India benefits from reforms and a bit of luck

If reforms progress and the RBI is able to continue to trim rates, India is likely to attract increasing notice from global investors, notes  James Saft.

Titularly now the fastest-growing major economy, India, having left China behind, is positioned for a good year, both in its economy and financial markets. 

India’s 7.5 percent clip of economic growth has edged out China’s 7.3 rate on the most recent readings, making it the fastest grower among the 20 major economies, a title somewhat tarnished by controversy over opaque revisions to how the data is compiled.  

The real challenge, and it may come soon: getting through a Federal Reserve interest rate hike later this year without re-enrolling its membership in the 'fragile five' group of vulnerable emerging markets. 

Perhaps more than the headline growth figures, which have come in for criticism, India's putative strength relies more on structural reforms by the government of Prime Minister Narendra Modi and a fortuitous drop in energy prices which leaves precious room for easier monetary policy. 

Napoleon had a preference for lucky generals, a title Reserve Bank of India Governor Raghuram Rajan might warrant: less than a year into taking a fraught job and the price of India's energy needs, 40 percent of which it must import, tumbled on global markets.

This is a triple boon: reducing the need for foreign cash with which to pay for it, tamping down inflation (and so giving room for growth-friendly rate cuts), and lowering the cost of fuel subsidies which crimp budget spending. 

"Eighteen months ago, India was one of the more fragile of the 'fragile five'. Three issues in particular beset both Indian corporates and foreign investors in Indian asset markets: structurally high and sticky inflation and slowing economic growth, or emerging markets stagflation; twin deficits on the current and fiscal accounts; and stale/poor macroeconomic governance," Maya Bhandari, an asset allocation specialist at fund house Columbia Management, wrote in a note to clients. 

"With helpful policy, politics and propitiousness, each of these seems less relevant today." 

The fragile five: Brazil, India, Indonesia, South Africa and Turkey, were marked out in large part for their dependence on foreign capital flows, money which abruptly repriced in 2013 when investors became concerned about the impact of the upcoming tapering of bond buying by the Fed. 

If a Fed rate hike comes, as many expect, this summer, it will almost certainly make waves in global funding markets but, to judge by recent rises in Indian shares and the rupee, investors are reasonably confident this time may be different. 

Reform and Preparation 

That in part is down to longer-term optimism over reforms brought in by Modi and his BJP, in office nine months, including steps to cut the time needed to register a new business from 27 days to one.

More fraught, and yet to be delivered, are full reforms to make it easier for large industrial developments to buy farmland, now a tortuous process thought to be holding up hundreds of billions of dollars' worth of projects. 

To be sure, recent losses by the BJP in regional elections show that reform is far from a one-way bet, and many will take a critical eye to a critical budget to be released on February 28. 

The RBI, taking advantage of falling inflation, cut rates for the first time in 20 months in January but held off at the beginning of February, instead fine-tuning a reserve requirement intended to push banks to pass along easier money to clients. 

Rajan has already curbed foreign purchases of Indian bonds, to try to limit the kind of 'hot money' flows which drain rapidly in time of stress, as well as limiting the strength of the rupee, a sore spot for exporters.

India has also piled up an all-time high of $333 billion of foreign currency reserves. 

If reforms progress and the RBI is able to continue to trim rates India is likely to attract increasing notice from global investors. Given that consumer inflation has more than halved to about 5 percent in two years, this is a reasonable bet. 

While about $20 billion of foreign cash has flowed into Indian shares in the past year, much of that has been as investors dedicated to emerging markets chose India as one of the best of a risky lot.

So-called global funds, which are nearly triple the size of dedicated emerging market funds, are still substantially underweight India, implying room for a re-weighting. 

India’s moment, not without dangers, may be arriving. 

(James Saft is a Reuters columnist. The opinions expressed are his own)