MADE IN INDIA. Baillie Gifford Pacific Fund January 2015

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1 MADE IN INDIA ENLIGHTENMENT PROVIDES NEW INSIGHTS INTO BAILLIE GIFFORD S PHILOSPHY AND FOCUS. IN THIS ISSUE EWAN MARKSON-BROWN EXAMINES THE ASPIRATIONS OF THE NEW INDIAN GOVERNMENT.

2 Ewan Markson-Brown Investment Manager Ewan graduated MA in Politics, Philosophy and Economics from Oxford University in He previously worked at Merrill Lynch and Newton as an Asia Pacific portfolio manager. Prior to joining Baillie Gifford in 2013, he was a Senior Vice President in Emerging Markets at PIMCO. Ewan is an Investment Manager in the Emerging Markets Equity Team and joint manager of the Pacific Fund. Important Information and Risk Factors The views that are expressed in this article are those of Ewan Markson-Brown and should not be taken as fact and no reliance should be placed upon these when making investment decisions. They should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The value of your investment and any income from it is not guaranteed and may go down as well as up. This article contains information on investments which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned. Investment markets and conditions can change rapidly and as such the views expressed should not be taken as statements of fact nor should reliance be placed on these views when making investment decisions. The Fund invests in overseas assets, priced in foreign currencies. Changes in the rates of exchange may cause the value of your shares to go down. The Fund invests in emerging markets where difficulties in trading could arise, resulting in a negative impact on the value of your investment. The Fund s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced. Past performance is not a guide to future performance. All data is source Baillie Gifford unless otherwise stated. 2

3 India is in a Hurry In May 2014 the Bharatiya Janata Party (BJP) and Narendra Modi won a majority of seats in the Indian Congress. It is an historic turning point for the country. This is the first majority pro-reform government in India s post Independence history. It has an unprecedented chance to turn back the tide of statism, nepotism and corruption that has reduced potential economic growth in the country since Independence and instead move the country towards a path of sustained growth in keeping with its East and North Asian neighbours. We believe the new government s efficiency drive and its focus on Made in India will help lift exports and allow India s sustainable growth rate could be much higher than in the past. INDIA S SUSTAINABLE GROWTH RATE COULD BE MUCH HIGHER THAN IN THE PAST Ideologies and Dynasties The adoption of socialism and the Licence Raj (an elaborate system of licenses, regulations and accompanying red tape that were required to set up and run businesses) in India was an accident of history. Post independence in 1947, India was left contemplating the veracity of the old British colonial system. In reaction, Jawaharlal Nehru, India s first Prime Minister, created a system based upon the Soviet Planning Commission that centrally administered the economy of the country and had Five Year plans along the lines of the former Soviet Union. Later faced by a US-backed Pakistan and Cold War ideologies, Indira Gandhi and the Congress Party led the country further towards the Soviet camp. This culminated in the Emergency, a declared state of emergency across the country in the period , and resulted in the 42nd amendment to the Indian constitution in 1976, which as well as attempting to limit the role of the Supreme court and High courts, redefined the country as a sovereign, socialist, secular, democratic republic. The 1984 assassination of Indira Gandhi and the resultant national mourning led her to become posthumously the most loved politician in the country s history but with the average age in India around 25 years, over half the population today were born after Gandhi s death the ties of memory that bound India to the Gandhi dynasty and socialist cause are fraying. The BJP stands for the antithesis of the Soviet ideology: Hindu, Nationalistic, pro-reform and progrowth. They would argue that both secularism and socialism are part of the root cause of India s so-called Hindu (low) rate of growth since independence. (The longer-term implications of both the religious and nationalist rhetoric are unclear and a lot will depend upon the power struggle between Modi and the right wing of the BJP). The collapse of the Congress Party in the recent polls is an indication that India has a chance to remove communist and socialist ideologies from mainstream politics. With Rahul Gandhi seemingly disinterested and his mother ill, the Congress Party remains leaderless and unwilling to undertake the necessary regicide to begin to rebuild. With Rahul looking to marry his Columbian girlfriend and with his mother s Italian heritage, any heir will only be one quarter Indian, effectively ending the dynasty. A new young, aspirational demography is emerging in India that has little or no attachments to the past and Modi is capturing this vote. 3

