India: Gateway to a multipolar world

“Mexico, India, Vietnam and Turkey stand out as countries that could benefit from US and EU companies diversifying value chains. For example, Mexico benefits from a large, lower-cost labour force, proximity to the US, and a free trade agreement with the US,” the Morgan Stanley report says. But of these, only one country is large enough to rival China as a means of production and as a major untapped domestic market.

No surprise then that Morgan Stanley released a “blue paper” on India on Oct 31 entitled The New India: Why this is India’s decade. The report outlines new digital initiatives, infrastructure projects and efforts to attract foreign direct investment (FDI). The most exciting of which is domestic digitalisation via India Stack which appears to be a consequence of what was viewed as a botched demonetisation programme in 2016.

On Nov 8, 2016, the government of India announced that 500 and 1,000 rupee notes would be taken out of circulation and replaced with new 500 and 2,000 rupee notes. At the time, the Indian government claimed the effort would increase cashless transactions, which was met with some scepticism.

Forward six years, cashless transactions are de rigueur. Digitalisation, which has touched many corners of Asia, is transforming India in a revolutionary way.

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“From my personal experience, I was surprised that I could pay a streetside vendor using my phone. He was selling coconut water by the road in a remote part of Tamilnadu. That’s how widespread digitalisation is,” says Sanjeev Dasgupta, CEO of CapitaLand India Trust’s trustee-manager.

“The pace of digitalisation in India really picked up over the last four or five years. Five years after demonetisation, the number of payments in digital form in India today happen from that genesis,” Dasgupta observes.

The ability of the vendor to accept digital payments is due to India Stack which is essentially a decentralised system. Ridham Desai, managing director of Morgan Stanley India and the lead author of The New India, says without India Stack, plenty of similar streetside vendors would have remained outside of the banking system without any formal access to credit.

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“A street vendor has cash flow and she can show her payments, data and tax filings on India Stack. She can take all that and she can give consent for a bank to access the data and use it to make a better decision. Suddenly, she’s in a position to convert her hawker’s cart into a shop. That is the type of revolution that’s underway. It’s very unique to India; Nobody else in the world has the digital infrastructure that India has.”

What is India Stack?

India Stack is the name given to a set of open APIs and digital public goods that aim to digitalise identity, data and payments for India’s 1.4 billion population. The products, services and frameworks are owned by different entities. Unlike private solutions, India Stack provides interoperability, democratises data and is decentralised.

The stack has three main layers, identity, payments and data empowerment. The Aadhaar card, eKYC and eSign are in the identity stack.

Under the payments stack, the layers are UPI (unified payments interface which will be linked with Singapore’s PayNow), Aadhaar Payments Bundle (for cash transfers), and Aadhaar Enabled Payment Service (AEPS, which facilitates direct transfers and other payments). Other sub-layers are the Bharat Bill Payment System or BBPS (for payment of bills), GST (goods and services tax), Fastag (highway tolls), and income tax.

The data empowerment stack includes a consent artefact (to give banks consent to use data), Digilocker (cloud document storage) and an account aggregator. Three more layers are being added to the stack. The first, OCEN (open credit enablement network) will simultaneously raise credit penetration by transitioning the system to cash flow-based lending. It also has the potential to lower credit costs due to enhanced data access from multiple systems. This will democratise credit for both consumers and businesses.

The second, ONDC (open network digital commerce), will aid the onboarding of merchants across the country and give consumers access to products hitherto available at a higher cost. E-commerce is gaining a share in overall retail. Products are moving from unbranded to branded and small traders are modernising as OCEN enables credit at scale. ONDC enables interoperability between buyers and sellers. As it stands, ONDC could have a disruptive impact on platforms such as ride-hailing and food delivery.

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The third new layer, a digital health ID, will be interoperable across health service providers. This will allow customised insurance and give the population better healthcare access. All these layers are based on user consent.

