Singapore: Prime Minister Narendra Modi may have introduced a string of reforms, but he has shied away from the hard-hitting ones—a disappointment, given that his government is the first in three decades to have won an absolute majority in the lower House, Shaily Mittal, an economist at MNI Indicators, a subsidiary of Deutsche Boerse AG, said in an interview.
Expectations from the government remain high, but patience is slowly running out among both domestic and international businesses, Mittal said. Edited excerpts:
How do you see India’s dismal exports performance—exports have fallen for 10 months, the longest streak since 2008-09?
Declining world trade volumes and heightened financial market volatility continue to negatively impact India’s exports. India’s merchandise exports have been in contraction for 10 consecutive months up to September. Major exports such as iron ore have suffered on the back of a significant price correction and growth in IT (information technology) exports has lagged on the back of a global reduction in IT spending.
Although the Indian rupee has depreciated in absolute terms over the last few years, it remains overvalued based on a 36-country, trade-based effective exchange rate, which could also be dampening exports. With further room to depreciate and, given the lags in the impact of exchange rate movements and with increased global demand and global economic recovery, we expect exports to start improving in 2016-17.
Is disinflation a new risk for India?
Unlike some developed Western economies, disinflation is not a real threat to the Indian economy. Low inflation is a recent phenomenon in India, driven by a sharp fall in global commodity prices, good food supply management by the government and a tight monetary policy by the central bank; and not from a lack of demand, as witnessed in Japan and some European nations. We have already started witnessing an increase in inflation in India, with CPI (Consumer Price Index)-based inflation rising to a three-month high of 4.41% in September, reflecting the waning of a favourable base effect and a hardening in food prices. Although WPI (Wholesale Price Index)-based inflation remains in contraction, the pace of decline has started to ease as well, largely reflecting some signs of stabilization of global commodity prices. The MNI India Consumer Sentiment Survey also shows a pick-up in inflation expectations in the next 12 months. When asked how much prices will rise over the next 12 months, a growing proportion of consumers in our survey anticipated that they would rise by less than 5%, a change in attitude from the previous months when respondents had much higher inflation expectations. Both low inflation and inflationary expectations are positive for sustainable economic growth.
What is your take on India’s growth picture—looking at a wider set of indicators, is it muddled by divergent readings?
Economic data from India has been mixed. While gross value added was up relatively firmly in the first quarter of the fiscal year, and the trend in industrial production has been positive, other parts of the economy show signs of stress. Notably, the trade data continue to ring alarm bells with the deficit up 27.6% on the year in September. Business and consumer sentiment surveys, including our own, have also shown confidence easing.
Still, we expect growth to pick up, led by lower inflation, easier financial conditions, greater transmission of cuts in interest rates, higher government investment and continued momentum on project clearances which should help improve the overall business environment. The trend in industrial production remains firm and robust growth in the capital goods sector inspires confidence that investment should eventually start to rise. GVA (gross value added) growth is expected to be driven by consumption, led by both government and private households. The moderation in commodity prices is expected to continue and is likely to boost domestic consumption.
We, therefore, think the long-term outlook for India is positive and it is definitely one of the few rising stars among large global emerging markets. The growth path, however, is dependent on the implementation of structural reforms such as GST (goods and services tax), innovation in agriculture production, changes in labour laws, large-scale investment in infrastructure, etc.
Even if we set aside the 7% headline growth numbers, do you think the momentum is slow but turning up in India’s favour? How do you see the recovery playing out going forward?
There is no denying that the economic fundamentals of India are significantly healthier than they were in 2012-13, with stronger economic growth, narrower current account deficit, the fiscal deficit on a consolidation path and inflation having halved. Therefore, recovery is underway, but it is far from robust. Underlying economic activity remains weak, given that exports have been in a free fall, recovery in industrial production and investment activity is slower than expected, private sector remains risk-averse, the banking sector is stressed and business and consumer confidence is waning as evidenced by the MNI India Business and Consumer Sentiment surveys. Problems are further compounded by a fragile global growth, exaggerated by a slowdown of the Chinese economy. India is still at a nascent stage of recovery, with potential to grow at a much higher rate, but requires prudent monitoring by the government and RBI (Reserve Bank of India). One cannot reject fiscal and monetary policy intervention to support growth momentum. The role of public sector investment and RBI’s efforts to clean up the banking sector to mobilize lending is critical.
