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Focus on infra, manufacturing

If the new government delivers on those fronts, that should ensure a secular, long-term bull market

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Devangshu Datta
Last Updated : Jun 01 2014 | 10:51 PM IST
The random nature of short-term stock market movements can obscure long-term trends. India, for example, often sees huge intra-day volatility and also big swings on a weekly basis. If those swings are filtered out, however, it becomes clear that the long-term trends have been very positive for the Indian market.

In US dollar terms, Indian stock indices have returned over 16 per cent per annum compounded in the past decade and over 10 per cent compounded in the past 20 years. Even after adjusting for inflation, those returns are comparable to the best in the world.

Over several decades, India's GDP (gross domestic product) growth rate has risen steadily. It was below 2.5 per cent in the 1970s. It rose to 4.5 per cent in the 1980s, and to six per cent in the 1990s, and to over seven per cent in the 2001-2011 period. The rolling ten-year GDP average growth rate is about 7.5 per cent. In that sense, the dip to below five per cent in the last two financial years is an aberration.

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Earnings growth rates have been much higher than GDP growth rates (even after adjustment of EPS for inflation). The increasing corporatisation of the economy also means that the contribution of listed firms is likely to increase as a share of GDP. Those are both good signals for the stock market.

A lot of problems have become apparent during the recession. Net-net, investment has not only declined as a percentage of GDP, it is also generating less in the way of growth. The ICOR or Incremental Capital Output Ratio was a fairly decent 3.5 during the boom five-year period of 2004-09. This means GDP grew by one unit for every 3.5 units of investment. The ICOR has risen close to seven by 2013-14. That is due in part to unproductive investments, with vast sums stuck in stalled projects.

This long period of low GDP growth and high inflation could represent a decadal trough if the new government turns things around. India has several things in its favour. One is the demographic dividend. A young population means that the ratio of the Indian workforce to dependants could be favourable for decades. Assuming that the new entrants to the workforce can be educated, skilled and employed, it should mean a major boost to growth.

This will be a big ask - the education/skilling infrastructure might not be adequate and the Indian economy doesn't have the sort of manufacturing base where 50-60 million new jobs could be created automatically. However, if this task of educating the youth and giving them employment opportunities is even partially accomplished, growth should accelerate.

Logically speaking, India possesses some of the key factors required to accelerate GDP growth through the next decade. The history of the East Asian tigers and the successive examples of Japan, Taiwan, South Korea, and China, also suggests that it is possible to maintain 10 per cent GDP growth for decades, given a young population, pragmatic policy making and access to sufficient capital at moderate interest rates. But, there are some key differences.

In the Far East, young populations were harnessed to build better infrastructure and to boost manufacturing in the early stages of each economic boom. As quality of education, and of life, improved, the respective economies turned more service-oriented and manufacturing moved to cheaper locales.

India's confused policy-making, and the insane regulations in areas such as labour and land rights, have more or less strangled conventional manufacturing and impacted infrastructure development badly as well. As a result, India has an extremely service-oriented economy, given its low per capita income and poor human development indicators. Policy has to change in order to create manufacturing jobs and to allow the creation of better infrastructure.

Narendra Modi-led government has come to power precisely because the young people voted for it in the hope that the policy changes would occur. If it delivers on that front, there should be a boom across infrastructure and then across manufacturing and that should ensure a secular, long-term bull market.

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First Published: Jun 01 2014 | 10:48 PM IST

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