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Rewriting the rule book: How corporate reform is reshaping India's investment prospects

  • Nov 2023
  • | Abhinav Mehra
  • | India team

According to the International Monetary Fund, India is on track to become the world’s third-largest economy by 2027.

It’s impressive when you consider this will push it ahead of countries like Japan, Germany, and the United Kingdom. It’s even more impressive when you consider that the nation’s first modern-era appearance on the IMF’s top ten ranking only came in 2010.

The world’s most populous country is clearly on a very impressive growth trajectory; and at the centre of it all is ongoing reform.

By this, we mean reforming the wider economy. This was catalysed by economic liberalisation in the 1990s before being cemented with the creation of a common market in the 2010s.

But we also mean reforming the rules governing how companies do business in India. Specifically, making it as easy as possible for them to operate when they follow the rules, and holding them to account properly when they do not or cannot.

The Indian government has been on just such a campaign of corporate reform for more than three decades now, and the pace at which it is driving change is only accelerating.

As we’ll examine, we believe that its efforts not only underpin India’s impressive economic growth forecasts but they are also the driving force behind the increasingly large pool of quality stocks emerging as clear opportunities for foreign investors like ourselves.

Economic liberalisation

Until the early 1990’s, the Indian economy was characterised by heavy government intervention, protectionism, and limited foreign investment, resulting in weak economic growth. In an attempt to avoid a looming crisis, the nation’s government – under the watchful eye of Prime Minister Narasimha Rao – embarked on a period of economic liberalisation from 1991.

These efforts took a number of forms and permeated a range of sectors. But the overall goals throughout were to increase foreign direct investment by simplifying trade policies, encourage business activity through deregulation, and stimulate private sector growth by privatising state-owned enterprises.

And it worked.

India developed into a thriving economy. Companies could expand and compete more effectively, foreign capital, tech, and expertise flowed into the country, and many new jobs were created.

As a result, the nation’s GDP per capita rose to an annual rate of 6% in the years after the reforms began and exports grew at an annual rate of 17.3%. Meanwhile, India’s score on the Fraser Institute’s Index of Economic Freedom rose from 4.8 in 1990 to 6.2 in 2000.

Corporate reform

After an extended period of consistent growth, the Indian economy – like all economies – began to feel the pressure in the wake of the 2008 Global Financial Crisis.

Its export growth rate slowed from 15% to 5%, the rupee depreciated, interest rates increased, and foreign investment stalled. Naturally, defaults and debts rose, and the greatest victims – the banks – were subject to a government rescue attempt in the face of soaring non-performing assets.

As highlighted by Indian economist Sanjeev Sanyal in a recent podcast, the solution to ensuring ongoing growth was clear – further reform; and this time, the Indian government’s focus shifted even further towards the regulation of corporations.

This again included many directives covering many areas. But among the most significant moves was undoubtedly the introduction of the Companies Act in 2013.

Updated in 2017 (and further in 2019 and 2020), this was a root to branch reform of corporate governance in India, clearly establishing the duties of companies and directors by building on the basic objectives of the original Companies Act of 1956:

  • Ensuring a standard of good behaviour and honesty among company management;
  • Providing shareholders with more effective participation in management decisions;
  • Requiring a fair and accurate picture of a company’s finances in its disclosures;
  • Establishing proper accounting and auditing standards;
  • Capping the portion of profits that can be paid to managements; and
  • Enabling the investigation of potential conflicts of interest and responsibility.

An equally important milestone then came in 2016 with the introduction of the Insolvency and Bankruptcy Code. This was designed to fix India’s historically weak system for cleaning out companies no longer functioning as a going concern by introducing:

  • Stricter timelines for insolvency resolution;
  • Creditor committees to make decisions on resolutions;
  • An expansion of corporate insolvency to both companies and LLPs;
  • Professional insolvency agencies to manage resolutions;
  • Fast tracked insolvency for smaller companies; and
  • Priority for creditors.

Taken together, the implications of these reforms are vast.

The Companies Act enhances shareholder rights, mandates corporate social responsibility, introduces board accountability, and ensures investor protection. The Insolvency and Bankruptcy Code, meanwhile, facilitates the timely resolution of non-performing assets, freeing up capital for banks and incentivising responsible borrowing.

In short, then, the pair set out to reform India’s approach to corporate governance entirely. And a look at recent figures suggests they have been very successful in doing so.

