Mark Dampier: A hot investment story is taking shape as India lets the light in

Stirring the pot: the Indian Government’s reforms of labour rules offer hope of a brighter future for businesses

Indian workers boil sugarcane juice to make jaggery, a traditional cane sugar, at a jaggery plant in Muradnagar, Uttar Pradesh's Ghaziabad district (PRAKASH SINGH/AFP/Getty Images))

I expect reviews of the best- performing areas this year to be dominated by one country: India.

In a landslide victory not seen since 1984, Narendra Modi was elected Prime Minister in May this year. His strong pro-market, pro-business agenda is expected to pull India out of the dark at last. Its stock market has risen strongly on the promise of political and economic reforms.

Mr Modi is abolishing many archaic labour laws and incentivising competition between individual states with the aim of rebuilding industries such as the diminishing manufacturing sector. Historically, a business needed more than 40 licences to trade, and companies with more than 50 employees were required to seek government approval before firing an employee. This was a significant barrier to growth, stopping companies competing on a global stage as they were reluctant to take on more than 50 staff. Indeed, more than 80 per cent of Indian businesses have fewer than 50 employees.

Alongside a manufacturing renaissance, Mr Modi is hoping to improve the country’s infrastructure, including building 100 new “smart cities”. India has a strong relationship with Japan and many of Mr Modi’s reforms have been compared favourably with those introduced by his Japanese counterpart, Shinzo Abe. Mr Modi has introduced three people to the Cabinet, two of whom are Japanese, with the sole purpose of maintaining the India-Japan relationship. Japan is providing investment for infrastructure projects, including a freight corridor linking four key areas within India.

The Government is working to change the population’s mentality of welfare and entitlement by reducing the number of subsidies. It has taken advantage of the recent fall in the oil price, for example, to deregulate petrol and diesel, which is saving the economy billions.

It is not just foreigners noticing these changes in India. After 10 years of shying away, domestic investors are increasingly shifting their focus from property and gold back to the stock market. India is largely self-reliant and not dependent on exports, so the slowing world economy is less of a concern than in many other emerging markets.

The promise of reform has been enough to drive the stock market higher this year. It was interesting this week to get the views of Neptune Investment Management, whose outlook remains positive. James Dowey, the chief economist, expects significant divergence between emerging market countries over the next few years, with India one of the big winners.

The Neptune India fund has been one of the best-performing Indian funds this year. It is managed by Kunal Desai, who joined Neptune in 2010 as an analyst before taking over management of the fund in December 2012. Its exposure to firms that perform better in a stronger business environment, and a bias towards medium-sized companies, have had a positive effect on performance this year.

Mr Desai is underweight in the large stocks that dominate the Indian index as he feels they are heavily overvalued. The consumer staples company Nestlé India, for example, is trading on a forward price-earnings ratio of around 50 times. Medium-sized companies aren’t covered to the same extent by analysts, so he sees an opportunity to uncover overlooked companies. He is also focused on businesses exposed to the manufacturing sector – to benefit from the sweeping labour law reforms.

The country is on track to be the world’s third-largest economy by 2030. Indian politics are notoriously volatile, and progress runs a significant risk of being derailed if anything were to happen to Mr Modi. That said, it would be very difficult to stop the many wheels of reform once they are in action.

I would suggest long-term investors should consider a small exposure to India as part of their portfolio. As an alternative to a unit trust, JP Morgan runs an Indian investment trust that is currently trading at a 10 per cent discount (although this investment has a higher exposure to large Indian companies). I believe India could be one of the most exciting investment stories of the next few years.