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Business News/ Market / Stock-market-news/  FY18 could see a revival in private sector investment: Radhika Rao
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FY18 could see a revival in private sector investment: Radhika Rao

The DBS Bank economist says higher off-balance sheet public spending, FDI inflows and an improvement in demand, spurred by a good monsoon, will drive revival

Radhika Rao of DBS Bank says that while the BJP hopes to expand its foothold in the five states that go to polls next year, it is unlikely that it will take eyes off reform agenda.Premium
Radhika Rao of DBS Bank says that while the BJP hopes to expand its foothold in the five states that go to polls next year, it is unlikely that it will take eyes off reform agenda.

Singapore: While India is unlikely to see a turnaround in private sector investment this year, FY18 could see a revival due to a combination of factors—higher off-balance sheet public spending, foreign direct investment inflows, and an improvement in urban and rural demand, spurred by a good monsoon, Radhika Rao, economist and vice-president, DBS Bank Ltd, Singapore, said in an interaction.

Gross domestic product (GDP) growth could edge towards 8% in late FY17, she said, adding that the bank expected the drag from weak private sector activity and soft trade numbers to keep annual growth at close to 7.8% this year. The implementation of the goods and services tax (GST), which the government wants to enforce from 1 April 2017, is likely to be delayed in the interest of ensuring a seamless and non-disruptive shift to the next tax regime, Rao said. Edited excerpts:

Can India see a turnaround this year with regard to the revival in investment cycle? Why is private sector activity yet to recover?

Weak private sector investment is a drag on India’s recovery. A combination of factors are at work. Firstly, capacity utilization is down since 2010-11 and near 70% at present. A private sector business survey results showed 68% of respondents expect not to add capacity over the next six months. Weak demand, high cost of borrowing and delayed clearances were named as the main constraints. Secondly, exports growth is weak. Finally, stressed private sector balance sheets have also translated to asset quality concerns for banks and hurt credit availability.

While a turnaround this year looks unlikely, we expect a combination of higher off-balance sheet public spending and FDI inflows to draw in private investments in FY18. Corporate earnings have also showed early signs of stabilization. Looking beyond this year, an improvement in urban and rural demand, spurred by a good monsoon, will also emerge as domestic catalysts to revive capex activity.

India will see some major state elections next year. Are you worried the momentum of the current reforms, especially implementation, may suffer if the government sees some setbacks in polls? Can the April 2017 deadline for GST be met?

Five states go to the polls in 2017. While the government hopes to expand its foothold in these states, we do not expect them to take their eyes off the reform agenda. In its first two years in office, the government has demonstrated an ability to take non-populist decisions, including fuel deregulation, modest increases in the minimum support prices and maintaining status quo on monetary policy framework, among others. Parliamentary approvals for GST are already in place and other formalities are being completed. The next areas of attention will be the contentious labour and land reforms, which have thus far been delegated to state governments. In the past, execution risks have been the Achilles’ heel for the economy. But there have been encouraging signs of late in the infrastructure, roads, power and coal sectors. This suggests that even if progress is slow and incremental, the reform path is unlikely to be abandoned.

The GST bill, in particular, will be a work-in-progress in 2017 as state polls get underway. Even though the implementation deadline of April 2017 may be missed, markets are unlikely to be unnerved.

Getting past the states and winter Parliament session will not be a hurdle, though tough negotiations thereafter, on the nitty-gritties of the GST structure i.e. the exact rate, revenue sharing agreement, revenue compensation, dispute resolution mechanism, etc., will be time-consuming. Getting the back-end systems up and running, whilst ensuring businesses and other stakeholders are up to speed on the new structure are other aspects that require attention and time. Hence, in the interest of ensuring a seamless and non-disruptive shift to a GST regime, the implementation timeline is likely to get stretched.

Your take on Urjit Patel’s appointment as Reserve Bank of India (RBI) governor? What message did the government send across?

With Dr. Patel as the new RBI governor, the government has voted for maintaining the status-quo—policy continuity and macro-stability. This marks the second instance after the decision to retain the inflation target of 4%—+/-2% range—where the government has demonstrated that inflation will remain a policy priority.

Dr. Patel was the chief architect of the monetary policy framework report published in January 2014. There he recommended a shift to flexible inflation-targeting, move to a medium-term target and need to maintain positive real rates. Inferring from the tone of this report and his sparing comments since, Dr. Patel will be perceived as being hawkish and allied with outgoing governor (Raghuram) Rajan’s views. Hence, there is a likelihood that the new governor will maintain its data-dependent mode, particularly in light of the recent firm inflation prints. While the coming shift to a policy committee will dilute the governor’s individual power over policy decisions, other members fall into the cautious-toward-inflation camp. It remains to be seen how the new governor and committee interpret the 2% target band—around 4%—where we assume the intermediate goal of 5% for this year and 4% thereafter will be preferred.

