India: fairest emerging market of them all?

Waseem Andrabi | Hindustan Times | Getty Images

The Indian economy is set to kick off the year as the favorite among emerging markets thanks to a series of positive economic developments coupled with the accelerating pace of Prime Minister Modi's reforms.

"We expect India's stock market to generally outperform emerging and developing peers in 2015," said Howie Lee, investment analyst at Phillip Futures, in a report last week. The Sensex stock index was Asia's second-best performing market in 2014, rising around 30 percent.

New Delhi is expected to post economic growth of 5.5 percent during the fiscal year ending March 2015, according to the finance ministry - a welcome sign for an economy that's seen sub-5 percent growth for two consecutive years.

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"The rise of India looks unstoppable," the Center for Economics and Business Research (CEBR) said last week. In its annual World Economic League Table, the group expects India to become the Commonwealth's largest economy by 2018. In 2024, the group expects India will become the world's third largest economy from its present status as fourth-largest.

2013 marked a year of vulnerability for India as a ballooning current account deficit triggered sharp capital outflows when the Federal Reserve first broached the idea it would reduce its stimulus program.

"Call it a huge slice of luck or astute economic forecasting, but going into 2015, the problems that have plagued India for the past two years have mostly been subdued. Due to falling commodity prices, the twin terrors of current account deficit and high inflation have come under substantial control," said Howie Lee of Phillip Futures.

What’s changed

November's wholesale price inflation rate came in at zero for the first time in over five years, and a far cry from May's 6 percent annual increase. Lee said a global fall in food prices proved more effective in containing inflation than the Reserve Bank of India's (RBI) 2013 interest rate hike.

While the current account deficit remained high at 2.1 percent of gross domestic product (GDP) during the July-September quarter, expectations for oil prices to remain low in the near term will ease the strain, Lee said. Not only does cheaper oil ease India's import bill, it also allowed Modi to end diesel subsidies, which cost the government over $20 billion in the last fiscal year.

As these "twin terrors" fade into the darkness, the economy is left more resilient to a looming U.S. rate hike, Keki Mistry, chief financial officer of HDFC Bank, India's third biggest lender by assets, told CNBC. "The period of taper tantrums is over. India has built up a huge amount of reserves and the domestic economy is very resilient, so increasing U.S. rates won't have as much as of an impact on India as other emerging markets."

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What’s still missing

For the government to achieve GDP growth above 6 percent, Morgan Stanley recommends greater focus on medium-term reforms, including the easing land acquisition rules, flexibility in labor markets, and the introduction of a goods and services tax (GST) to create a national taxation system.

Moreover, the overall ease of doing business remains a major priority for the government, the bank added. It's watching for various policy steps on streamlining clearances for forest and environmental projects, expediting industrial licensing processes and providing stable taxation policies. It also wants to see initiatives under the "Make in India" campaign aimed at convincing multi-national companies to manufacture within the country.

HDFC's Keki Mistry believes there's one another component missing: "We are all waiting for a little enhancement or increase in the investment cycle. That is now a critical thing which we need to look at. Once the investment cycle starts taking off, then I'm sure the economy will get into much higher growth rates."

Foreign direct investment for 2014 is expected around $25 billion, versus $28 billion in 2013