At last, long-suffering investors in India’s economy have something to cheer about. On Friday, the country announced steep corporate tax cuts, sending the value of its main stock index up 6 per cent in dollar terms on the day and another 3 per cent on Monday.

The tax cut is significant, with the rate for manufacturing now on a par with low-rate jurisdictions such as Singapore. The message is that India is open to business, and that it aims not just to assuage investors’ concerns but to set a new path for growth. India’s prime minister Narendra Modi has been meeting investors and Indian diaspora on a US tour this week to make sure the message gets through.

It is about time. In a low-growth world, India and its regional neighbour Indonesia became investor favourites, boasting a combination that the developed world lacks: large populations and favourable demographic trends.

But sagging growth and the glacial pace of reforms mean they have come to be viewed as Asia’s “sleeping giants”. Investors backing the growth story have been increasingly fearful that their bets will never pay off.

India’s population is predicted to surpass that of China by 2030, yet it will have a median age by then of just 30 versus 40 in China, 47 in South Korea and 51 in Japan. Indonesia’s population will be similarly youthful with the median age of 31, according to UN population estimates.

The potential is clear for both countries to transform demographic booms into engines of domestic demand while positioning themselves as alternatives to China for labour-intensive manufacturing

The potential is clear for both countries to transform these demographic booms into engines of domestic demand while positioning themselves as alternatives to China for labour-intensive manufacturing.

This helps explain the valuations of India and Indonesia’s stock markets, which are among the highest rated in the region with price/earnings multiples of 20 and above.

Yet before India’s tax boost last week, both countries’ equity markets were among the region’s worst performers year-to-date in dollar terms. That reflected investors’ frustrations that the liberalisation measures needed to enable these economies to reach their potential are moving too slowly, or not at all.

Foreign direct investment serves as a useful proxy for the success of reforms, with the long-term funding indicating external confidence in a country’s economic prospects. This investment is also fundamental to India and Indonesia’s success because it can create the jobs the countries need to absorb excess labour supply and plug the financing gaps.

But India today pulls in a pitiful 0.6 per cent of GDP in manufacturing FDI, while Indonesia manages just 1 per cent. In the early 2000s, when China was at a similar stage of development, it managed 2.5 per cent.

So the foundations are shaky. But both countries have also struggled with geopolitical and macroeconomic trends that have resulted in weaker than expected growth, which highlights a shared vulnerability to volatile external funding.

The strong US dollar has reduced cross-border lending as well as investors’ appetite for emerging market assets, while declining Chinese imports — down almost 5 per cent so far this year — are dampening regional export earnings.

The trade war is exacerbating these trends, depressing Chinese demand for goods from neighbouring economies and adding to pressure exerted by the weakening renminbi and insipid Chinese domestic investment.

Aspirations of countries such as India and Indonesia to substitute China’s exports to the US are limited due to China’s manufacturing heft — representing one-fifth of the world’s manufacturing output. This means that any gains in revenue are likely to be offset by margin pressure as China drops prices.

While the tax news is good, there is still plenty more room to unleash India’s “animal spirits”, notably through much-needed land and labour reforms. The hope is that this is just the beginning.

Until India’s surprise tax cut, it was Indonesia that had shown a greater sense of urgency, having announced an ambitious five-year plan to spend the equivalent of about 40 per cent of its annual GDP on infrastructure.

Still, financing is an issue given weak FDI inflows and limited room for manoeuvre in fiscal policy. Earlier this month, President Joko Widodo ordered ministers to come up with measures to support inward investment, following a sobering assessment of Indonesia’s FDI performance by the World Bank. His government will now be under increasing pressure to keep up with India.

Investors badly want these countries to succeed and will cheer on any bits of good news through portfolio and direct investment, providing a tailwind for their leaders to push through hard reforms.

The playbook — trade liberalisation, infrastructure construction, land and labour reforms, tax breaks for foreign investors — has been clearly written by Thailand and Vietnam.

The challenges facing India and Indonesia seem to have been enough to wake these giants from their slumber. It is up to them to retain and reward investors’ confidence by grabbing the opportunity to transform themselves from victims of external turbulence to victors in the trade war.

The writer is senior economist for Asia emerging markets in the corporate and investment banking division at Natixis

Letter in response to this article:

India’s growth prospects deserve vigorous analysis / From Amit A Pandya, Silver Spring, MA, US

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