Economic reforms by the Narendra Modi govt are being carried out against a backdrop of fragile global growth. All this makes for a high level of uncertainty
Research reports by brokers, even the ones on the macro-economy, are usually focused strictly on economic parameters, avoiding all mention of politics. Fuzzy matters such as political economy, which can’t be reduced to a set of numbers, are generally given a miss. When politics is discussed, it is through the narrow lens of how many seats the ruling party will win in a state and whether that will help improve the chances of pushing through reforms. As a result, all too often, they miss the wood for the trees.
And yet, there are many changes in the air that could alter the Indian business climate in fundamental ways. To take one instance, Reserve Bank of India governor Raghuram Rajan has, very refreshingly, been talking of the culture of impunity that big borrowers enjoy and how they continue with a lavish lifestyle despite owing hundreds of crores of rupees to banks. The bankruptcy code, direct transfer of government benefits to bank accounts, changes in the ease of doing business and the emphasis on improving infrastructure are other examples.
One broker that has taken the less-travelled road is Ambit Capital Pvt. Ltd. Last year, they identified what they called three “resets"—taking steps to increase India’s financial savings, measures taken by the government to curb subsidies and an attempt to attack black money and crony capitalism. They say these measures would lead to profound changes in the Indian economy.
In a report brought out on 16 December, they say, “After a decade of ossification, the landscape is changing at a rapid rate for India Inc. as: (1) An unconventional PM calls time on the traditional model of subsidy funded consumption growth and crony capitalism driven capex growth in India; (2) A gutsy RBI governor brings about multiple policy changes to radically increase competition in the Financial Services sector; and (3) Technology lowers the barriers to entry into sectors such as lending, consumer goods and auto."
Interestingly, the political economy part of the changes mentioned by Ambit parallel the analysis put forward by an Effective States and Inclusive Development working paper titled The political economy of economic growth in India 1993-2014 in December 2014 by Kunal Sen of the University of Manchester and Sabyasachi Kar and Jagadish Prasad Sahu of the Institute of Economic Growth. The authors say that India’s growth trajectory can best be described by studying the changes in political economy from ordered deals to disordered deals and from closed deals to open deals. Ordered deals are deals struck between political elites and businesses that are honoured, while disordered deals may be reneged on. An example of disordered deals would be retrospective taxation. Open deals are deals where participation is larger and more open to the public, as opposed to closed deals, which benefit only the well-connected.
The authors say the 1990s were a period during which the Indian economy became much more open and the benefits of reform trickled down to all sections of the population. This was an ‘ordered deals’ environment and it was also more open, as it saw the entry of many new companies, while at the same time allowing the old elites of the pre-reform period to grow.
From 2002-10, argue the authors, there was a marked change in the type of growth. Because of the increase in prices of commodities during this period, resource extraction sectors, with their close links to government land, became far more important. The paper says, “Thus, economic growth in the second growth episode was qualitatively different from the first episode, in that it relied more on Rentier sectors (such as mining and petroleum refining) and other high rent Powerbroker sectors (such as telecommunications and real estate), along with a reversal in structural transformation of the economy (as reflected in decreasing product complexity of India’s exports)." The entry of new companies declined during this period. In the authors’ framework, this was a ‘closed deals’ regime.
However, these cosy deals between the political and business elites brought about a backlash, seen in the movement against corruption and in the decision to auction national resources instead of leaving them to discretionary allocation. That, in turn, led to massive uncertainty in the business sector, resulting in a slowing down of growth. Also, as question marks were raised about the legitimacy of government contracts, as the land acquisition law was tightened and as the government desperately tried to offset declining revenues by milking the corporate sector through retrospective taxation, the environment shifted to one of ‘disordered deals’ after 2010.
That crisis of legitimacy led to a change of government at the centre in 2014. The Modi government, aided by Rajan, is trying to change to a new environment of open ordered deals. The paper says that much of the product churning in the 1990s was due to product additions and therefore, the “creative destruction" of this period was more “creative" and less “destruction". This time, however, many businesses are in dire straits and the churn in the economy is likely to be far more destructive, particularly as it also involves disruptive technology.
It’s far from certain whether the government will succeed in its efforts. It has already lost a few political battles. The less said about the capability of some of its ministers, the better. There are question marks over the agenda of many of the ruling party’s elite. It will be up against powerful vested interests, including a change-resistant bureaucracy. Large sections of the economy, including the crucial banking sector, are in trouble. Moreover, the changes are being carried out against a backdrop of fragile global growth. All this makes for a high level of uncertainty.
That is why, although the changes, if carried through sincerely, will be beneficial to the economy and to the corporate sector in the long run, Ambit’s December report predicts “(a) Weak earnings growth in FY16 and FY17; (b) A big step-up in Sensex churn; and (c) Single digit returns from the Sensex over the next sixteen months."
Manas Chakravarty looks at trends and issues in the financial markets. Comments are welcome at email@example.com