Decentralised system lowers costs

India Stack has changed the way India processes documents (especially official ones), invests and makes payments. The three secondary layers are likely to alter the way India lends, spends and insures.

“For financial services, the KYC costs are reduced dramatically with eKYC. Previously, a bank would spend about US$10 per customer to do a KYC. With the Aadhar card, costs for eKYC dropped by 95% and are as low as 50 US cents. Suddenly, a whole bunch of people became viable for the banking system. Banks had 300 million new accounts in 2016–2017,” Desai says.

Niraj Mittal, managing director & head of institutional banking group, DBS Bank India, says: “India Stack has unlocked the potential of organised and verified data, promoting financial and social inclusion. DBS has positioned its offerings using this available data to serve its customers. For instance, DBS Bank India offers Analytics-Based Lending (ABL), a completely digital offering for SME customers, promising a quick turnaround on loan applications from decision-making to actual fulfilment. DBS Bank is also collaborating with leading fintech companies in India that provide various offerings to customers on the back of the evolving India Stack.”

Mittal adds, “DBS sees demand in India across various industries, including renewable energy, power transmission, airports, ports, and telecom. New structures like InvITs present opportunities for developers, allowing them to free up their equity capital and create a more risk-acceptable framework for banks to enter.”

“The expansion of digital payments, facilitated by the stack, is an important driver of economic development in India and has helped stabilise incomes in rural areas and boost sales for firms in the informal sector, according to the International Monetary Fund. More importantly, it serves as a model for other emerging markets, it adds.

“The OCEN will allow credit dissemination in India to move from an asset-based activity to a cash flow-based activity and will make it (credit dissemination) far more ubiquitous,” Desai indicates. “There’s no legacy system in India so everything is running on very high levels of encryption standards. It’s very modern because India built all of this within the last 10 years.”

The Covid-19 vaccination drive also succeeded in India because of digitalisation. The Indian government knew exactly how many people got vaccinated and when they were due for their second dose because of the digital platform.

Democracy, highways, railways

Some 30 years ago, the Indian government of the time had initiated an opening up of the economy from her socialist past. However, India has underperformed China in terms of GDP growth and FDIs since then. Part of this was because of its infrastructure; and partly because of its federal system of government, where state governments have autonomy over investment decisions within their respective states.

More than that, Indians vote for both state governments and the central government. Sometimes, their interests are not necessarily aligned. And Desai readily acknowledges that India’s free and fair elections are a risk, according to the Blue Paper.

“India could vote in a weaker government … raising the risk of policy errors. A fractious political situation could also inhibit the ability and willingness of policymakers to continue with the reforms required to achieve a sustainably higher growth rate. Indeed, policy-driven support is embedded in our base-case expectation of a push for capex-led growth,” the blue paper states.

For the time being though, Modi’s government has enabled something termed competitive federalism. “Multinational companies coming to India have to deal with state governments. The Constitution of India empowers the state governments enormously. Things like land, labour, agriculture, and electricity are still state subjects. They’re not something on which the centre can legislate, at will,” Desai explains.

“The only difference between today and say 10 years ago, is that competitive federalism has emerged, where states are competing with each other for investments because the electorate is voting the next government on the basis of their own prosperity, which in turn is intricately linked to growth and therefore states want more investments,” he adds.

In terms of regions, Desai believes that the turnaround story in India is Uttar Pradesh, India’s most populous state. “It continues to be one of India’s poorest states where the average income is one third of India’s average. Now, Uttar Pradesh is inviting businesses to set up shop and is growing its infrastructure and manufacturing base. This has come about since Modi came in because he introduced this concept of competitive federalism, that you need to attract more investments if you want to win elections,” Desai says.

In the last eight years, India has been building 50km of highway daily. It is now putting up a new highway from Mumbai to Delhi which will reduce the travel time between Mumbai and Delhi to about 14 hours for a distance of 12,150km.

