Will India spur a resources revival?

The government changeover in India could stir up big demand for minerals and energy … but don’t expect another China.

Summary: The new government in India has the opportunity to drive significant structural reforms and, in doing so, to dramatically ramp up demand for commodities including iron ore, coal, gas and other minerals that are plentiful in Australia. But investors are not getting too excited just yet. It’s unlikely India will be another China anytime soon.
Key take-out: According to HSBC Bank, if India were to follow the path of China, it would take around 25 years from the introduction of major reforms until it requires large quantities of commodities from abroad.
Key beneficiaries: General investors. Category: Commodities.

In answer to the question posed by in one of our recent articles, India is not the new China (see India’s investment outlook brightens). Which is one reason why investors are not particularly excited, yet, about the election of a pro-business government in India.

But, even if the dead weight of over-population, excessive government regulation, appalling infrastructure and ingrained corruption hampers the recovery of the Indian economy, there are still reasons for investors to shift the country up a notch on their watch list – from no-go, to observe.

For Australian investors with their better-than-average understanding of the resources sector, it might even be worth going a step further to consider what an Indian revival might do for commodities demand, especially for bulk materials such as iron ore, and for fuels such as coal and gas.

No action is required for now, and will not be required until the Indian government proves that it’s not a replica of the previous lot, which successfully suffocated the country’s economy.

However, the view of India from London, where I have been working for the past week, is shifting from pessimism to the first hints of optimism.

Historic ties, and a curry shop on every corner in some parts of Britain, are one reason why London-based investment banks have been calling up files from the basement marked “forgotten Indian investment opportunities”.

Whether any opportunities mature this time around from a country with a reputation as a serial disappointment is the big risk that cautious investors will not take, for good reason.

But if positive signs do emerge which indicate the potential for an Indian revival, then there might be a reason to get excited about Australian resource stocks which have ridden on the China boom over the past 20 years, and which could enjoy a similar ride in India.

HSBC Bank is one of the London-based banks with close Asian ties to put a positive spin on India and its potential impact on commodities.

In a report sent to clients after the election of Narendra Modi as the country’s Prime Minister late last month, the bank summed up the situation in seven succinct words: “If India lifts, commodity demand could too”. The key word in that assessment, obviously, is the first word: If.

What HSBC and others want to see from Modi and his government is proof that they can introduce policies which encourage economic growth, and whether those policies will replicate the Chinese process that started with essential repairs to dilapidated roads, rail and port systems, and also bringing mothballed power stations back into action.
Graph for Will India spur a resources revival?

The size of the problem confronting the new Indian government, and the opportunity for Australian resource companies, is best shown in a single example: two giant coal-fired power stations capable of producing 4000 megawatts of electricity each which are not working because of a coal shortage.

At the heart of that coal problem is the extreme inefficiency of the stock exchange listed but state-controlled business, Coal India, which has proved to be incapable of developing new mines or modernising old mines.

Some investors – well, let’s call them speculators at this stage – can sense the potential for a revolution inside Coal India, with the company’s share price rising by 6% over the past week.

What has caught the eye of share traders is a study of Coal India by an outside, international, consultancy, Deloitte, which has recommended sweeping changes to the way the business operates.

A consultant’s report is a modest first step, but it is a step in the right direction, and the report is focused on an industry which provides one of a modern economy’s essential services, electricity. And that’s a pointer to how Modi and his government propose to overhaul India; from the ground up.

Coal is an obvious starting point for a revived relationship between Australian mining companies and Indian power generators, though there are many obstacles to overcome. A major one is the worldwide coal glut, which has trashed the price and environmental objections for coal ships passing through the Barrier Reef off the Queensland coast.

The trick in looking at the opportunity presented by India is to see beyond the immediate and depressing picture of a country which has failed to perform, and see how its revival might occur.

The first step in meeting expanded resource demand will come from internal sources, just as it did in China during the 1990s. That’s why Coal India shares are on the rise.

The next step comes when India cleans up its constipated port system, where it can take weeks to shift cargo, then its single-lane highway system, and its railways, which were once the pride of the country but are now the equivalent of a mechanical dinosaur.

HSBC notes these problems but adds an important rider: “It is worth remembering how quickly commodity demand from China ramped up a decade ago and then began to outpace domestic supply”.

With India, as it was with China, the first demands will be very basic, including efforts to improve food supply, housing and electricity production and distribution.

“Historical patterns suggest that the strongest upside to commodity demand from India may come from demand for hard commodities and energy,” HSBC said.

A pointer to the latent demand for commodities represented by India lies in measures such as steel consumption. India consumes less than 15% the amount of steel as China on a per head basis, and electricity is being consumed at 25% of the Chinese per head rate.

After considering the “if” part of the Indian question comes the “when” part, which is the point at which Australian resource companies might find their “new China”.

The answer to the when question is interesting, because HSBC thinks the process that will lead to India becoming a big importer of raw materials might have already started.

“If India were to follow the path of China it would take around 25 years from the introduction of major reforms until it requires large quantities of commodities from abroad,” the bank said.

“In China, the economy began to open up in 1978, but it was not until 2003 that commodity demand from abroad ramped up.

“If India follows a similar pace of progress, and India’s big reforms were in 1991, it would begin to emerge as a significant commodity net importer over the next few years.”

It is obviously expecting too much of India to replicate the Chinese period of rapid growth – but it would also be unwise to underestimate the determination of the new Indian government to try and catch up with its great rival for Asian leadership.

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