As investors, we love reform because it leads to change, and if the reform is big enough, that change can persist and lead to a long-lived investment theme. These are the best kinds of opportunities because they allow one to compound returns uninterrupted for years, even decades in some cases. Reforms under way in Japan and India, investment themes we have been highlighting for several years, are bound to have significant implications for global markets and economies.
I recently visited both nations to understand the magnitude of their reforms, meeting with investors, companies, strategists, analysts and central bankers. Traveling through both countries in the same week made for a striking comparison. Nominal growth in India, which has one of the world’s youngest populations, has consistently clocked double digits for the past 20 years. Japan, with one of the world’s oldest populations, has not grown at all. While India has been plagued by bouts of inflation, Japan has struggled with outright deflation.
Still, both share something necessary for true reform—a strong leader with broad support for his policies. I think about India as an Internet stock that is expensive and highly volatile, but can eventually justify its hype. Japan is more like the restructuring story that somehow can turn an ugly duckling into a swan.
Structural Reform in Japan
Japan’s economy lacks dynamism, which helps explains its two decades of stagnation. Prime Minister Shinzo Abe understands this, which is why his economic reform, known as Abenomics, centers on changing the behavior of Japan’s households and corporations. Deflation has gripped the country because of a broad belief that growth will never resume; thus, the best thing is to save, spend as little as possible and don’t waste any resources investing for growth.
Japan’s aging population, low birth rate and very high 225% government-debt-to-GDP ratio has been well documented. Less appreciated is how much in savings has accumulated over two decades and how much the typical consumer and the financial system are underleveraged. In many ways, Japan is ahead of the rest of the world on the current global deleveraging because it went through its own financial crisis 20 years ago.
A country cannot save its way to prosperity. The success of reform in Japan hinges on putting the excess savings to more productive use.
India on the Rise
India's drive to development, with its population of 1.3 billion people and vast geographic, social and economic variations, is often described as organized chaos. Enter Prime Minister Narendra Modi, elected in 2014 on the promise that he would fix the broken tracks that have derailed India’s long-term potential.
Modi’s victory has unleashed reforms that should help India move forward in a sustainable way. His greatest legislative victory so far may have been to win passage in the opposition-controlled Upper House for a bill that would raise the cap on foreign direct investment in Indian insurance companies to 49% from the current 26%. In addition, the recently proposed national budget would jump-start infrastructure spending, a move that is in line with our global view that the era of fiscal austerity appears to be ending. Witness Japan’s decision to delay its planned consumption-tax increase, along with Europe’s move to loosen its fiscal restrictions on Greece—and possibly other struggling EU member states.
Modi has also benefitted from the 50% decline in oil prices, which offers fiscal flexibility to the prime minister, while also offering cover to the Reserve Bank of India to begin cutting interest rates—a trend we believe will continue into 2016. This supportive fiscal and monetary policy will help Modi and his reform allies stay on their structural-reform path, much as Japan’s aggressive policy mix has helped Shinzo Abe.
For more insights from Mike Wilson and the Global Investment Committee, contact a Morgan Stanley Financial Advisor.
