India goes to the polls

Key takeaways:

• A combination of factors is driving investor confidence in a BJP win. The party maintains a solid economic record, it is well organized and has a record of meritocracy in candidate selection.
• An election victory with a two-thirds majority for the BJP and its partners will enable PM Modi to make constitutional changes.
• India is targeting developed country status by 2047. Policies to achieve this include Production-Linked Incentives, the “Make in India” program and supply-side policies.
• The 2020’s are viewed as India’s “Techade.” the government is increasing its focus on investment in information technology hardware, in particular semiconductors.

India will go the polls on April 19, with voting in the general election continuing over six weeks, concluding on June 1. The incumbent Bharatiya Janata Party (BJP), led by Prime Minister Narendra Modi, is expected to win comfortably. Investors are focusing on whether the party and its partners can win 358 seats—or a two thirds majority in the lower house—which will enable them to make constitutional changes. In the 2019 general election, the BJP won 303 seats, versus 52 of the 543 seats won by the opposition Congress party.

A combination of factors is driving investor confidence in a BJP win. The party maintains a solid economic record, with this year’s gross domestic product (GDP) growth the highest among large global economies. The party is also well organized. Party representatives will be present at the majority of the one million polling stations in India, where 969 million voters cast their votes. The party also has a record of meritocracy in selecting candidates, which creates an inclusive environment and reduces the risk of internal splintering.  

A two-thirds majority of votes for the BJP and its partners will enable Modi to make constitutional changes, addressing some of the biggest concerns among local business and foreign investors. These include unifying the timing of local and national elections, versus the current practice of state elections being held at various times over the year. This could boost productivity as state elections are deemed holidays. There is also the possibility of boosting the government’s ability to raise additional tax revenue with judicial and economic reforms.

Conservative fiscal policy

If he wins a third term, Modi’s focus on conservative fiscal policies is likely to remain in place. The reform of the goods and services tax in 2017, which has doubled collections to US$180 billion, has increased total tax collected as a percentage of GDP to 11.7% in FY22, up from 9.9% in FY20.¹ As such, spending on infrastructure and welfare has increased, and the size of the budget deficit has been reduced.

With rising tax revenues, the government has been able to support green investments and amplify its focus on investment in information technology hardware. Recently there has been a focus on investment in semiconductors, as policymakers seek to increase domestic supply and diversify the technology sectors’ reliance on software services.

“India’s largest population of IT professionals and their AI skills will help lead the AI revolution.” Jensen Huang, CEO NVIDIA.²

On February 29, Modi announced three semiconductor investments totaling US$15 billion. The investments include India’s first wafer fabrication production facility, with an initial capacity of 50,000 wafers per month.³ The plant will be based in Gujarat. These projects will involve joint ventures with leading Taiwanese and Japanese semiconductor companies. In addition, the world’s leading memory chip producer in 2023,⁴ will invest US$2.75 billion in an assembly and testing facility in Gujarat.

Increased labor-force participation

India has a working age population of 900 million; however, only 45% are in possession of an intermediate education. For women, this falls to 19%.⁵ Low by international standards, female labor- force participation is 25%.⁶

Modi has initiated a new education policy focused on reforming laws which are obstacles to increased female participation in the labor force.⁷ The policies include training and potentially quotas to encourage companies to hire more women. The UNICEF and PWC upskill program will complement this policy. UNICEF will implement, and PWC upskill will finance skills education for 300 million people of working age in India, with a focus on women. The program will address skills shortages and fill the education gap created by the COVID-19 pandemic.⁸

Targeting developed country status by 2047

A hundred years after its independence, India is targeting developed country status by 2047. Policies to achieve this include Production-Linked Incentives, which were launched in 2020, and the “Make in India” program. Supply-side policies centering on improving infrastructure and the upskilling of the workforce have also been announced.

Assumptions for India to achieve developed market status by 2047:

• Nominal annual GDP growth of 12%
• Current population growth maintained
• INR/USD depreciation of 2% annually through 2025, annual appreciation of 0.5% thereafter

Improving skills and in turn raising productivity are among the most important policies to achieve developed market status by 2047. While these policies may not be as eye catching as urban metro systems or semiconductor fabrication investments, they are no less important. Increasing the educational attainment of India’s young people is vital to reaping the demographic dividend.

India’s “Techade”

Modi speaks about the 2020’s as India’s “Techade.” In the near term, he is focused on expanding domestic demand, while in the medium term, the focus is on raising export capacity. Free trade agreement negotiations are underway with the European Union and the United Kingdom. The India, Middle East, Europe trade corridor is being developed to take advantage of tariff free access to these markets. These supply-side policies are as important as investments in manufacturing capacity to build a long-term sustainable export base in India.

The fiscal year 2023 budget included three policy priorities for India to fulfill its potential in the Techade ahead:

• Promoting a digital economy, focusing on technology enabled development and energy transition
• Creating a virtuous circle of public and private investment to “crowd in” private investment
• Micro economic reforms focused on expanding welfare programs for the poor
   

Equity-market implications

The focus on investment and raising educational attainment will contribute to the expansion of India’s middle class, ideally lifting millions out of poverty. Companies in the consumer discretionary sector are likely to be beneficiaries of these policies. Our on-the-ground research has also identified opportunities in the health care sector, both in the production of pharmaceuticals and healthcare providers. We also see opportunities in the real estate sector, particularly with companies with balance-sheet strength.      

Foreign institutional investors have recently joined local investors in buying into the India Techade theme, with flows turning positive in March 2023 following a period of foreign fund outflows. Domestic investors have remained resolutely positive this year.

What to watch for

If the BJP wins the upcoming Indian general election, we do not expect any significant changes in government policies. Modi has set out his vision for achieving developed market status by 2047 and will focus on the continued implementation of policies to achieve that goal. If he achieves a two-thirds majority in the election, he will have a mandate for constitutional change, which may include judicial and election reform. These should be broadly positive for investors.

Risks for investors center on the implications of the successful execution of Modi’s economic priorities. A “winner’s curse” could see India’s export ambitions curtailed by an appreciating exchange rate. The INRUSD exchange rate depreciated by 35% over the past 10 years. This was due to a combination of a rising current account deficit and a wide inflation differential with peers, necessitating a weak exchange- rate policy to maintain export competitiveness. In our view, any future exchange rate appreciation is likely to be gradual, so policymakers can liberalize the capital account in stages to manage the upside.

Looking ahead, a reduced dependence on fossil fuel for power generation and a focus on value-added manufacturing for export could result in a currency account surplus, putting appreciating pressure on the INR/USD exchange rate. While import costs would be reduced in this scenario, if India successfully executes its supply side policies, in particular education reform, we believe the country should be able to compete internationally and not rely on a weaker exchange rate.