In Part 1 of this series, I had laid out my thesis on why Indian stocks are set for a long term bull market. The second part of this series expanded on the political factors behind the fundamental improvement in the Indian economy. This article will focus on the economic and social reforms that have been undertaken by the new government, as well as potential reforms in the pipeline. India had been a socialist economy for most of its independent history with business running under strict controls. Almost every business activity required permission from the government. This system was infamously known as the "License Raj". The 1991 economic reforms started the sharp growth in the Indian economy. The reforms sharply reduced import tariffs and cut a lot of the red tape associated with business. However, as the foreign exchange crisis receded and the Indian economy grew, the appetite for reforms disappeared. The sharp slowdown in the last few years has allowed a new political dispensation to come to power, using development as the main electoral plank. Here we examine the key reforms that the government has initiated in the first 6 months of its rule and the important ones in the pipeline.
- Removal of diesel subsidies - India imports almost $150 billion of crude oil and its products every year, as the country is deficient in fossil fuel sources. The recent fall in crude oil prices has allowed the government not only to reduce the prices of oil, but also remove the subsidies on diesel. Both petrol and diesel are now subsidy-free. The government is also working on reducing the subsidies given for cooking gas and kerosene. The approach will be directed to provide subsidies only to the needy and eliminate the subsidies given to the richer classes.
- Labor Reforms - India's labor laws are quite stringent making both hiring and firing of workers a big problem for employers. This has given rise to a big informal economy in which most workers do not have any protection or benefits. Even big employers such as Suzuki use "contract workers". These workers are not on the payroll of the company, but on the payroll of contractors who supply workers. They earn much lower salaries than normal workers and do not get benefits. This not only creates friction amongst workers, but also between employers and employees. This recently led to the murder of a manager of one Suzuki factory. The Modi government has already started reforms, reducing the number of forms that employers need to fill to comply with labor norms. He has also made it easier for workers to transfer government pension scheme between employers, by moving most of the transactions online.
- Insurance Reforms - The government is all set to increase the FDI limit in insurance companies from 26% to 49%. The Indian insurance companies have suffered due to lack of capital. The raising of the limit will allow many insurance companies to raise capital from foreign investors.
- Goods and Service Tax Reforms - The government is trying to build a consensus to implement a uniform goods and service tax. This reform has not been implemented, as all the states have to be brought on board. Once implemented, it will lead to a big boost to the country's GDP growth as inefficiencies will be greatly reduced. Currently, a lot of time and money is wasted by companies looking to utilize the differentials between different state taxes.
- Defense Production Reforms -The Modi government has already raised the FDI limit in defense production. It is also proactively trying to invite investors to build ordnance factories in the country. India is the largest importer of defense equipment in the world. Most of its defense production is done by the state owned companies, which are inefficient and make outdated products. India is also trying to encourage its large private domestic conglomerates like the Mahindras and Tatas to get into defense production.
- "Swachh Bharat Abhiyan" - This campaign has been launched by the PM to increase cleanliness in the country. A large part of the country still does not have access to toilets and has to resort to open defecation. This leads to an increase in morbidity and decreases overall productivity. The government is pushing strongly towards increasing cleanliness and insisting companies to spend money in building toilets across the country.
- "Make in India" - India suffers from a high trade deficit, as it imports a huge amount of goods which could be easily manufactured in the country. India is importing toys, shoes, simple electronic goods in large quantities. Domestic manufacturing suffers from many hurdles such as high capital costs, lack of skilled labor, difficulty in getting lands, red tape etc. The Modi government is systematically trying to reduce hurdles and making it easier to do business in India. India currently lacks very poorly in "Ease of Doing Business" index, as compared to other countries. One of the goals is to dramatically improve this ranking.
Lack of majority in the Upper House - While the BJP government has a majority in the Lower House of the parliament, it suffers from a lack of majority in the Upper House of the Parliament. Important legislations have to be passed in both the houses. Opposition parties are creating impediments in passing bills in the house by stalling the functioning over various issues.
The Indian stock market has been almost immune to the turmoil in the global markets due to the tumble in crude oil prices. Even as emerging markets such as Brazil, Russia, South Africa etc. saw their markets and currencies fall sharply over the oil price fall, India was insulated. The Indian market still trades just 5% shy of its all-time high, as falling commodity prices will strongly benefit the Indian economy. While the pace of economic reforms may not be fast enough for everyone's liking, the government has shown great intent.
Which Indian market sectors to invest in
The Indian stock market is a large, liquid market with total market capitalization of over $1 trillion and with more than 5000 stocks. Investors can directly put money into the Indian market and also invest in some of the Indian ADRs and ETFs listed in the USA market.
Currently the best sectors to invest for the next couple of years would be cyclical sectors such as banks, infrastructure companies, consumer discretionary etc. Indian IT and non-discretionary consumer stocks are also attractive over the long term.
Banks listed on the US markets are a good long term bet. ICICI Bank (NYSE:IBN) and HDFC Bank (NYSE:HDB) are the two biggest private banks in India and have good track records. IT stocks such as Cognizant (NASDAQ:CTSH), Infosys (NASDAQ:INFY) and Wipro (NYSE:WIT) are also good buys in my opinion.
India will become one of the largest consumer markets in the world, with a large growing population moving from the "low income" category to the "middle income" category. The only thing stopping the Indian economic growth has been Indian leadership. After 20 years, a government has come which is strongly focused on development and passing social and economic reforms. Falling commodity prices is a boon for the Indian economy, which is heavily dependent on commodity imports. A large number of favorable factors are converging to make India as one of the best places to invest in over the medium and long term. I would use the temporary small correction in the last month to add to my Indian positions.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.