Active Perspectives on India's Evolution
May 2020 / Investment Management
ndia’s economic potential has largely gone unfulfilled because of the country’s lack of a formalized economy. Numerous recent
developments, however, have reenergized the belief that India may have reached a key point in its development. That said, COVID-19 has created a headwind, and structural challenges mean that India’s transition to a more formalized economy will not be smooth. This provides opportunities for active investors to seek companies capable of sustainable value creation.
Viewing India Through an Active Lens
Drivers of India’s Economic Formalization
India’s growth has been slowed by an economy that lacks the organization, connectivity, and basic infrastructure of developed countries. But major advances in India’s digital infrastructure over the last several years, coupled with a series of governmental reforms, suggest that India has entered a new phase of its economic development.
1. Digital Infrastructure and Connectivity
Thanks to recent efforts by Reliance Jio to build a wireless and fiber-optic network across the country, many Indian cities and villages now have low-cost, high-speed digital connectivity. Access to banking and credit services, e-commerce, and video streaming drives increased consumer spending. Small and midsize Indian businesses now have access to real-time information and point-of-sale systems that power better decision-making for pricing, forecasting, and supply-chain management.
How Reliance Jio Is Reshaping India’s Digital Connectivity
Reliance Jio’s investment in building digital infrastructure across India in the past several years has brought high-speed wireless connectivity to consumers and businesses across India.
Before Reliance Jio
After Reliance Jio
• INR 250 – 20,000 (Per GB of Data)
• < INR 130 (Per GB of Data)
• Expanding and Shifting User Cases
• Voice, SMS, Radio
• Audio and Video Steaming (Primarily Through Bundled Offerings by Telcom Players), Online Gaming, Social Media, News
Source: Reliance Jio Investor Presentation and William Blair, as of October 26, 2019. INR refers to Indian rupee.
• 256 Kbps (Download Speed)
• 21 Mbps (Download Speed)
• Increasing Usage
• 240 MB (Avg. Data Usage Per Subscriber Per Month)
• 11.7 GB (Avg. Data Usage Per Subscriber Per Month)
2. Governmental Policy
India has experienced more meaningful economic reforms in the past few years than in the previous two decades combined. Prime Minister Narendra Modi and his government have aggressively implemented changes designed to formalize India’s economy, improve financial inclusion, and limit the influence of graft and crony capitalism. Financial inclusion and the shift toward digital payments are helping to address the widespread corruption and “leakage” that have been a drag on India’s economic growth.
Unified Payments Interface
To reduce the country’s reliance on cash transactions and fight corruption and tax avoidance, the Modi government announced in November 2016 that it would replace existing 500- and 1,000-rupee banknotes. This, along with direct deposit of government subsidies into recipients’ bank accounts, has begun to reduce the influence of the “black economy.”
In 2017, India implemented a new goods and services tax (GST). The tax is designed to streamline India’s complicated system of state and federal levies and improve tax collection from companies that operate within India’s informal economy. In September 2019, India cut its headline corporate tax rate from 30% to 22% to attract private investment and improve private-sector competitiveness.
The National Payments Corporation of India launched UPI in 2016. This fast ACH system is part of the government’s efforts to support digital payments and extend banking services to underbanked citizens. UPI has attracted major investments from Google, Amazon, Ant Financial, and other tech giants looking to promote adoption of their digital wallets.
A November 2019 ruling by India’s Supreme Court involving Essar Steel confirmed the rights of secured creditors in bankruptcy proceedings. Historically, businesses in India could continue to borrow even when they were failing. Bribes to officials in the Ministry of Finance often would result in new loans, leaving the state-owned banks with bad loans.
Realities That Could Constrain India’s Growth
Despite optimism resulting from India’s new digital infrastructure and transition to a cashless, rules-based economy, there are many factors that will constrain the country’s economic growth and progress.
1. Outdated Physical Infrastructure
The dilapidated state of the country’s physical infrastructure is a major barrier to economic activity. Decaying roads and gridlock traffic impede the movement of goods across the country, and an outdated power grid is a major challenge to India’s efforts to enhance local manufacturing. India is experiencing a mass migration to its largest cities, but these urban centers lack the infrastructure to support a surging population.
Infrastructure Investment by Country: India, China, and United States
India’s infrastructure has historically lagged that of the United States and even China.
Source: Michael J. Silverstein. The $10 Trillion Prize: Captivating the Newly Affluent in China and India. Boston: Harvard Business Review Press, 2012. Hours to travel is at an approximate average speed of 75 miles per hour (United States), 50 miles per hour (China), and 35 miles per hour (India). Data is as of 2010.
Hours To Travel 1,000 Miles
2. Air Quality and Environmental Concerns
Seven of the world’s 10 most polluted cities, and 22 of the top 30, are in India. This affects more than just the health of India’s residents; it chokes off economic growth. For example, more than 30 flights were diverted from Delhi on a single day in November 2019 because of poor visibility due to air pollution, and schools were closed and construction halted because of the poor air quality.
3. Unintended Consequences of Reforms
The reforms implemented by the Modi government are creating unintended consequences that need to be managed. For example, demonetization caused liquidity in India’s banking system to surge, and the resulting “irrational exuberance” on the part of lenders led to a rapid deterioration in the quality of their loan portfolios. Separately, the Essar Steel ruling is a positive step in reinforcing orderly rules for bankruptcy, but it remains to be seen how quickly or efficiently these rules will be implemented.
Loan Volume from Indian Non-Bank Lenders
India’s demonetization contributed to a credit crunch, which led to loan volumes from non-bank lenders falling 30% for the 12 months ending in March 2019.
Source: Financial Times. “India’s Shadow Banking Crisis Sparks Credit Crunch.”
4. Legacy of Crony Capitalism
The Modi government’s concerted effort to formalize India’s economy must overcome decades of business practices and consumer behavior that had adapted to a largely underground economy plagued by crony capitalism. These practices won’t be eradicated overnight. It will take many years for Indians to adapt to and embrace the norms that define a formalized economy, and periods of economic uncertainty may threaten progress.
Pursuing Sustainable Value Creation in India
India’s transition to a more formal, organized economy is progressing, but it will likely be a messy, non-linear process. An expanding gap between leaders and laggards could create ample opportunity for active investors to identify high-quality companies that can thrive in this new competitive reality.
Learn how we are applying our rigorous, bottom-up approach to identifying high-quality companies across sectors in India.
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World's Most Polluted Cities
Air pollution is a major threat to economic activity–and quality of life–in many of India's largest cities.
(Avg. Data Usage Per Subscriber Per Month)
₹250 – 20,000
(Per GB of Data)
(Per GB of Data)
(Avg. Data Usage Per Subscriber Per Month)
Uneven GDP Growth Reﬂects Challenge
The uneven pace of India’s growth reﬂects the challenges of transitioning to a more formalized structure outside of a centrally planned economy. This volatility may create additional opportunities for high-quality, durable franchises to gain market share from lower-quality competitors.
India's GDP Growth by Year
Source: Reliance Jio and William Blair, as of October 2019.
Source: AirVisual. Based on average particulate matter pollution scores in 2018.
Source: The World Bank.