The election-inspired excitement of Narendra Modi’s landslide victory in May has subsided and investors are beginning to question whether the Modi government can actually deliver on their promised reforms. The macro story in India is very powerful, with inflation falling, interest rates dropping and the currency strengthening. All this at time of weakening commodity prices, especially oil, improving India’s external position and further helping to bring inflation down. We view India as one of the better top down investment opportunities globally; while the market has performed well over the last year, the longer term opportunities are considerable.

While the Prime Minister has been busy on the international stage in Japan, China and the U.S. securing major investments into the country, there has also been significant progress to change the way that business is conducted by the bureaucrats within the government. Corruption is one of the key areas under attack. The internet and electronic platforms are being used to allow a far swifter approval process rather than the old system of paper forms needing to be filled out and actioned. In this way the system is not being radically changed, but the mind set and work ethic of key functionaries is changing at all levels. These changes have already led to a doubling of new investment projects to Rs2.2tn July-September 2014 from Rs1.1tr in the same period last year. However, there is little evidence that the economy is doing more than bump along the bottom and expectations for a significant pick up are muted.

India Consumer Price Indices graph

The falling oil price is helpful to India and has facilitated the dismantling of the diesel subsidy. Diesel was the largest contributor to the fuel subsidy, costing the government US$10bn last year. From now on the price of diesel will be linked to the market price. Oil is a major contributor to India’s current account deficit, which has fallen from US$88bn to US$44bn over the last twelve months. At the current level of oil prices the deficit could fall further to the US$30bn level. Inflation has fallen from a peak of 11% a year ago to 5.5% in October. However, inflation expectations remain stubbornly high at around 13.5%, which is a long way from the stated central bank inflation target of 4% +/-2% over the long term. Bond yields are around 8.5% currently and these could fall further to around 6% over the next year. The current governor of the central bank, the BRI, has the support of the markets and is expected to hold interest rates at current level, which would help to squeeze inflationary expectations out of the system, allowing for lower inflation over the long term.

India 10Y Government Bond Yield graph

The role and the use of information technology are going to be transformational in terms of enabling the India growth story. Prime Minister Modi has stated that every Indian should have a bank account by 2016. The success of the electronic identity card held by over 700m Indians, up from 200m in mid-2012, makes this a real possibility. This financial inclusion is coming at a time when access to the internet through smartphones is forecast to grow from 190m now to 500m in four years’ time. This enables businesses to access the rural market in India often for the first time ever. Currently there are 930m mobile subscribers and only 20m fixed telephone lines, illustrating the potential to enfranchise a population into a world of financial services. The very large numbers of young people in India to embrace this technological revolution makes it all the more exciting.

BSE Sensex graph

Valuations for the Indian markets are 15x-16x on a forward PE basis, which is higher than many other Emerging Markets as well as much of Europe at a time when the BSE is up 38% this year, making it one of the best performing markets. However, there are very few other places in the world that offer the potential for such structural growth and at a time when the investment cycle in India should be turning up any time soon.