Emerging Markets

Three reasons why investors remain confident on India

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A shining star among emerging markets, Asia's third-largest economy is losing momentum but economists remain nonplussed, flagging catalysts that could see growth top 8 percent in coming years.

India's gross domestic product (GDP) grew 7 percent on-year in the April-June quarter, versus a 7.5 percent gain in the first three months of the year, dragged down by weak net exports.

"While the headline GDP has disappointed, the internals, as reflected by improving consumption and investment demand, support our view that a gradual revival is under way," Anurag Jha, Citi economist, said in a note.

Both Citi and Morgan Stanley are forecasting 7.5 percent annual growth in fiscal 2016 and 8.1 percent the following year, compared to 7.3 percent in 2014-2015.

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Emerging markets guru Mark Mobius also sounded a bright note: "GDP will go higher in coming months; India will probably achieve what China did 5-8 years ago," the Franklin Templeton Investments chairman told CNBC.

But that's not to say risks are minimal.

A 7 percent growth rate makes India one of the world's fastest-growing countries, on par with China, and similar to Beijing, economic data must be taken with a pinch of salt. Earlier this year, New Delhi announced a landmark change in its calculation of GDP by basing economic activity on market prices instead of production costs.

"The bottom line is we can't read too much into the new GDP growth data - up or down - as the new methodology hasn't yet gained credibility," ANZ economists said in a report.

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Moreover, mounting non-performing loans at state-owned banks are also concerning. As of end-March, bad debts were at a decade-high of $49 billion or 4.6 percent of total loans, according to Reuters. The drag from non-performing loans is worrisome since they hinder private sector investments, Vishnu Varathan, senior economist at Mizuho Bank, told CNBC.

Despite these challenges, the following growth drivers are likely to keep India a favorite among emerging market investors.

Seventh Pay Commission

This government panel meets every ten years to revise wages and pensions of India's central government employees and pensioners, estimated at around 7.5-8 million people, according to Citi. This year marks the seventh meeting of the Pay Commission and its recommendations are due by December, with the proposed salary revisions set to be implemented early next year.

The Commission's proposals could help boost private consumption growth to 8.4 percent in FY17, from 6.3 percent on-year in FY15, Citi's Jha noted. The proposals could also bring about needed fiscal stimulus, he added, forecasting government revenue expenditure to rise by 0.4 to 0.6 percent of GDP in FY17.

Structural reforms

Investors have complained of Prime Minister Modi's stalled progress in pursuing reforms essential to improving the ease of doing business, such as Modi's recent decision to delay a plan aimed at facilitating state acquisition of land. Other reforms in the pipeline include a goods and service tax and updated labor laws.

But the ambitious scale of the reform agenda could ultimately work for, not against, the country.

"The policy logjam is concerning, we would have loved to see the reforms implemented immediately, but if Modi's able to achieve 20 percent what he set out to do, that will be terrific." Mark Mobius told CNBC.

Monetary policy support

Data showing consumer price inflation at a record low of 3.78 percent in July gives the Reserve Bank of India (RBI) ample room to loosen monetary policy and buffer slowing growth. Indeed, in a CNBC interview on Friday, RBI Governor Raghuram Rajan said he wasn't ruling out cutting rates for a fourth time.

"This is unprecedented in recent history in India," Mobius remarked. "The RBI has always raised rates in fear of inflation and now, we're in a situation where they are lowering rates. As rates come down, stocks and the economy will benefit."

Moreover, cheaper oil prices also underpin expectations for continued low inflation seeing as India is a net-energy importer.

ANZ economists believe the central bank will move at its next scheduled policy review on September 29, but warned of concerns should onion prices continue spiking this month.