India has seen a perfect storm in the first nine months of 2018, created by oil prices, interest rates, the rupee, banking liquidity, credit events like IL&FS and FII selling. With some luck and some deft management, now the economy is in a reasonable shape. Oil prices are down and are likely to remain stable. The rupee is near its fair value. It will depreciate but at a reasonable pace. Interest rates have declined 75 basis points and are likely to remain range-bound. FIIs have turned from consistent sellers to occasional sellers. Domestic flows have slowed down, but there isn’t much supply pressure. Liquidity is still short, though open-market operations and forex-market intervention can bring that to a neutral level. The IL&FS event has been contained. And, most importantly, market valuations have corrected sharply and are around their historical average.
The market has a near-term concern on two factors. There is a distinct shift towards populist policies like farm-loan waiver to win elections. This, if applied judiciously and funded from monetisation of assets, can still be withstood by the economy. But, if we go back to the fiscal profligacy of the past, it could affect long-term growth. While demonetisation and GST have helped expand the tax base, tax revenue growth is not high enough to support fiscal profligacy. India has brought persistent double-digit inflation to a low single digit with huge effort of the government and RBI. That can be lost in no time if there is fiscal profligacy. Private investment has remained subdued due to excess leverage of the past. High real interest rates, limited transmission of credit due to the PCA (Prompt Corrective Action) framework on state-run banks and tight liquidity also weighed on private investment. Fiscal profligacy will crowd out private investment. The market so far has taken the finance minister’s assurance on maintaining fiscal discipline.
The market will be closely watching the elections. At the current level, it is pricing in a stable government. GST, RERA, insolvency process, digitisation of the economy, financial inclusion through Jan Dhan accounts, a dramatic improvement in the ease of doing business ranking, reduction in leakages of subsides through direct benefit transfer and Aadhar linkages, and a massive build up in infrastructure from roads to waterways have helped build a strong platform for the economy to accelerate growth.
The US-China tariff war is a godsend opportunity to develop India’s manufacturing base. In 1978, India was ahead of China in per-capita GDP. China has since become the manufacturer of the world. We missed the bus. Due to the tariff war, manufacturers are looking to shift base from China. If we can push large buyers of Chinese goods in the US, then we can develop our manufacturing base. To achieve that, we need a stable government focussed on economic growth and not one fighting for survival.
The market will get impacted in the short term by many factors including global developments. However, in the long-term, fundamentals will prevail. How the economy grows and how companies increase profit will determine where our markets will reach. In a world where countries are fiercely competing with each other, it is extremely important to have a political leadership which is farsighted and rigorously pushes India’s economic interest. While elections matter far more on the result day and not much over the tenure of the government as fundamentals take over, it is critical to ensure that momentum isn’t lost.
A fiscally prudent budget and reforms-oriented government is necessary for maintaining or increasing the pace of growth. The market will be praying for both in the days to come.
(The author is Managing Director, Kotak Mutual Fund.)
Source: Economic Times