Reforming India: just the beginning

By Kunal Desai, Neptune India Fund

As global investors continue to scour emerging markets through the lens of reform potential, India shines bright. Indeed, we think it can sparkle even brighter. We anticipate India’s self-imposed 10-year ‘policy holiday’ to turn into one of the most pro-growth and pro-investment policy calendars seen in Asia in years. The Indian electorate has engineered a historic verdict. We now have the strongest Indian government since 1984, with the pro-market Bharatiya Janata Party (BJP) achieving an absolute majority for the first time in the party’s history.

A false dawn?
There have been false dawns before. But we believe this time is different for three reasons:

  • Firstly, the strength of the BJP government is unprecedented.
  • Secondly, the electorate has voted directly for economic growth and development over populism and caste.
  • And thirdly, this presidential-style election was essentially won by one individual, Narendra Modi — a man with a track record of decisive action during his tenure as Gujarat chief minister.

July budget
Clearly the markets have already celebrated Modi’s landslide victory with a 18.5 per cent (GBP) rally this year so far*. However, we believe the move so far is due to a reduction in political risk premia rather than a pricing in of upcoming reforms. The July Budget will be an important moment for the market as India’s emboldened government has a unique opportunity to push through the next generation of reforms. With significant political capital on their side, we expect a strong focus on liberalising factor markets that have been a binding constraint to growth. The tax system will be simplified and made more attractive for investors, while labour laws will begin to be reconstructed. Most important though will be the outline of the government’s path to sustained fiscal funding. A tax amnesty scheme for black money alongside a large-scale privatisation scheme would be positive for the equity market. The combination of fiscal consolidation alongside a responsible central bank fixated on inflation targeting would certainly be a formidable policy mix.

But isn’t the market wildly expensive? Assessing the value of Indian equities through the market multiple is meaningless. India remains a bifurcated market with huge valuation divergence. Over the past five years, large-cap, quality stocks have been the winners in an era of uncertainty and re-adjustment. As a result, the top 20 stocks on a price-to-book basis trade at a 70 per cent premium to the rest of the market. Mid-caps, meanwhile, trade at a 33 per cent discount to large-caps. Indeed, mid-caps and cyclicals trade significantly below long-term averages — value exists in the market but have you have to find it. The Neptune India Fund therefore remains overweight both mid-caps and domestic cyclicals as they are likely to benefit from valuation support, are under owned and are the most leveraged to the market’s cyclical upswing. This election will prove to be a seminal moment for the Indian market as India likely progresses to be the fastest-growing major economy over the next decade.

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Source: Lipper as at 16.06.2014 in sterling with net income reinvested and no initial charges. Past performance is not a guide to future performance.

Important information: This is not for retail clients. It is intended for investment professionals and is not for forward

Forecasts are not a reliable indicator of future performance. The value of an investment and any income from it can fall as well as rise as a result of market or currency fluctuation and investors may not get back the amount originally invested. Investments in emerging markets are higher risk and potentially more volatile than those in established markets. Past performance is not a guide to future performance. Some information and statistical data herein has been obtained from sources we believe to be reliable but in no way are warranted by us as to their accuracy or completeness. Neptune funds may invest more than 35 per cent in government and public securities in a number of jurisdictions.

These are Neptune’s views and as such this document is deemed to be impartial research. We do not undertake to advise you as to any change of our views. This is not a solicitation or an offer to buy or sell our funds. All information is given in good faith but without any warranty. Neptune does not give investment advice and only provides information on Neptune products.