The Modi government will soon finish 18 months in office. How has the NDA government done?
Step back to the summer of 2013, when India was categorized by Morgan Stanley as one of the “fragile five"—when the Fed threatened to taper (quantitative easing), India went through a pretty rough time—currency went down 20%, equities went down in high double digits. We had two things that changed then—we had a new RBI (Reserve Bank of India) governor and Narendra Modi became the prime ministerial candidate of the BJP (Bharatiya Janata Party). From there to now, two years have passed. India is now sitting at a position where its macro-stability has been the best it has seen in history. Current account deficit has gone from minus five to zero (as a percentage of gross domestic product, or GDP), inflation has gone from 11% to sub-5%, fiscal deficit has gone from 6.4% to 3.8% and growth has gone from 4% to 6%.
Policymakers in India have delivered—the government and central bank have both played a role in this. The government did its bit by reining in the fiscal deficit—on the fiscal side, the most important thing they did was to shift mix of spending. What they had inherited was a consumption-oriented spending budget, and they made it an investment-oriented budget, and this is why inflation has come down. A lot of people say inflation is down in India due to oil prices—arguably if this adjustment had not been done on the fiscal side, and oil prices had gone down, India’s inflation may not have come down so much—it would have been down by 2% or 3%, and not by 7%.
RBI helped the cause by keeping real rates positive... The biggest surprise from the Modi-led government has been labour law reforms—we had not anticipated that. Labour laws have always been a tricky issue in India, and for them to dismantle 65 years of archaic laws in Madhya Pradesh, Rajasthan and Maharashtra is obviously a very big step. They’ve done well in infrastructure, especially roads, and work in progress in terms of railways.
The ease of doing business, which is a very big focus area, is a work in progress, and that will take longer, as we can’t expect results in 18 months. But India did see a rise in the recent rankings—the best performance in the last six years—and the damage of the last six years has been reversed in a matter of a year—that is quite a lot.
It has been a good performance, and India enjoys much better external stability, which is why the rupee has been one of the best performing currencies in the world, and the stock markets have also been one of the best performing ones in the world. I hate to assess performance of governments using market matrices, but it is further evidence they’ve delivered, and markets have rewarded performance. If you speak to investors at the (Morgan Stanley) summit here, they will tell you that India is their favourite in emerging markets.
When you talk to investors here, what are they asking you about India? Are they worried about social tensions? Are they worried about setbacks this government faces from the loss in Bihar?
A lot is happening in India—you have 1.3 billion people—and statistically speaking, a lot can happen. I’ve seen a lot of media coverage that tends to suggest India is in internal strife—I don’t think anyone who lives in India agrees with that view. It is more of a communication issue, rather than a problem on the ground. Investors are not concerned with that—they are concerned about (corporate) earnings. The media is concerned about social tensions. The priorities of investors and the media are different.
But earnings growth remains weak. We’ve been waiting for a rebound for several quarters now.
Yes, earnings growth has not come back. When I met you last year, we had a certain earnings forecast in mind—we’ve gone wrong on that number by 7-8 months. When I look back to see what drove the miss, it is two issues—in the first six months of this 10-month period, we’ve had very heavy fiscal tightening, and that exceeded our expectations, and it caused growth to slow. Domestic growth faltered. Private spending was still weak.
The other factor that drives earnings is global growth, which we have cut since we met last year. If you ask me what is ailing earnings in India, it is largely to do with global growth. For example, India’s Wholesale Price Index is in deflation—we’ve had 11 months of deflation, and that is feeding from the fall in global commodity prices. That is hurting earnings because earnings is a nominal number. If you look at industrial growth, it is at a five-year high, but when you multiply that with the price index, it is actually falling. Revenues for Indian companies are actually down because that is function of volume, which is represented by the industrial index and price.
If revenues are falling, how can earnings go up, even though margins have expanded a lot in the last 12 months? Bulk of the pressure, in my view, is coming from slowing global growth. Ironically, India will do better in terms of earnings if commodity prices stop falling.
I would argue that from a macro standpoint, there is not that much benefit for India to see a further fall in commodity prices. Oil going from $120 to $50 was great for India, but if it goes down further to $30, it is not that great for India. A further fall in oil could be symptomatic of a slowing world, and it could also cause risk appetite to dwindle.
