1. Will Narendra Modi Magic work: Cyclical recovery likely

Will Narendra Modi Magic work: Cyclical recovery likely

India’s ‘strongman’ is unlikely to change GDP composition, but a cyclical recovery is likely

Updated: December 1, 2014 4:45 AM
Narendra Modi speaks before flaging off the first passenger train between Mendipathar in Meghalaya state to Gauhati, in Gauhati, on Saturday. (AP)

Narendra Modi speaks before flaging off the first passenger train between Mendipathar in Meghalaya state to Gauhati, in Gauhati, on Saturday. (AP)

The rise of ‘strongman economics’…The spate of economic crises that unfolded – from the East Asian Crisis of 1997 to the Lehman Crisis of 2008 – dented the credentials of neo-liberal economics. Over the past decade, aggressive leaders or ‘strongmen’ in leading emerging economies (such as Putin in Russia, Erdogan in Turkey and Lula in Brazil) have sought to fill this ideological void with what we call ‘strongman economics’ i.e. ad-hoc economic policies alongside hyper-nationalism.

Narendra Modi’s rise to power and his key policy initiatives – the Prime Minister’s Jan Dhan Yojana,  Make in India campaign, and the Sanitation Mission – need to be viewed against this backdrop of hyper-nationalistic leaders implementing ad-hoc economic policies.

…rarely has a structural impact on the economy. Cross-country experience suggests ‘strongman economics’ has seldom resulted in the structure of the economy changing. The only common outcomes that each of these strongmen have delivered are lower inflation and higher GDP growth.

The former has been achieved by allowing central banks to focus on price stabilisation and the latter by adopting ad-hoc need-of-the-hour policies to revive growth. We expect the same dynamic to unfold in India.


India may be heading towards a cyclical recovery. India appears to be on the cusp of its ‘fourth wave’ of GDP growth, triggered by the change of guard in New Delhi as well as the policy reset. The new majority government looks likely to kick-start a cyclical recovery and it should be able to control inflation. Whilst Modi is focussed on propagating his pet schemes, the fact that India has a government with a simple majority should mean fewer decisions will be driven solely by political expediency and more  decisions should have a focus on economic efficiency. Modi’s likely focus on breaking down the self-perpetuating triangle of ‘corruption, competition and inflation’ should result in lower inflation.

Investment implications
The Mega-themes that will characterise Modi’s India are mostly the Mega-themes that have characterised the economy over the past five years i.e. (i) the rise of light industrial exports, (ii) the rise of aspirational consumption, and (iii) the decline of ‘connected’ companies. In a cyclical recovery, high-quality cyclical companies would perform well. Finally—and the market is ignoring this theme completely—as India moves into a lower inflation environment, the operating margins of entrenched players will come under pressure.

The rise of light industrial exports. Whilst China’s manufactured exports is 10x the size of India’s, China is losing its competitiveness, as India’s manufactured exports’ growth has exceeded China’s for the past five out of six years. The space vacated by China is likely to be distributed amongst various nations. Whilst India is capturing a share of China’s manufactured exports market too, which sub-sector is India likely to create a substantial mark in?

Given India’s rising expertise in the medium-technology space and its deficiencies on infrastructure and capital, India will likely enlarge its footing most decisively in the engineering goods space, which fortunately requires moderate amounts of capital, labour and technology.
India’s manufactured exports sector is growing at a healthy rate and it possesses formidable competitive advantages in cost and engineering talent. In particular, in light industrial manufacturing, sectors like auto & auto ancillaries, light capital goods, and chemicals seem to have a critical mass of relatively established companies with large export franchises. Here are 13 promising manufactured export plays from these sectors.

Stock-specific impact
Auto & auto ancillaries: Our export plays are Bajaj Auto, the poster boy of India manufactured exports; TVS Motors, our favourite turnaround story in the sector; Bharat Forge, the global leader in forgings; Balkrishna Industries, India’s largest tyre exporter; and WABCO, the well-managed Indian subsidiary of the global leader in brakes.

Light engineering: We focus here on a handful of companies which have built meaningful export franchises – Cummins India, the Indian subsidiary of the dominant American genset manufacturer; AIA Engineering, the #2 player globally in high-chrome grinding media; TTK Prestige, the largest manufacturer of pressure cookers globally; VA Tech, India’s leading water treatment project management company; Triveni Turbines, the leading manufacturer of small turbines (0-30MW); and Elgi Equipments, the second-largest domestic air compressor manufacturer.

Chemicals: We highlight the two most-appealing export plays in specialty chemicals – PI Industries, the best-positioned listed company in agrochemicals; and Aarti Industries, one of the leading suppliers of specialty chemicals to global manufacturers.

The sustained rise of aspirational consumption. The stellar rural wage inflation (10-year CAGR of 13%) has been responsible for the current rural prosperity. Besides the rise blue-collar wages and the number of rural roads and state/national highways are largely behind this step-up in demand.

Urban teledensity in India expanded from 48% in FY07 to 169% in FY12, implying a 4x increase. Rural teledensity has increased by 7x from 6% to 39%, led by Bihar, Bengal, MP and Maharashtra, which together account for nearly a third of rural population.

The continued fall of the connected company. Aidede by a series of landmark legal verdicts, the ‘connected company’ continues to fade away. Secondly, with Modi seemingly focused on maintaining his distance from the crony capitalist construct, the heyday of the connected company is behind us. Thirdly, it also appears that ‘connected companies’ that flourished during the UPA regime are having more regulatory/legal challenges than others. We reiterate that the share prices of such companies are headed towards zero. Since March 2011, our Good & Clean portfolios have beaten the BSE500 by 28% points.

Structural changes unlikely but cyclical recovery highly likely. Despite Modi’s claims of pursuing a mix of the ‘neo-liberal model of economic growth’ and the ‘East Asian growth model’, we believe Modi wouldn’t be able to change the trend path assumed by the various constituents of GDP over the past decades. But a cyclical recovery seems likely as the Centre improves business confidence through able governance.

Pressure on the margins of entrenched category leaders. In a high inflation environment, companies with strong brand names tend to be better placed than their newer, run-of-the-mill rivals, owing to their better pricing power. As a result, over the past decade, high and variable inflation has been a friend of strong companies and an enemy of weak companies. In effect, inflation takes profit from weak firms and gives it to stronger firms. If the core inflation starts coming off, we should be seeing corporates taking operating margin hits instead of hiking prices.


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