With the adoption of socialism following independence in 1947, India’s global GDP weight troughed in 1979 at just above 3 per cent. 
Since then it has risen steadily. Today, we can see meaningful and significant steps taken by the government, the private sector and, most importantly, by the people of India to change their destiny.
With the average age of the population below 29, India will most likely be the world’s youngest large nation until 2056. By 2030 it is possible that India’s economy will have grown three-fold in nominal terms, from $3trn today to $10trn – and be striving for the title of the world’s largest economy by the middle of this century.
Share of global GDP from 1700 to 2008
Source: The Maddison-Project
There are certain moments in a country’s history when it becomes clear that what came before cannot continue. For India, one such moment was 1991. The balance of payments crisis which ended socialism/stasis in the country ushered in a period of reforms and consequently much higher growth. The 2014 election of Narendra Modi as India’s Prime Minister was another.
Around 172 million voters, out of a total of 553 million, voted overwhelmingly for growth and Modi’s BJP party – many of whom were under the age of 22. The impact of youth voters is likely to be even bigger by 2019; as politics change, so will the economy.
A networked power?
In November 2016, Modi unilaterally decided to demonetise over 85 per cent of currency in circulation without warning. Critics highlighted the short-term costs to growth and the inconvenience caused by this move. They also questioned the efficacy of the operation. Taking a step back, a bigger picture emerges.
India over the past few years, via the Aadhaar program, has created the largest digitalised database of people in the world. One billion people have had their fingerprint and iris scanned and registered. In essence, India has created the groundwork for the largest digital and financial network within any country in the world. Demonetisation was just another step on the path towards making India a digital economy. This data network will drive profound changes in the economy.
India is leap-frogging developed nations into the digital age. At one small Indian private bank, an account can be opened and fully functional within ten minutes with only a mobile phone and a finger-print reader. The leading company in digital payments whose offline transactions have soared 12-fold since demonetisation, is helping India bypass credit and debit cards completely. In India, there are around 20 million unique credit card users and around 1.5 million point of sale machines at merchants. But imagine going for a run, no wallet or phone, you go into the local convenience store and buy some water with only your fingerprint – the Indian government is currently trialling this technology today. Frictionless and costless banking has arrived in India before anywhere else in the world.
The private banking sector, especially some of the smaller and more nimble banks who can embrace new technology, are very well placed to participate in the rapid growth of the financial inclusion of the Indian population.
Another aim of demonetisation was to help bring the unorganised, or black, economy into the formal economy by increasing the costs of tax avoidance. In India, most companies will have two books, one for the taxman and one for the owner. It is in this dual economy that the move towards digitalisation is really going to bring about change, as the costs of managing untaxed money and assets begins to spiral upward. The agreed implementation of a goods and service tax (GST) in July 2017 will bring about another profound move towards a more formal economy. In short, the final seller of a product or service has to pay the GST but can claim back the tax paid by all of its supply chain – effectively forcing the entire chain to be either in the formal or informal economy. This is likely to lead to a significant increase in India's total tax income which, latest (2013) data shows, languishes at around 11 per cent of GDP. If this occurs, there will be a reduction, and possibly an elimination, of India's structural fiscal deficit and a renewed ability for greater government investment in infrastructure. It would also likely result in a fall in interest rates and a stronger currency.
India's fiscal deficit vs tax revenue as a percentage of GDP
Source: World Bank, Government of India
Many companies should gain from these trends. For example, we believe mortgage providers in the country will benefit significantly from increased housing starts. Land has been a good place to store illicit wealth; hence land prices are artificially high. Enforced digital land registration will bring land back into the formal economy, increase tax revenues and lower land prices. Government support for middle-income housing is likely to produce significant growth in the housing sector over the next few years.
Don't underestimate the power of these networks
As an example, take a private company that was incorporated in 2006 as an associate business of a famous yoga guru. It initially launched toothpaste and a few personal care products based on Ayurveda, the natural Indian herbal heritage of foods and healing, with the goal of making people “proud of being Indian”.
Using the Swami as the brand ambassador and offering quality and healthy products at a greater discount than traditional fast-moving consumer goods (FMCG) companies, it has created its own distribution network, giving it a significant competitive advantage. Today the company claims it reaches over 1 million retail outlets. The power of the yogi’s network has enabled little to be spent on advertising, a key cost for FMCG products. This saving is reflected in the discounted pricing which, in turn, helps growth. The company claims that it is now the third largest FMCG in the country and by 2020 it aims to be larger than the long-standing number one player; as the company’s investor relations people are wont to say, “the best is best, the rest is rest!” Unfortunately, the company does not need capital but its story should be seen as a Siren's song, emphasising the power of networks and the risk that old business models face. The consumer staples space is one area where we believe increased competition is likely to reduce historic returns.
Information fuels competition and growth
In 2010, a not-for-profit organisation called ‘Invest India’ was established to help facilitate foreign direct investment (FDI) into the country, something which has historically been notoriously difficult. In 2015, India was, for the first time, the world’s largest recipient of FDI by capital investment. Today, Invest India has an FDI facilitation pipeline of $60bn and has received over 58,000 enquiries, which the organisation believes will create a potential 1.7 million jobs over the next 24 months. The organisation spends 80 per cent of its time on facilitation and 20 per cent on promotion. It helps with market strategy and location searches. Most importantly, it liaises with local states and helps with government clearances, and will push for local policy changes when required.
Value of greenfield FDI projects by source/destination
Source: UNCTAD, World Investment Reports 2013 and 2016
The government has started to publish a ranking of Indian states based on ease of access for FDI and doing business. The rankings in themselves have made the chief ministers of the states enact reforms in the pursuit of improved rankings. The pace of improvement is such that it plans to update and disseminate the rankings in real-time. The act of measuring alone is fuelling internal competition and improving outcomes for foreign investors.
According to Invest India, the country is at a tipping point. Out of 29 states, nine have been growing strongly; nine have been growing around 5.5-7.6 per cent; with a further nine likely to move into a growth phase in the next 24 months. The recent elections in Uttar Pradesh, the largest but one of the more deprived states, were won by the BJP with a higher voter share than in 2014, another example of the electorate voting for change and growth.
Ewan Markson-Brown is an investment manager in Baillie Gifford’s emerging markets equity team. The views expressed above are his own and should not be taken as investment advice.