Across several states in India, violent protests have broken out in response to the new military policy for young recruits, known as "Agnipath" — translated as Path of Fire. The trigger is the lack of any guarantee of continuing service or pension benefits after an initial four-year stint for new recruits (aged 17 to 21 years old).
The context is the difficulty in balancing the conflicting priorities of persistent defence threats, reforming to improve efficiency, fiscal deficit reduction, and dangerously high youth unemployment.
Protests that result in economic disruption and, more importantly, further disincentivise structural reform reinforce our caution on India equities relative to cheaper peers in large emerging markets.
Conflicting priorities behind the protests
There are five underlying factors, some of which are conflicting, at play here:
Persistent external defence threats because disputed borders with China and Pakistan, instability in Afghanistan, and, over time, greater involvement in Asia-Pacific defence matters (eg via the Quad).
Military expenditure that is higher than the average of large EM peers (ex-Saudi), but where staff salary and pension costs account for about 60% of that budget (amounting to 1.5% of GDP).
Fiscal deficit of close to 10% in 2022, according to IMF forecasts, and where the need to combat inflation is narrowing the space for continuing monetary policy stimulus (negative real interest rate).
Youth unemployment of 20%, which is high by Asia EM standards.
PM Modi's efforts to reignite a reform agenda, derailed by the Farmers Protests and the re-focus on re-election.
We prefer other large EM equities over India
This development does not help the investment case in India equities because of the economic impact of any lingering civil disruption and the disincentive for the government to engage in more difficult economic reforms.
This compounds the challenges of the withdrawal of policy stimulus (monetary even more than fiscal, as inflation expectations increase), and a valuation that is more expensive relative to the historic average than is the case for large EM peers.
Among large EM peers, there is cheaper valuation on offer in, for example, China (which also has the rare capacity for policy stimulus) and Brazil (which is on the exporter side of the commodity trade).
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