A Promising and Just Transition in India?

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    Stockholm (NordSIP) – The recent Adani turmoil raised several questions regarding the ability of sustainable investors to navigate the complicated nuances of investing in Emerging markets (EMs) and the ability of economic development and ESG investors to contribute to a just energy transition. One asset manager with strong views on this topic, argues that sustainable direct investments have a crucial role to play in EMs and India, in particular.

    Vuk Srdanovic, Investor Relations, Nordics, Triodos IM

    “Triodos’ motto is ‘finance change, change finance’. If we don’t invest in a more conscious way that applies capital to projects and industries that will create greater good further down the line, we will eventually find ourselves living in a world that is unsustainable. While Scandinavia leads in the adoption of sustainable policies, investments in EMs can have a strong impact. Triodos IM seeks to do this by focusing our investments on five themes – Resource Transition, Energy Transition, Social Transition, Well-being Transition and Food Transition. The application of these themes to our Triodos Microfinance Fund, has improved lives and supported SME’s in EMs while providing strong returns. This fund invests private debt and private equity in EMs and has a strong presence in India,” says Vuk Srdanovic, who has been responsible for investor relations in the Nordics at Triodos Investment Management since last year.

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    Disappointing Emerging Markets

    Experienced investors will be familiar with the disappointing performance of stock prices in EMs. While they promise high returns to compensate investors for the risk of going into less developed countries, the truth is that this promise has not always been fulfilled. Whether we consider the S&P Emerging BMI or the MSCI Emerging Market Index, the conclusion remains that listed EMs have greatly underperformed their developed market counterparts over the last ten to twenty years. However, opportunities remain in the non-listed space.

    Tim Crijns, Portfolio Manager at Triodos IM

    In India’s case, investors may be hoping to be compensated for a risk that is actually less present. “The starting point for many investors is that EMs are perceived to have much higher risk. Instead, if we look at historical defaults, risks may turn out much lower than expected. For example, during COVID19, the rates of default were low, even with absent government support; all our Indian investments survived lockdown periods and recovered quickly. If you invest in stable, well-run institutions in EMs, the risk premium that investors expect should match the actual risks, at least in private markets,” says Tim Crijns, Portfolio Manager of Triodos Microfinance Fund.

    Potential Going Forward

    Sagar Thakar, Senior Investment Manager at Triodos IM, argues there’s a good case to be made for private EM investments. “There’s been a surge of economic activity, compounded by strong domestic growth and new opportunities facilitated by disruptions of China’s place on the global trading system. Based on what we are seeing on the ground, our conversations with local CEOs from non-listed companies, and research from other financial institutions, there’s a new landscape of opportunities in Asian EMs,” Thakar argues.

    Sagar Thakar, Senior Investment Manager at Triodos IM

    “With the world waking up to the risks of the Chinese economy, and supply chains adjusting accordingly, trade lines and investment flows are shifting,” Crijns adds. “Different countries are impacted differently, so investors have to be selective. In Asia, we are seeing a surge of economic activity, a reasonably stable inflation and interest rate environment in India, Indonesia, Vietnam and the Philippines. The opposite is true for Sri Lanka, Pakistan and Myanmar, which have their own macro-economic and political challenges,” Thakar continues.

    The Political Bottle Neck

    To benefit from these exogenous tailwinds, India will have to overcome the bottle necks that have plagued its economic development in the past. Bureaucratic attrition and limited infrastructure investment have ground the gears of economic growth in India. “India is a federal country, which leads to a less uniform institutional base from which to work from,” Crijns argues.

    “Political and bureaucratic bottle necks do still persist in India.  Democratic processes slow down decision making. However, local business leaders in our three focus fields – energy, food and financial services – tell us that the government has been proactive in meeting its five-year plans and that the political environment has been supportive,” Thakar says.

    The recent economic history of India is also relevant. “One needs to understand that the entire eco-system of India’s Venture PE market is only ten years old. The role of the Modi governments’ deregulation and privatisation policies in improving business conditions over the last ten years cannot be underestimated.  But it is not the only positive factor,” Thakar adds.