4 Made in India The Asian growth miracle which spread from Japan through Korea, Taiwan and into China and South-East Asia had one thing in common: a strong manufacturing sector and high export growth rates. As the chart shows, no emerging country has managed to sustain over 6% real GDP growth without exports rising by at least circa 10% annually. This is logical as exports are necessary to fund the capital accumulation to allow higher domestic investment. India stands out as it has been unable to achieve an average 6% growth rate over the last few decades in-line with many of its East Asian neighbours. The base effect is important, but today India only has a fraction of the market share of US imports compared with China, despite similar sized populations and India s industrial share of GDP has been stagnant for over three decades. Modi believes this can change and the BJP has Made in India a major plank of the reform process. (The stated goal is to increase the GDP share of the manufacturing sector from 16% to 25% by 2022 as well as add 100 million new manufacturing jobs. This goal is aggressive, for example, it took East Asian countries 10 years to achieve an average of 3 5% improvement in the manufacturing share of GDP.) India may be in a hurry but the new government is taking the long-term approach to fundamental change, an indication of their confidence that this is not going to be just a one or two term period in office. They have disappointed the market with the lack of a visible infrastructure development plan or any big bang reforms. However, when existing infrastructure projects have failed to deliver on time, on budget or even at all, it is better to start by making the system work rather than promising what you cannot deliver. INCREASE THE GDP SHARE OF THE MANUFACTURING SECTOR FROM 16% TO 25% BY 2022 Real Growth vs Export Since 1960 Average Real Export Growth, % Argentina Mexico South Africa India Brazil Chile Pakistan Egypt Turkey Colombia Thailand Korea Malaysia Taiwan Vietnam* Hong Kong Singapore China* % Average Real GDP Growth, Source: Emerging Advisors Group. *Figures from 1980 onwards. 4

5 Efficiency at the Heart of Government The new government has set efficiency of government at the heart of the solution of bringing about the required changes necessary to boost exports and hence GDP growth. Past Indian Governments have not had efficiency benchmarks; the BJP has set India s bureaucracy the goal to be in the top 50 countries, in terms of most friendly business regulations globally (see chart). This focus on efficiency, efficiency and efficiency started on day one of Modi taking office, for example, the number of points where a file goes and how long it stays with any one person or department has been cut from 32 points to seven with a maximum stay of seven days per person. Every file at the Prime Ministers Office (PMO) will be cleared within three days. The aim is to create a seamless infrastructure at the top to lead by example. One of Modi s earlier moves was to demand that civil servants work full days. Within the first month of office, civil servants were staying till nine at night and his ministers are said to be working hour days! He has also been quick to correct failure. The new Minister of Railways was asked to leave after five months in office due to lack of progress. THE AIM IS TO CREATE A SEAMLESS INFRASTRUCTURE AT THE TOP TO LEAD BY EXAMPLE EFFICIENCY, EFFICIENCY AND EFFICIENCY THIS FOCUS ON EFFICIENCY, EFFICIENCY AND EFFICIENCY STARTED ON DAY ONE OF MODI TAKING OFFICE 5

