A steady pace of implementation of policy reforms can lay foundation of India's read GDP at an average of 6.75%, and the economy would pass the $5 trillion mark over the next 10 years, says Morgan Stanley

The effects of corrective policy measures in India during the past 12 months in the form of adjustments in the real effective exchange rate and real interest rates, and steps to improve the business environment alongside the steady improvement in the external environment, are beginning to show in improving macro stability indicators. Stock markets have responded as well, and there is growing evidence that the market believes in a new growth cycle – the most pertinent signal being the widening gap between bond and equity yields, says Morgan Stanley in a research note.

Morgan Stanley said, it believes that India’s medium-term growth trend will be supported by the inter-play of the structurally positive factors of demographics like strong growth in the working age population, reforms that can help improve productivity and globalisation accelerating productive job opportunities, income and saving. "In the coming 12 months, as policy makers focus on maintaining improvement in macro stability indicators, particularly inflation, we believe that the growth recovery will remain somewhat slow."

"However," the report says, "we believe the cumulative impact of sustained policy measures to improve investment sentiment for domestic and foreign entrepreneurs will begin to support a more meaningful acceleration in gross domestic product (GDP) growth from FY2016 onwards. This will likely lead to a new profit cycle in FY2016, as well as a greater appetite for equities among domestic investors. We believe that domestic households could end up buying in excess of $230 billion of stocks by FY2025, as compared to $40 billion in the past 10 years."
 

_{Source: Morgan Stanley}

According to Morgan Stanley, two key variables that will be critical in reviving India’s growth trend are improvement in the external environment and a pick up in the pace of structural reforms. The global economics team at Morgan Stanley expects global growth to improve further to 3.7% in 2015, moving closer to the last 30 years’ average, giving it the confidence that the external environment will be supportive of India’s growth recovery.

However, policy reforms at home would be even more critical, the report cautions. Over the past five years, the Indian government’s policy was focused more on redistribution and less on boosting productive income growth. Moreover, bureaucratic hurdles and corruption-related investigations have exacerbated the challenges of weak demand and low corporate confidence. This has held back the much needed capex cycle and has been a drag on economic growth, it added.

The reports says, overhauling bureaucratic processes and enacting reforms to lift sustainable growth is imperative. It says, "The macro stability risks of higher inflation, a wide current account deficit and asset quality issues in the banking system associated with such a policy approach has forced a recognition among policy makers of the need to pay greater attention to reviving the productive dynamic."

Morgan Stanley feels that to generate productive employment opportunities for India’s large and growing working age population, higher economic growth rates are needed. Moreover, India’s literate and well-connected middle class is now reaching critical mass, it added.
 

According to the report, India’s relatively lower Gini coefficient as compared with other large emerging market economies indicates that the fruits of higher income growth have been shared relatively evenly across a larger segment of the population and, hence, have supported the rise of the middle class. "As we have seen in other major Asian economies, this middle class will demand greater accountability of policy makers to deliver on reforms that revive the virtuous dynamic of productive jobs – income growth – savings – investment," the report said.

In its base case, Morgan Stanley expects a steady pace of implementation of policy reforms, which will lay the foundations for India’s real GDP growth to move higher to an average of 6.75% over the next 10 years. It said, "If our projections were to come to fruition, India’s economy would pass the $5 trillion dollar mark, a feat that has been achieved by only the US and China thus far and would make India the fifth-largest economy from 10th currently in the world. Accordingly, India’s consumption and investment opportunities would rise to 3.6 trillion and $1.9 trillion, respectively."

Morgan Stanley feels India's strong macro story also means money-making opportunities for stock market investors. According to the research note, there are three themes for this...

1) the macro story leading to the next profit boom – Morgan Stanley said it expect profit growth to average 14.6% over the coming decade

2) the drivers for the rising household ownership of equities, given that equities could compound between 12% and 15% over the coming decade in local currency terms; and, ultimately,

3) India will remain a portfolio manager's delight because of its intense stock-picking characteristics and, ultimately, how all this translates into stock market returns, which will likely make India one of the biggest equity markets in the world.

However, Morgan Stanley cautions about the challenges and risk in the journey towards $5 trillion GDP and $4 trillion market cap. It says, "We see three reasons why this is the case. First, while we have assumed that the global growth environment will be benign and supportive for India, there remain considerable risks to this outlook, as the advanced economies will still have to deal with the challenges associated with de-leveraging, while the emerging markets will have to contend with the challenges associated with a change in their growth models. Second, closer to home, implementing the needed reforms will require a stable political environment that is geared towards providing a reformist push to achieve sustainable higher growth rates. Third, the list of reforms is long and, in some cases, will be difficult to implement in a timely fashion, as consensus will need to be built and vested interests overcome. Overhauling bureaucratic processes and installing transparent mechanisms for allocation of resources and projects, which is critical for kick-starting the capex cycle and infrastructure development, will also be a time-consuming endeavour."

"In addition, there are specific risks to equity returns, including a shrinking free float for foreign investors, evolving corporate governance standards, acute dependence on foreign capital, which causes extreme stock market volatility, and negative real rates," Morgan Stanley added.