India’s Infrastructure-Build Critical for Growth and Inclusive Prosperity

By Moses Harding, Group CEO & Chief Economist, Srei Infrastructure Finance Ltd

Sentiment shift from gloom and doom to hope and euphoria

India is different now from what it was a year back! During the period July 2013-May 2014, India was at risk of a sovereign-rating downgrade to junk status due to a severe deterioration in macroeconomic fundamentals beyond comfort levels. The outlook was not optimistic, with worries around policy paralysis, regulatory irritants and administrative bottlenecks in the absence of political stability. India was not seen as an attractive destination in which to invest for businesses. All taken, the Indian economy (and its financial markets) went into a phase of gloom and doom!

Come May 2014, the change of guard in the government under the leadership of Narendra Modi, with a political majority mandate, made a big difference. As a first step, Modi built bridges internally with state governments, worked for establishing cordial relationships with neighbouring nations and reached out to deep-pocketed, developed economies to invest in India, to make in India and to buy from India. Modi’s vision is built around three Ss: to build Skills and Scale at great Speed, backed with positive statements—the “red tape is off, and red carpet is on” and “make in (for) India”—that attract external investments, finance, technology, intellect to participate in the evolving Indian opportunities. India’s huge consumption potential has been opened up to domestic and external investments. Quickly, Modi has brought together all the political, administrative and bureaucratic channels under one agenda of “India economic and social prosperity”. The worries (and risks) around policy paralysis, regulatory irritants and administrative bottlenecks are largely behind and seen as no longer relevant. Modi looked beyond economic prosperity for inclusive social well-being with a focus on financial inclusion, rural and agriculture development, a “clean” India and an increase in the consumption capabilities of the large Indian population through expanded geographical coverage, employment and wealth creation. If these efforts are converted into inclusive prosperity, the pyramid structure of India’s consumption will be smashed in exchange for a buildup of a very large belly constituting huge mass and affluent segments promoting consistent and sustainable growth in consumption, which will lead to sustainable investment opportunities in India’s economic-capacity expansion. All these will lead to hope, optimism and euphoria for the long-term, sustainable growth prospects of India.

During this transitional period, India was lucky on account of strong external tailwinds. The sharp fall in Brent Crude (from over $115 to below $60 per barrel) and gold (from over $1,400 to below $1,200 per ounce) made a big difference for the current account deficit (CAD) and consumer price inflation (CPI), and had a beneficial impact on the fiscal deficit through the adjustment of the fuel subsidy against the lower cost of landed imported commodities. The plentiful flow of off-shore liquidity, thanks to QE (quantitative-easing) programmes of developed economies with zero (or negative) interest-rate policies, released pressure on domestic liquidity and the rupee exchange rate. These “luck” factors have impacted India’s macroeconomic fundamentals, and the re-rating of India’s financial markets has led to hope, optimism and euphoria for the Indian economy—now seen as one of the world’s best growth destinations, even ahead of China. India has emerged as the strongest economy amongst the BRICS nations with a combination of strong domestic potential and good external appetite.

Macroeconomic fundamentals in great shape for sovereign-rating upgrade

The road map ahead for India’s economic prosperity is enviable for global investors. The FY16-FY19 targets for GDP growth of 8-10 percent, fiscal deficit of 3.0-3.9 percent, current account deficit of 0.5-1.5 percent and consumer price inflation of 4.0-6.0 percent will help to set up a firm base for building scale. There is more upside potential (with low downside risks) beyond FY19, if scale is built on this strong platform. The monetary environment has already turned supportive for growth. RBI (Reserve Bank of India) has begun the rate-reversal cycle with the delivery of a 50-bps (basis points) rate cut so far in 2015, in preparation for a shift of system liquidity from deficit to surplus and for a one-percent push of the operative policy rate shift from a repo to a reverse repo rate, from the higher to lower end of the LAF (liquidity adjustment facility) corridor (presently at 6.50-7.50 percent).

The Railway and Union Budgets for FY16 have laid out the investment and growth plans for FY16-FY19. The focus clearly revolves around infrastructure to build linkages for the scaling-up of the manufacturing and agriculture sectors. The growth rates in these core sectors are well below average, at sub-2 percent. These sectors hold the key to taking India’s GDP into a sustainable double-digit growth phase. India has already gone through the first phase of 25 years of liberalisation since 1991. The second phase is seen to be the golden era for India. The catalyst will obviously be from the low cost of debt and equity capital, and a sovereign-rating upgrade in 2015 will help to attract more off-shore money at affordable cost.

Infrastructure development is the central theme for FY16-FY19

The government has already moved ahead in its vision to build infrastructure. There is absolute clarity on long-term strategies, and building tactics are works in progress, while the execution machinery is geared up for speedy roll-out. The focus is on economic and social infrastructure. There will be huge investment opportunities in logistical infrastructure for roads, railways, air and seaports, power, telecom, defence, etc. The focus is also on building clean and renewable energy and building social infrastructure across affordable housing, employment generation in rural and semi-urban India, and meeting the basic requirements of quality education and health. All these will open up opportunities for off-shore manufacturing entities to participate in building India’s infrastructure through the export of machinery, technology and knowledge capabilities and for investors to participate in long-term value creation. When lenders are struggling with excess liquidity and limited viable financing opportunities elsewhere, India has opened doors for them to participate in low-risk/high-reward, long-term opportunities.

