” the dominant informal sector that drives the bulk of the economy and open it up for credit access. The bankruptcy code will bolster a determined push by India’s central bank, the Reserve Bank of India (RBI), to clean up bank balance sheets of non-performing assets (NPAs) and provision sufficient capital buffers. Those and other structural changes would prepare the economy for sustained growth over the long term, according to Viral Acharya, the recently-appointed deputy governor at the Reserve Bank of India (RBI), who was formerly a professor of economics at New York University’s Stern School of Business.

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India's debt/GDP ratio
myeviajes / Pixabay

Additionally, India’s equity markets are bracing for a much-awaited uptick in corporate earnings, an increasing flow of new investments from pension funds, provident fund retirement accounts and insurance, and a historical shift in domestic household investments in equities overtaking those by foreign institutional investors. With current stock market earnings multiples at “reasonable” levels, higher corporate earnings and a flush of new money chasing limited equity stock, the stage looks set for Indian stock market indices to triple over the next five years, according to Ridham Desai, managing director and head of India Research at Morgan Stanley.

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Acharya and Desai discussed the outlook for the Indian economy and its stock markets on the Behind the Markets show on Wharton Business Radio on SiriusXM channel 111. The show is co-hosted by Wharton finance professor Jeremy Siegel and Jeremy Schwartz of WisdomTree. The segment also featured guest Gaurav Sinha of WisdomTree.

Here are select highlights from their discussion:

Fixing the growth drivers: According to Acharya, it is critical to realize that the Indian economy has “many different drivers of growth” such as private consumption, agricultural output, state-generated output and manufacturing. “It is best to fix the structural conditions for growth, and then when growth comes around, you are ready to capitalize on it in a big way,” he said. He listed the GST, the Insolvency and Bankruptcy code, and regulatory reforms governing the real estate sector among those.

Acharya acknowledged that those reforms may come with some necessary short-term pain. “It’s better to accept slower growth for a short period as long as you are doing the right structural reforms to resurrect that growth to a higher level,” he said. “What doesn’t work is when you do temporary fixes; you are just putting a Band-Aid on what really needs a deeper reform.”

Acharya felt the Indian economy is well-placed on other fronts. On the macroeconomic front, he said growth in output is reasonable with respect to inflation levels; the government’s balance sheet is “quite austere in terms of maintaining a tight fiscal discipline;” and the central bank’s foreign exchange reserves are “quite healthy” relative to imports, external debt and the short-term component of external.

“Credit is a lagging indicator,” said Desai. “You start fixing the growth problem and then credit will come back.” He also felt that the current distribution of credit — a fifth to the household sector and four-fifths to the corporate sector — would change in favor of the household sector borrowing more. “For example, 300 million new bank accounts have been opened after the new government took over. They are all going to come into the formal credit economy.”

“It’s better to accept slower growth for a short period as long as you are doing the right structural reforms to resurrect that growth to a higher level.”–Viral Acharya

GST a game-changer: GST will entail “some temporary hiccups and glitches,” but it would work well “as long as the system remains adaptive and focused towards ensuring good execution and delivery down the road,” said Acharya. “This is a game changer. The Indian economy and the consumers would be the ultimate beneficiaries of the removal of a large number of taxes and complications that have ridden the system to date.”

According to Desai, the GST rollout is a mammoth endeavor that overcame huge odds. “Imagine getting the 50 states [in the U.S.] to give up their power to tax goods and services. It would probably take decades to get that done,” he said. “A lot of people criticize India for having taken 15 years [to roll out the GST], but with the democratic setup that India has and the consensus that was needed to do this was going to take a lot of time. It is not easy to convince 29 states to give up their power to tax, so this is a very big change.”

Culture shift in India: Households in India have historically been reluctant to borrow, and people generally don’t use their credit cards other than for convenience, said Desai. “But the 20- and 30-somethings in the country have no hesitation to borrow,” he said. “With the culture shift that is happening, households will start leveraging much more in the next five or 10 years, which means our estimates for consumption will be too conservative. A fair bit of future consumption will come into current consumption, and it will be a while before household debt gets to a level that will be worrying — that may be a decade or two from now.”

“Foreign investors have invested more than $150 billion over the past 15 years,” Desai said. “We’re forecasting that over the next 10 years, Indian households could invest between $400 billion and $500 billion into equities. Unless it is matched by a huge increase in supply of equity stocks, there will be excess demand for equities in India.”

Institutionalization of equity savings: According to Desai, a huge savings pool that didn’t exist before is emerging and is headed for the equity markets. The National Pension System and the provident fund have always stuck to debt investments, even though they were allowed to invest in equities. But now with the Modi government mandating them to make small allocations for equity investments on a rising scale, they would become significant forces on the stock markets, he explained. Similarly, the insurance industry is also headed towards more equity investments with an expanding growth in a largely underpenetrated market, and the preferred match they find in equity in terms of asset tenures and returns, he said.

“The right way to do this is to get the system to a point where the underlying stress of assets is at rest.”–Viral Acharya

The third big institutional change occurring is the resurgence of domestic mutual funds with more and more individuals opting for “systematic investment plans,” or SIPs, where their investments are automatically deducted from monthly salary checks, said Desai. “The new generation driving those investments has no memory of the scandals of the 1990s and are looking at the equity markets with a fresh pair of eyes,” he said. It helps that the equity markets are now generating excess returns over almost every other asset class,

The post Is The Indian Economy Poised For A New Phase Of Growth? appeared first on ValueWalk.

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