Reform Is Key To Growth

Reform Is Key To Growth

Reducing trade barriers, improving capital flows, developing infrastructure or enhancing institutional frameworks are vital drivers of long-term economic and social change. We believe momentum from such reforms is key to the compelling structural growth story in emerging markets.

India – at the forefront of reform

Since assuming office in 2014, Indian Prime Minister Narendra Modi’s government has put in place a raft of reform measures aimed at strengthening the nation’s infrastructure and economic fundamentals. 

Notably, Foreign Direct Investment (FDI) conditions have been reduced or eliminated in a wide range of sectors including defence, real estate, civil aviation and construction. As a result, India experienced record inflows from foreign investors in 2017 and once again featured in the list of top host countries for inbound FDI in 2017, receiving an estimated US$45 billion in investment during the year. Interestingly, half of the nations on this list are emerging market countries, and many will also be able to trace increases in FDI inflows to the implementation of specific reform measures.


Source: From Investment Trends Monitor, No. 28, by UNCTAD, ©2018 United Nations. Reused with the permission of the United Nations.


Creating one of the world’s biggest common markets

Undoubtedly, the headline reform measure from emerging markets last year was in India. The introduction of the Goods and Services Tax (GST) in July 2017 marks a new era in India’s economy by replacing more than a dozen federal and state levies. In doing so, it effectively unifies its US$2 trillion economy and 1.3 billion people into one of the world’s biggest common markets.

By fundamentally simplifying the tax structure, the measure is expected to make it easier to do business; to lower the tax burden (and increase consumption rates); reduce the likelihood of tax evasion, improve government revenues and potentially boost GDP.  


Digital reform

The best example of the ambition of India’s reform programme is Aadhar – the largest biometric ID database in the world – which aims to give every one of its citizens an official, verifiable identity. It has the distinction of being the only non-US technical system in the world that has more than one billion users.  

Upon taking power in 2014 Prime Minister Modi committed to building on this system, and pretty swiftly supplemented it with a financial inclusion programme dubbed Jan Dhan, which to date has created over 300 million new low-cost bank accounts using the Aadhaar IDs. Added to this is a mobile payments app which runs on the government-created United Payments Interface.

As a result, the possibilities for digital banking through the Aadhaar initiative are immense. Following on the back of 2016’s demonetisation process (where around 86% of the country’s cash was removed from circulation), the ‘remonetisation’ of the country is increasingly characterized by a move towards online transactions, paving the way for a boom in digital payments and e‑commerce.


Brazil’s large-scale change

The transformational power of reform is also clearly understood by Brazil. The country has implemented a large-scale plan, spanning fiscal, structural and business environment measures which aim to transform its economy over the next five years.

Included in the agenda is a restructure of state debt. Rio de Janeiro is the first to benefit from rule changes allowing suspension of federal debt payments, in return for implementing austerity measures such as wage freezes and higher state value-added taxes. A federal spending cap has also been approved in Brazil’s lower house. The effects are likely to put the country’s economy on a more solid footing, reducing debt-to-GDP ratios and narrowing its budget deficit.

Corporate governance also features high on Brazil’s schedule of reform. In June 2016, its congress passed a bill that enforced tighter corporate governance in the operation of public sector companies. With a specific focus on the realm of state-owned enterprises (SOEs), minimum levels of qualifications were established for officials running the companies, with political appointees barred from eligibility.  

It’s been a difficult few years for Brazil’s oil production, but recent legislation should provide a welcome fillip for the industry. A formalised bidding process and the elimination of state-controlled oil firm Petrobras’ exclusive rights to operate in the deposit-rich pre-salt area have enabled much greater scope for foreign investment in Brazil’s energy sector. As a result of the increased drilling of the pre-salt basins, Brazil’s overall oil output has increased in recent years, with the prospect of increased investment likely to push barrels-per-day numbers even higher.  


Source: US Energy Information Administration (December 2017)

Active management essential

Far from being an isolated theme, reforms and the tailwinds they bring are evident across many emerging markets, from Argentina’s Fiscal Responsibility Pact to minimum-wage legislation in Mexico.

However, with so many differences in reform initiatives and outcomes, there is a wide dispersion in the benefits accruing to emerging market countries and companies. We therefore believe an active investment approach, focused on stock-driven fundamental analysis is by far the best way to unlock this opportunity.