In 1989, Desai drove to the city of Baroda in Gujarat from Mumbai — a distance of 440km — and it took him 13 hours. “I did the same journey last year for a wedding and I got there in five-and-a-half hours,” he says. The point is that India’s roads have indeed improved as has the rail network.

A dedicated freight corridor is coming up with railway lines, which will support double-decker trains. This will allow rapid transportation of goods in the industrial corridor. If you look at the turnaround time, which was poor in the past, it has improved dramatically in the last few years, Desai points out. The improved road and rail network is a boon to businesses.

Dedicated freight corridors (DFC) in India are a network of broad-gauge freight railway lines that solely serve freight trains, making the freight service in India faster and more efficient. Although some are partially completed, around 56% of the DFCs are operational. They include parts of the western corridor between Delhi and Mumbai, and the eastern corridor between Delhi and Kolkata. Other freight corridors such as the southern corridor around Chennai, the north-south corridor and the east-west corridor are in various stages of planning and construction.

Challenges remain

For all of India’s potential, in the short term, her GDP growth is likely to continue to slow, from 8.3% in the calendar year 2021 to an expected 6.9% this year, and to 5.9% in 2023. “Growth will likely be a tale of two halves, with a slower first half as the reopening boost fades, and monetary tightening weighs on domestic demand,” say economists at Goldman Sachs led by Santanu Sengupta in a report dated Nov 20.

In the second half, growth is likely to re-accelerate as global growth recovers, drag from net exports diminishes and the investment cycle picks up, he indicates.

Inflation may remain stubbornly high though. The inflation rate for this year is likely to be 6.8% despite government intervention to cap food inflation, while Goldman forecasts next year’s inflation at 6.1%. “We think core goods inflation has peaked, but upside risks to services inflation are likely to keep core inflation sticky around 6% y-o-y,” Sengupta writes in his report.

As a result, the Reserve Bank of India is likely to hike the repo rate by 50 bps in December, followed by 35 bps in February taking the repo rate to 6.75%. Meanwhile, Goldman is forecasting for oil prices to rise to US$110 per barrel (from US$80 currently). That is likely to keep India’s current account deficit at 3.5% in 2023 compared to an expected 3.4% this year.

On the flip side, corporate India is well-placed. Although gearing ratios of services companies have risen since the global financial crisis, manufacturing companies have deleveraged and their gearing is at a 15-year low, Goldman says, which should ready them for a capex cycle.

The Indian government plans to continue investing in infrastructure and capex is likely to rise to 2.9% of GDP in 2023 from 2.6% of GDP this year. Banks are healthy with non-performing assets in a declining trend after peaking in 2017–2018 as corporates deleverage. Capital ratios have improved with CET1 in excess of 9.5% (the Basel minimum is 6%).

“Given that asset quality is already recovering post-Covid, we see adequate capital buffer and enough headroom to start a lending cycle in 2023, as industrial credit demand recovers,” the Goldman report says.

FDI, production and consumption

With corporate and bank balance sheets fairly robust, India is ready for an investment cycle from friend-shoring. According to Morgan Stanley’s proprietary MNC Sentiment Index, which tracks boards across the world discussing their investment plans, India is the flavour of the year.

This Index has remained high for India, up 28% y-o-y for 2Q2022 based on data up to June 30, a third consecutive quarter of strong MNC sentiment. “Relative to China, where we run a similar index, India continued to outperform for the fourth consecutive quarter even as sentiment toward China recovered from an alltime low,” the Morgan Stanley report says.

“India is a lot easier for FDIs and more competitive now. The second reason is that, in our multipolar world thesis, production at the margin is moving out of China and going to other places, and India is a natural destination. There’s government policy support, but one of the most important things is India has a consumer market that is getting bigger. If you’re a multinational company which is looking to sell your goods, it makes sense to go and set up production in India, because you have a [big] market,” Desai points out.

“If there is serious relocation of supply chains, which is what Morgan Stanley is running as a pervasive theme for the next few years, there are very few places on the planet with size that you can actually you can actually go to. India is one of them,” he concludes.