With reforms to show, how does India look as an investment destination? How do you look at the India story within the emerging market (EM) pack on an absolute as well as on a relative basis?

India is among the few countries in the Asia or EM bloc where the domestic macro environment has seen a sea-change despite global headwinds. While part of this turnaround is on domestic catalysts, a conducive external backdrop of low commodity prices and accommodative global central banks has also been timely. Besides being viewed as a purely high-yield story, India is also a fundamentals play. The OECD’s (Organisation for Economic Co-operation and Development’s) composite lead indicator index points to a steady climb in India’s gauge in contrast to signs of moderation in the G7 economies and China. Growth recovery is on track this year, primarily led by consumption and public investments, which also get a hand from higher public sector wages and a strong monsoon. Private sector investments are, however, weak due to cyclical headwinds of balance sheet stress and excess capacity, not helped the least by a weak external sector.

Importantly, unlike the previous episodes of high growth, this recovery is neither accompanied by current account and fiscal excesses, nor strong core inflationary impulses. With inflation rearing its head in recent months, we expect the central bank to be focused on transmission to ease borrowing costs. Dependence on foreign inflows is lower, with the focus instead on attracting more non-debt creating investment flows. It will be important to sustain this momentum to ensure that these “positive base effects" help the economy reach an ideal state of stable inflation and sustainable growth path.

While Prime Minister Narendra Modi is reaching out to foreign investors, are government agencies working against him? I am referring to the government’s latest move—it stunned investors—as India has served notices to 57 countries demanding that existing bilateral investment treaties (BITs) be terminated, and new ones signed. Is India, therefore, failing to assure investors that it can offer a transparent and good-faith dispute resolution?

The Indian authorities’ long-standing litigations with a few top foreign companies and, more recently, plans to review existing BITs are likely to dissuade long-term investors. Such retrospective action might hurt the government’s plans to attract more foreign investment flows and improve the ease of doing business.

Concerns are that the new BITs might tilt the dispute mechanism process against foreign investors, forcing them to exhaust domestic judicial channels before moving to offshore jurisdictions. Unfortunately, some of these rules are also open to political risks. Hence, until the government provides clarity and transparency on the dispute mechanism process and clarifies the tax or legal treatment of foreign investors, one should expect prospective players to stand by the sidelines.

Monsoon rains have been very good. Does that mean 8% growth is on the radar? But again, when you look at the numbers from India and China, can you believe them? Are the two biggest emerging markets, India and China, growing much slower than official data suggests?

GDP growth could edge towards 8% towards late FY17, though we still expect the drag from weak private sector activity and soft trade numbers to keep annual growth at close to 7.8% this year.

On your second question, data quality is important in all circumstances, especially for policymakers to make decisions based on facts rather than erroneous inputs. While there are doubts on the reliability of India’s GDP numbers, we believe part of this is also because of lack of sufficient background data points. While the GDP series have been re-based, the rest of high-frequency data pool is either outdated or out-of-sync with the sources that the GDP numbers are computed from. For instance, the Index of Industrial Production is still based on the old base year; thus, making it difficult to compare trends here with the new GDP series. Another hurdle is the lack of backdated data series, which has made it a challenge to work on trend growth cycles. Hence, while broad indicators provide a sense of improvement on the ground, the existing pool of data is not exhaustive to capture the complete momentum.

Two key challenges for India going forward are going to be creating a large number of non-farm jobs and at the same time make its manufacturing more competitive and productive to fully realise its potential. How has the government’s progress in these two areas been so far? Is excess manufacturing capacity impeding growth?

In our view, the challenges to expand the manufacturing base and encouraging job creation are interlinked. As the labour absorptive capacity of the services and agricultural sectors is disproportional to its contribution to overall growth, there is an urgent need to promote industrial activity. Admittedly, this will be no easy feat. A sharp revival in manufacturing activity is hampered by leveraged private sector players and stressed banking assets. Excess capacity in the system is also an additional bugbear.

While the balance sheet clean-up is underway, incoming FDI flows are expected to kick-start industrial growth, whilst also lending a hand to job creation and broader capex activity. At the same time, the government has also overcome the limited fiscal headroom and tapped off-budgetary resources to fund investments.

In this regard, much emphasis is on improving the ease of doing business, lifting sectoral caps and easing restrictions. This includes a push towards web-based and time-bound clearances, passage of the bankruptcy bill, simplifying the taxation regime, among others.

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Published: 26 Aug 2016, 12:27 AM IST
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