6 India lags its peers substantially on ease of business Index Korea 18 Thailand 27 Japan China India Ease of doing business index (1= most business-friendly regulations in CY13). Source: World Bank, Ambit Capital Research. The next step will be to change restrictive legislation: labour reform and nationwide Goods and Services Tax (GST) are high up the agenda, followed by the more controversial Land Reform Act. The inability of companies to hire and fire workers acts as a huge disincentive to expand production and hence limits the ability of companies to achieve economies of scale. Leading reform states like Rajasthan have changed their labour laws with Madhya Pradesh likely to be next. It is probable that we will see a bandwagon emerging as each state tries to outdo the other in attracting FDI, growth and jobs. The second key impediment to Made in India is the lack of a nationwide GST. Currently there are customs at each state border implementing taxes, bribes and confiscating goods, making inter-indian trade and production difficult and expensive a unifying tax would remove these issues in one go, creating significant efficiency benefits plausibly adding significantly to GDP growth. The current target is for this to be implemented in Lastly, domestic infrastructure has been severely lacking. Even if goods could be manufactured in India, the lack of rail transit, has led to the increased use of road haulage, which is slow and unreliable and with the high possibility of not having the same quality/quantity of goods at the destination as at the start. The dedicated rail freight corridor that is being built and expected to be completed by 2017 will solve many of these issues and increase container capacity over six-fold. UNIFYING TAX WOULD REMOVE THESE ISSUES IN ONE GO, CREATING SIGNIFICANT EFFICIENCY BENEFITS PLAUSIBLY ADDING SIGNIFICANTLY TO GDP GROWTH 6

7 Dedicated Freight Corridor Project, India Jamnagar Bhavnagar Mumbai Amritsar Jalandhar Ludhiana Jodhpur Ajmer Udaipur Ahmadabad Vadodara Surat Membal Pune Srinagar New Delhi Agra Jaipur Lucknow Kanpur Allahabad Varanasi I N D I A Nagpur Chandigarh Raipur Patna Dhanbad Howrah-Kolkata Haldia Cuttack Reference Indian Railways 2020 Vision Dedicated Freight Corridors & High Speed Rails, India s Ultra Low Carbon Mega Rail Projects Gauhati Imphal Solapur Kolhapur Hyderabad Dornakal Vishakhapatnam Hubli-Dharwad Kurnool Vijayawada Mangalore Bangalore Chennai Mysore Kozhikode Coimbatore Tiruchirappalli Cochin-Ernakulam Madurai Thiruvananthapuram Route Source Vision 2020 DFC & HSR Vision 2020, and DFC & HSR Source: Harvardton, 3 March The Indian Rupee against the Chinese Renminbi 1 Rupee Equals We believe these reforms will dramatically change the way Indians and multinational companies see India as a manufacturing location. Given that Chinese wages have risen considerably over the last decade and the relative weakness of the Rupee versus the Renminbi, the competitive dynamics are shifting in India s favour. Made in India may well be at the start of the next new global industrial centre Source: Bloomberg

8 Conclusion The elections last year signalled a shift in the electorate away from the Gandhi dynasty, and its associated nepotism, to a more pro-growth and aspirational ideology. We believe the BJP, and especially Modi, can capture and use this shift to help enable much needed reforms within India. The implementation of the government efficiency drive, coupled with Modi s impeccable personnel record, is likely to help transform India s bureaucracy and eventually enable changes to some of the country s stymying labour laws, putting it on the path to become a manufacturing nation. In the short-term, the focus on longer-term goals by the government and high market expectations may lead to near-term disappointment. However, we see economic growth accelerating from here for many years and would expect India to be the fastest growing large country in the world over the coming decades. PAST INDIAN GOVERNMENTS HAVE NOT HAS EFFICIENCY BENCHMARKS; THE BJP HAS SET INDIA S BUREAUCRACY THE GOAL TO BE IN THE TOP 50 COUNTRIES The Baillie Gifford Pacific fund is well-placed to benefit from India s renewed growth and potential export boom, it currently has around 26% of the portfolio invested in India in a number of exciting growth stocks benefitting from these reforms in the banking, industrial and transportation space. THE BAILLIE GIFFORD PACIFIC FUND IS WELL-PLACED TO BENEFIT FROM INDIA S RENEWED GROWTH AND POTENTIAL EXPORT BOOM 8

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