The government has already reaffirmed its commitment towards building infrastructure through budgetary-investment allocation; creation of a dedicated investment fund; permission for issuance of cost-efficient, tax-free bonds; revitalization of the Public-Private Partnership (PPP) through rebalancing of risks; creation of five new Ultra Mega Power Projects in the plug-and-play model for hassle-free execution; 10-year tax holiday for power projects; extension of plug-and-play models to roads, ports and railways; and many more pipeline policy initiatives to build world-class infrastructure. Special emphasis has also been made on the creation of smart cities, putting Special Economic Zones to work, and on the creation of the International Financial Services Centre to compete with other major centres in Asia.

The need for infrastructure in India is huge, given its wide geography and large population. The resultant demand for goods and services leading to higher wealth creation and consumption needs are to be met with very high levels of investment flows into India through long-term, direct investments and finance. It is pertinent for India to emerge as a destination with “ease of doing business”. The issues around easy entry, timely execution, efficient operations, hassle-free exit options and other irritants around labour and legal matters are being addressed with policy initiatives across land, labour and legal laws and are withstanding the tests of international standards and fair practice. All combined, the government is seen to be leading from the front and creating viable opportunities for domestic and foreign entities to partner with India in the next-generation growth agenda for financial prosperity.

Great opportunities ahead for foreign infrastructure companies

While infrastructure expansion is in slow-down mode across developed and emerging economies, India’s is opening up. Given that kind of scale, India cannot execute the infrastructure-build agenda with the limited expertise and bandwidth of its domestic companies. It is a great opportunity for foreign companies to build their balance sheets through Indian participation. The country’s FDI (foreign direct investment) norms have been liberalised to attract foreign investment in partnership with Indian companies. The opportunity to build and export from India is huge across high-end machinery, technology and skilled human resources. The combination of money power and capabilities of foreign companies can be put to work for higher productivity and financial efficiency. Modi is promoting the model of “build in India for India” instead of “build outside and export into India” for international manufacturing companies. India has emerged as a global hub for software technology, research and development for pharmaceuticals, business-process outsourcing, etc., and now is the time for India to emerge as a global manufacturing hub!

The time for global investors to increase their India appetite and exposure

Liquidity in the hands of global investor (and financing) entities is huge, and opportunities elsewhere are few. On the back of India’s sovereign-rating upgrade sooner rather than later, it is time for global investors, spanning across banks, financial institutions, private equity and venture-capital funds, sovereign funds, provident and pension funds, and family trusts to review their India exposure and risk appetite. The combination of higher return on investment against rupee exchange-rate stability over the long-term is an attractive proposition. The opportunities can be realised through direct or indirect exposure, and in investments in structured investment and financing products. The various options range across extensions of lines of credit to domestic financial intermediaries (banks or non-banking financial companies), direct exposure on projects (with or without credit comfort from domestic financial entities), investment into infrastructure debt funds (IDFs), alternate investment funds (AIFs), asset- or cash-flow-backed security trusts (REIT and InvIT funds), etc.

Investors’ entry strategies largely revolve around brand effectiveness, management capabilities, product and service efficiency, and the strength of the financial balance sheet against the comfort of a long-term, sustainable growth momentum that creates a consistent flow of opportunities. Brand “India” stands out against most of its peers given its re-rating in the macroeconomic fundamentals with a vibrant financial system and tight regulatory framework ensuring transparency in financial reporting and protection of shareholders’ interests. The management capabilities of India Inc. have been established beyond doubt, as many Indian companies have turned global since India’s economic liberalisation. The Indian government has emerged strong with a clear agenda to provide good and effective governance. The demand and consumption capacity is huge, which opens up supply-side opportunities for capacity expansion for monies to be put to effective work. Above all, the upside potential for India’s balance sheet is huge for sustainable, higher growth over the next couple of decades. All combined downside risks on exposure and investments are limited, while exchange-rate adjusted returns can be high, thus offering a higher investment (and credit) risk premium over the domestic markets of foreign investors. The interest advantage between India and developed economies is already under a squeeze. The India-US 10-year spread is down from more than 6.5 percent to below 6 percent. Given the inflation outlook in India at 4 percent and in the US at 2 percent, the differential is on a downtrend towards 4 percent, allowing for 2-percent real returns, against the rupee’s emergence as the strongest global currency, evident from its sharp appreciation against the euro, GBP and JPY. This scenario is truly an investor’s delight!

India’s emergence as the most preferred partner for developed economies is the bullish trigger

The relationship between India and developed countries such as the US, Eurozone members, Japan, Australia, Canada, China, to name a few, has significantly improved, thanks to Modi’s aggressive initiatives and open invitation to partner with India in its glorious growth phase. This platform is built on the “give more–take less” model, which feeds into the huge domestic appetite from emerging opportunities, thus making it the best time for long-term entry by foreign entities with the greatest rewards. It is also a great time for foreign institutional investors to invest in India’s booming capital markets and to participate in the next round of re-rating through FY16-FY19. The re-rating of the Indian financial markets since August 2013 is very significant, and the present consolidation phase in FY16 will set up a good entry point for more returns in the years ahead!