Both the UK and India have much to gain from reviving their affiliation during PM Narendra Modi’s visit.
By Edward Smith, asset allocation strategist, Rathbones
In 2010, PM David Cameron chose Bangalore for one of his first transcontinental state visits, promising that taking the economic relationship between India and Britain ‘to the next level’ was a political priority. Since then, bilateral trade, investment and banking have shrunk relative to the size of their economies. Both nations have much to gain from reviving their affiliation during PM Narendra Modi’s visit.
Although declining, the financial relationship remains significant. India borrows more from Britain’s banks than from any other country, and the UK is at least the third most important source of foreign direct investment (FDI - ownership stakes greater than 10%). The relationship is reciprocal: India is the UK’s third most important source of FDI, and the UK is India’s favourite investment destination. However, all these numbers are skewed by a handful of multi-billion pound projects, and new opportunities should be sought.
The widening of Britain’s current account deficit is due to the poor profitability of our overseas investments relative to foreign investment into the UK. Actively seeking more profitable opportunities could help redress the balance. India is starved of investment and needs new technology, public infrastructure and better capitalised banks to lift growth prospects. India also requires $2-4bn of foreign capital a month to fund its current account deficit. In 2013, India was branded one of ‘the fragile five’ emerging markets (EM) after the ‘taper tantrum’ caused sharp portfolio outflows. Today, its current account and fiscal deficits are notably improved, but this is largely thanks to the oil price, and our analysis suggests that India is still somewhat vulnerable to a burst of EM contagion, whether via the US Fed or China. In short, India needs more committed, long-term investors.
Trade has been the worst performer. Shares of each other’s markets have decreased since the millennium, and despite the two countries setting a target in 2010 of doubling trade to £19bn in 2015, it’s just £13.7bn today. Of course this is far less reflective of failed diplomacy than it is of the goods and services each has to offer. Unlike China, India is not the world’s assembly line for the consumer electronics and high-end fashion that dominate our highstreets, while Britain’s major exports are services that are blocked by Indian protectionist laws. Nevertheless, the relationship could be improved.
Britain may consider facilitating a greater presence of its small and medium sized enterprises in India, following Germany’s lead, boosting trade by establishing new supply chains. British banks could also use their global expertise in supply-chain financing. Assembling bank-to-building site cooperatives of British companies to finance, engineer and service dormant infrastructure projects could also be highly beneficial to both countries (partnering with India’s new National Infrastructure and Investment Fund, perhaps). However, it is imperative that Modi opens up many sectors still closed to foreign competition if he is to arrest the slump in productivity growth.
India has suffered from a dearth of capital investment over the last decade, in no small part due to labyrinthine regulation and bureaucracy. Even the government finds it difficult to procure land for much needed public works. Labour laws and the equivalent of our VAT are near unfathomable, even to the Indians, as they are set by myriad local authorities, deterring corporate investment. High profile British ventures have had mixed results, frequently getting caught out by red tape. Of course, Modi has risen to prominence as the man finally prepared to take an haladie* to this.
Modi’s promise of reform captivated markets as soon as he acceded the premiership, catalysing pronounced stock market outperformance. However, his reform agenda is now alarmingly behind schedule, and will only become more difficult to implement in 2016 as his party faces a number of sensitive local elections – members of his own party already boycotted the land acquisition bill on which he ultimately capitulated over the summer. We believe that this is triggering a temporary derating, and investors should expect more volatility ahead.
Modi, like China’s President Xi, is a leader who appears to know exactly what needs to be done to transition his economy to the next stage of growth. Economically, India’s reforms should be easier to implement than China’s, but they may fall victim to the same sclerotic politics that have mired its growth for decades. India is not the new China: By our calculation it would still take over 30 years for Indian GDP to exceed China’s, even if India achieves all of its reform requirements and China achieves very few. Yet it could be the only BRIC economy to grow at a faster rate in the next decade than it did during the last. For that reason alone it should still command investors, and politicians, attention.
*a double-edged dagger from ancient Syria and India.