India jumped 79 positions in the World Bank’s Ease of Doing Business 2020 ranking between 2014 and 2019. This suggests vast improvements in its regulation of companies and its protection of consumers and investors.

Meanwhile, a corresponding leap in foreign investment not only helped to keep GDP growth strong through much of the 2010s, but it also enabled the India to bounce back remarkably after Covid.

In fact, the nation’s GDP growth came in at 9.05% in 2021 and 7.00%% in 2022 ­– far above the global averages of 6% and 3.1% respectively.

The next chapter

Widespread corporate reform corresponding with prolonged economic strength is, of course, excellent to see in India.

Still, if the nation’s economy is to reach the heights forecast – especially by 2027 – then further changes to the ways in which firms operate and are held to account seem inevitable. It is these, after all, that stand the best chance of sparking the additional levels of direct foreign investment required to sustain long-term economic outperformance.

The good news is that such changes are now emerging across two areas in particular.

First-of-all, the Indian government is continuing to tackle the nation’s ongoing problem of over-bureaucratisation through an approach Sanyal refers to as “process reform”.

This is pretty much what it sounds like – going through the economy sector-by-sector and removing any red tape unnecessarily slowing down the progress of related companies.

As of February 2023, the Indian government reported that it had already eliminated more than 39,000 compliances to foster ease of doing business. A further 3,500 provisions related to minor technical or procedural defaults, meanwhile, had also been decriminalised.

But while this is excellent progress, the sheer size of the Indian economy means these efforts are likely to take several years to complete.

The second area where we expect to see reform over the coming years is India’s judiciary system.

As it stands, the nation’s courts have a backlog of some 40 million cases, as at April 2023. That’s a chronically large amount. And in a market-based economy underpinned by contracts held between two or more parties, it’s a very big issue.

How, for example, can someone run their business, if their contract dispute will not be handled or enforced for three years?

That’s a specific example. But it goes to show why India’s flawed court system may represent a significant constraint to growth. And it goes to show why calls for reform system are growing significantly.

It may take time; but as pressure continues to mount, we expect to see the government and the judiciary spearhead a move towards a simpler, more efficient court system over the coming years.

This, as far as we’re concerned, will be another big tick in box for India among foreign investors.

Expanding opportunity set

As things stand today, our view is improvements to India’s corporate governance standards are being underappreciated.

Clearly, all of the nation’s issues are not yet resolved in this respect. However, the direction of reform is clear and there is little doubt in our view that foreign investment will continue to rise in response.

Initiatives like the Companies Act and the Insolvency and Bankruptcy Code, along with emerging process and judicial reform, are driving consolidation across many sectors.

We aim to benefit from this by owning a portfolio of leaders in categories with lower levels of penetration. As penetration rises over time, these holdings should control a larger share of a much larger market.

As the trend towards improving corporate governance continues in India, we look forward to benefitting from an ever-increasing pool of opportunities as more and more companies see the benefits of listing.

In making India a more attractive investment destination, these measures should also help the nation to remain on track for becoming the world’s third-largest economy within just a few short years.

Important Information

This document does not purport to provide investment advice and should not be relied on for the purposes of any investment decision. It is not an offer to sell or the solicitation of an offer to purchase shares. In particular this document is not intended for distribution in the United States or for the account of U.S. persons (as defined in Regulation S under the United States Securities Act of 1933, as amended (the Securities Act)) except to persons who are "accredited investors" (as defined in Rule 501(a) under the Securities Act).  Chikara Investments LLP (Chikara) is not registered with the United States Securities and Exchange Commission as an investment adviser.  This document and its contents are confidential and must not be copied or otherwise circulated to any other person. Certain assumptions may have been made in the calculations and analysis in this document which have resulted in returns detailed herein. This document is based upon information which Chikara Investments LLP (Chikara) considers reliable, but no representation is made that it is accurate or complete and nor should it be relied upon as such. All information and research material provided herein is subject to change and this document does not purport to provide a complete description of the funds, securities or other investments or markets referred to or the performance thereof. All expressions of opinion are subject to change without notice. This document is issued for the purposes of section21 of the Financial Services and Markets Act 2000 by Chikara Investments LLP (Chikara), 31-32 St. James’s Street, London SW1A 1HD, who are authorised and regulated by the Financial Conduct Authority.