At the stage of growth India is in, it needs global risk capital to come in. Maybe it is one of the things that the Modi government has done well on—if you look at foreign direct investment (FDI) numbers, it is at a record high, and India now ranks No. 1 in the world, according to various reports, in attracting FDI. That is an indication that people want to do business in India.
But you cannot actually grow if the rest of the world is not growing. That is the biggest impediment to earnings. If you analyse earnings from that perspective, and look at just pure domestic sectors, we are actually doing quite okay. It is the export-related sectors that are driving down the headline numbers. If earnings have to change, global growth has to stabilize.
It is also one of the reasons why there is such a split opinion in the press about Modi’s performance. Everyone uses growth as their scale to measure performance, and then say, “growth has really not recovered so much, and so the government is not doing too well". But growth has not recovered because exports are dragging it down. The scale gets distorted because of external factors, which are outside the control of the government.
Are investors asking you about the setback in Bihar?
The fear over Bihar, prior to the elections, was that if the NDA lost Bihar, it would slip into a populist mode. My counter argument is, whatever I’ve seen of the NDA, it is not one that slips into populist mode, and so an election defeat will only push it to do more reforms. The minute that evidence came to the table, Bihar become irrelevant. The other reason why people thought Bihar is important is because it would change the constitution of the upper House. T
his is also mythical. We had done the simulation and had come up with a report in January called, India’s law making challenge’, in which we stimulated state election results up to 2019, assuming BJP wins each one of them—even if that happened, BJP does not go to even three digits on Rajya Sabha seats by the end of its first term. What people don’t understand is the Rajya Sabha is a permanent House, where a third of its members retire by rotation every two years—the change in composition is very slow. The loss of Bihar will hurt the BJP if it wins the 2019 Lok Sabha elections and then it may still not have a majority in the upper House.
The deal with the upper House is the Congress is losing seats—that is already baked in the cake because of previous election results, and their influence on the upper House will wane.
If you look at the Modi government’s relationships with non-Congress opposition, it has actually been better than it has been in the last three years. I will say it with great caution, but I think the business of Parliament will show a marked improvement in the winter session. In a democracy, I think parties have to work together, and that is how it is set up.
India is a very vibrant democracy—the splintered upper House is actually a good thing. I know investors will say “policymaking has stalled". Think about it—the upper House sent the GST (goods and services tax) bill to the standing committee, and what came of it was a superior bill—it is a major reform, and there is no need to rush into it. The problem here lies with expectations. Now we have a more robust GST bill that will come to the House.
The land bill was another important reform, but people overestimate its importance. Eventually, the states will decide on it—this is exactly what happened with labour reforms. Wherever there is concurrent law-making power, the reforms will happen at the state level.
I would safely say the biggest contribution of the Modi-led government in the last 18 months is competitive federalism. He has changed the revenue share for the states, he is giving them greater independence in decision making, and this comes from his experience as chief minister of Gujarat. Labour law and land law reforms—I think the idea is that a few states will do it and they will attract more investments, and other states will follow.
This is so much a better way of doing reforms, which is bottom-up, rather than top-down. Top-down reforms work only in certain areas. It does not work in contentious areas like land and labour, where there are opinions both left of centre and right of centre.
How do you see 2016?
The relative story remains strong. India is our biggest overweight position in EMs (emerging markets), and it is partly to do with what the emerging world is up to; if the emerging world for some reason turns around, India may lose some of its performance.
Obviously, the rest of the emerging world looks extremely attractive on headline valuations, compared with India. On the medium-term basis, I feel India can retain its valuations premium both on currency and on stocks because it has a better growth story. In the next 12 months, on a relative basis, India should continue to do well, and on an absolute basis, may be the returns will be better than what they have been in the last 12 months.
There could be a few shifts at the sector level—sectors which have been out of the limelight over the last couple of years like utilities may come back, and we are more bullish on cyclical sectors. Economic growth will steadily improve.
The government will continue to push forward with reforms and the next big thing will be bankruptcy code, and that will be a significant contributor towards the ease of doing business. Hopefully in 2016, GST will also be done and implemented, and that will bring about change. We are in a modest return world, and India cannot deliver exceptionally high returns in a modest return world.