    Tackling Governance Issues in India

    Business governance is one of the top issues facing India. “Doing early to mid-stage investments in India requires proper due-diligence, understanding of the markets and setting up relationships in a way that requires a local presence in order to dive into the local regulation and the local business culture. In our home markets we are already familiar with how things work and can often rely on desk analysis of financial reports. It takes a long time to develop this expertise in EMs. Triodos has been building up this knowhow with a strong expertise in direct EM investments since the 1990s ,” Crijns explains

    “Governance remains a challenge in India. Approximately, 10% to 15% of VC/PE-relevant Indian businesses face governance challenges. This fact is sometimes difficult to understand regardless of the diligence. As Tim mentioned, local knowhow, good due diligence, reference checks and deep engagements can help to mitigate these challenges,” Thakar says.

    Investors can use due diligence insights to overcome some of these challenges via exclusions or engagement. “For example, businesses that are doing business with provincial governments are a red flag and investors should be careful and scrutinise them more carefully. Privatised and well-regulated sectors tend to present less governance challenges. Every sector is its own business microcosm. Living in India, one has an implicit understanding of the challenges facing every pocket of the economy and can more easily distinguish between viable and non-viable sectors,” Thakar continues.

    “There are many ways to mitigate governance risks, and it is important to admit their existence. We assess the role of strong governance, auditors, regulators, independent board members and committees. But it is also important to see it in practice; to see these factors work on the ground,” Crijns argues.

    Renewable Energy

    According to this approach, infrastructure projects rank high on potential governance problems given the need for contracts with local governments. However, Thakar is quick to explain that not all infrastructure projects are alike. “Renewable energy is also infrastructure, but it’s a different story, with private players changing the dynamics of the industry. Solar power’s attractive commercial proposition is a good example. With solar per unit costs of 3-6 cents compared to conventional fossil fuel sources, which are 5-10 cents, the need for political capture and obfuscation is greatly mitigated,” Thakar explains.

    But not all infrastructure is equal, according to Thakar. “One needs to know what sectors to target. That knowledge needs to be built into the investment analysis.,” Thakar says.

    Inequality and the Role of Large Conglomerates

    Large business conglomerates play an important role in most economic development paths by being the onus of government support for the concentration and galvanising of the capital necessary to develop expertise and capacity in selected industrial sectors. Japan’s Zaibatsus and South Korea’s chaebols are text book examples of this sort of process. However, they can also be problematic. Corruption scandals have been rife in both countries and their relevance can create monopolistic hurdles to new market entrants. India is no an exception.

    “The existence of these conglomerates creates a lot of income inequality and concentration of wealth. Everyone’s reliance on these groups means that they just keep on growing and have the ability to enter new businesses given their economic clout. Their size sometimes also grants them political clout,” Thakar argues.

    However, investors can take certain steps to address economic inequality. “In the businesses we invest, we endeavour to mitigate large income disparities between management and workers, and between men and women. These are things that will become quite evident during due diligence, which allows us to see what policies companies have and their compensation packages. We endeavour to engage in a dialogue with existing and potential investees and see how we can work with their teams to help them move towards more equitable outcomes. As a member of the board, investors can also voice their opinions to mitigate such divergences,” Thakar explains.

     Just Energy Transition

    The final outcome of these dynamics in the context of India’s experience of the energy transition is crucial for sustainable investors. “I’m very bullish about the energy transition. India has very strong tailwinds (such as policy support, technological developments, availability of skilled workforce, investor support etc.)  and is likely to exceed its climate commitments. Renewable energy, waste management, energy storage, and  electric mobility, offer very promising opportunities,” Thakar says.

    “Renewable energy – solar and wind – is established and is growing steadily. Waste to Energy is another part of the energy transition, an example of circularity with interesting implications for living conditions, which is changing the face of India. For example, Biogas not only solves the problem of energy deficiency but also the problem of waste disposal, which is a significant national healthcare problem,” Thakar continues.

    “In light of all these headwinds, I believe that if done well, there is evidence to suggest that the energy transition will be promising and just in India and facilitate a more equitable society”, Thakar concludes.

    Images courtesy of Raj Rana via unsplash and Copyright © 2018 ONNO ROOZEN
    Filipe Albuquerque
    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.
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