06 September 2017 at 2:00 GMT
- New tax looks set to plug Indian deficit
- Modi, BJP party enjoy broad and growing support
- Large foreign inflows have driven up stock valuations
Long term positive, short term risks
- On July 1, India launched a nationwide goods and services tax (GST), its biggest tax overhaul since independence. India has one of the lowest tax-to-GDP ratios in the world and the implementation of GST looks set to plug the persistent budget deficit.
- GST is one of many reforms which have been enacted under prime minister Modi since he came to power in May 2014. In November 2016, the overnight announcement to demonetize all 500 and 1000 rupee notes – effectively cancelling 86% of the country’s cash overnight. The bold and risky move was done to in an attempt to stamp out corruption in India’s cash-heavy economy.
- In conjunction with bold tax reforms and moves to stamp out corruption, Modi has also embarked on a raft of economic reforms to shore up the nation’s finances, including opening up to more foreign portfolio flows, removal of costly subsidies, and extensive fiscal projects to bring power to the most remote regions of India.
- Reforms have been complimented by economic improvements, with India’s current account deficit narrowing from -5% in 2012 to -0.56% now; real GDP in 2016 was a world beating 8% while inflation has fallen back towards the RBI’s target at 4%, allowing rates to be cut.
- While the implementation of some measures has been far from smooth, the end goal justifies the means. November’s 2016 demonetisation crippled consumption and slowed GDP, the GST implementation will likely cause some near-term slowdown.
- Despite some of the difficulties, Modi and his BJP party enjoy broad and growing support. Modi will look to build on this support over the coming 18 months into the next elections working to solidify existing reforms rather than attempting new, riskier ones.
- With an urbanisation rate of 31% -- the same as level as the US in 1895 – structural reforms well underway, and extremely strong and increasingly less fragile economic growth, it’s hard not to be bullish on India’s long-term outlook.
- However, near-term positioning risks warrant caution. $7 billion of foreign inflows have entered the equity market this year, one of the most expensive markets in the region with over a 23 P/E on the Nifty. We also note the $19.6 billion that has gone into the bond market, taking up 99% of the central bank’s allowed quota.
- With positioning high and given India’s sensitivity to rising US rates, a positioning squeeze could inflict pain, but ultimately it presents a long-term buying opportunity.
Mumbai, India: The country's long-term forecast remains bright. Photo: Shutterstock
— Edited by Michael McKenna