India’s recent macroeconomic performance has placed it above most big emerging markets in the current cycle, but the country’s longer-term structural problems are yet to be addressed. Can India continue to remain a “bright spot" among emerging markets for a considerable period, say over 5-10 years?
India has transitioned from one of the most fragile economies in emerging markets in mid-2013 to one that is a bright spot, helped by a shrinking current account deficit, falling inflation and improving government finances. Going forward, the growth potential of India rests on two pillars, its favourable demographics and the scope for large-scale investments in infrastructure fuelled by real economic reforms. India has the potential to remain attractive among emerging markets based on easier financial conditions, government measures to clear projects that have been held up in the system, a focus on boosting investment, larger volumes of FDI (foreign direct investment) and lower input costs. However, the process of executing economic reforms is not easy due to diverse economic priorities of very different political outfits. This has already been witnessed by the failure of passage of key reforms in Parliament despite the government having won a very strong mandate and this could dim its limelight.
As an economist, when you look at the India picture, do you think Modi’s bet on higher public spending to spur economic activity has started paying off? Yet in total contrast, corporate spending is tepid and federal revenue remains stressed.
The government push towards reviving the investment cycle is critical to boost growth. India’s private sector continues to be burdened by heavy debt, limited equity and low profitability, thereby reducing its ability to execute large-scale investments. The uncertain global macroeconomic environment is further adding to their risk aversion. The four cuts in the key policy rate by RBI by a total 125 basis points (bps) in 2015 is expected to ease the burden as the transmission of lower capital costs benefits private sector over the next few quarters. A reduction in the cost burden, along with potentially supportive capital markets on expectations of economic revival, will allow large-scale equity raising for private firms and help support investments. Until then, it is important that the government continues to provide support to fill the vacuum. Infrastructure investment push by the government, combined with supportive capital markets, should help large private firms deleverage and strengthen balance sheets to revive investment capacity.
Where do you see the rupee headed? Should RBI intervene more?
The reduction in global economic growth prospects, combined with the deterioration in the Chinese economy, has significantly increased volatility in markets and exchange rates. While the rupee dropped by as much as 3.6% in only a few days since the yuan devaluation, the current scenario is different than what we saw in 2013. RBI has built up foreign exchange reserves in excess of $350 billion, strengthening its capacity to counter any financial shocks. It is expected to intervene to curb excessive volatility of the rupee exchange rate. We expect the rupee to maintain a slight depreciation bias as the US economy starts to normalize interest rates and as RBI moves towards a more dovish policy on the back of a decline in inflation and slow recovery of the economy.
A year ago, you had said a lot would depend on Modi. How would you rate the government and its policies so far?
Even the harshest critiques of the incumbent government would agree that India has a new sense of vigour in engagement with its neighbours and the world after Narendra Modi became Prime Minister. It is now playing an important and engaging role on the global stage, showcasing itself as a market with huge potential and doing well at attracting much needed investment. So far, Prime Minister Modi’s ability to woo foreign governments appears to be proving a success at winning vital investment for India. His continuing success, though, relies on his ability to also change and modernize India’s domestic economy and, most notably, make the environment for business far easier.
On the domestic front, an important beginning was made by liberalizing diesel prices by taking advantage of low global oil prices, putting state-owned coal mines up for sale, raising foreign investment limit to 49% in insurance and launching a worldwide “Make in India" campaign aimed at transforming India into a manufacturing powerhouse and generating large-scale employment.
While Modi has introduced a string of reforms, he has shied away from the hard hitting reforms such as GST, land acquisition bill that many had anticipated. This is disappointing, given that this was the first government in three decades to have won an absolute majority in the lower House and, hence, was expected to be tougher in bringing faster structural changes to the country.
Overall, the government has been positive for the economy, but far more needs to be done. Expectations remain high but patience is slowly running out among both domestic and international businesses; so, clearly, it needs to fast-track its reforms agenda.
When will earnings meet expectations?
Corporate earnings have been weak for the last four years. However, over the next few quarters, we expect the benefit of reduced borrowing costs, combined with lower commodity prices, to help boost margins and consequently earnings. The big uncertainty remains the global economic climate, where a further reduction in global demand could negatively impact sales of Indian corporates, reducing any potential for improvement in earnings.