The coming Rupee regime change

One of my favorite people to see when I'm in Mumbai is Navneet Munot . You never leave his office empty-handed or without gaining significant insights. His generosity is particularly remarkable since we have never conducted any transactions together. I work with his competitors.

During my last trip, Navneet gifted me a copy of Krishnamurthy Subramanian's new book, titled India @100: Envisioning Tomorrow’s Economic Powerhouse. This book sat on my desk collecting dust, overshadowed by more formidable literary options. This week I delved into Subramanian's book. Once I started, I couldn’t put it down.

A Regime Change!

Subramanian's thesis is crucial for every international investor considering investments in India. He hypothesizes that a “regime change” is coming regarding the relationship between the Indian Rupee and the US dollar. Conventional wisdom (based on past trends) suggests that foreign investors should anticipate an annual depreciation of 2.5% to 3% for the currency, impacting dollar returns. However, Subramanian asserts that in the future the rupee will depreciate only 0.5%. This is a game-changer.

He identifies two key dynamics behind this shift: First, India is reducing long-term inflation through the Reserve Bank of India's (RBI) inflation-targeting policy framework. Second, significant Indian reforms are expected to enhance productivity growth and boost GDP growth. A dynamic underpinned by investments in physical and digital public infrastructure.

Productivity Growth

Subramanian argues that the current government (which he served) has wisely focused on capital expenditure (capex) rather than revenue expenditure (revex). Capex "crowds in" private investments, while revex can crowd them out. Alongside infrastructure investment, he highlights Production-Linked Incentive (PLI) schemes. Some Indian thought leaders, like Naushad Forbes, are concerned about the sustainability of these policies. His book, The Struggle and the Promise: Restoring India’s Potential, is an important read on this subject.

Productivity growth in India is expected to further accelerate due to the increasing formalization of the economy. Consequently, with a slower nominal depreciation of the Indian currency and an anticipated GDP growth rate of 8% per annum, India could become a $55 trillion economy by 2047. Subramanian's projection also indicates that GDP per capita in USD terms will be higher than previously expected.

2047 will mark the 100th anniversary of India’s independence from British colonial rule.

Reforms, Jobs, and Private Capex

Subramanian's proposition is upbeat. It necessitates India to implement essential reforms that he considers crucial. Notably, judicial reform is needed, as the slow resolution of civil and criminal cases in India remains an issue. Reforms are also required in the Indian bureaucracy to improve the ease of doing business (EoDB). While India has made progress, significant challenges remain; for instance, the regulatory hurdles confronting India’s restaurant industry are staggering. A European friend is currently facing difficulties while trying to distribute a premium energy drink in India. I'm concerned that his enthusiasm for India is being curbed by this difficult journey.

Subramanian also addresses the challenges of creating jobs for India’s youth. This will require unshackling medium and small enterprises (again highlighting the need for reforms) and expanding India’s manufacturing sector. He suggests that India can replicate its success in the auto industry within the electronics assembly sector. For instance, Maruti Suzuki, which started in 1980 with just 883 employees, has spawned a sector that has witnessed employment grow 50,000 times over the past fifty years.

A robust manufacturing sector is essential for developing a substantial Indian middle class. Additionally, India’s economy and labor market must focus on empowering entrepreneurship, increasing privatization, and improving education and skills development. A key aspect of this involves the need for increased private-sector investment, which has yet to materialize significantly. Corporate India's hesitancy—linked to low-capacity utilization rates, cautious sentiment post-Covid, and a strong desire to avoid corporate entanglement—challenges Subramanian's optimistic narrative.

Implications for International Investors

As someone who has invested significant time, passion, and capital in India, I wholeheartedly embrace this new rupee/dollar regime. I would be more than happy to accept a depreciation between 0.5% and 3%. If India delivers a long-term depreciation of around 1%, optimistic investors like me will greatly benefit. More importantly, the fence sitters may finally wade into the waters and view India as a strategic allocation opportunity.