After 19 months of Narendra Modi rule, Indian stock markets have crashed to 2014 levels, reminding the days of Pre-Modi-mania. The rupee is nearing its all-time lows. Fresh investments are declining. There are more in number now who question what the NDA government has done so far to lift the animal spirits in the economy; the promises it made to the investors and the common man on the street.
Once again, fingers are being pointed to the man himself -- the invincible Modi (of course, until Delhi and Bihar happened) -- who single-handedly guided the BJP to a landslide victory in May 2014 defeating the Congress party, which weakened by allegations of corruption and policy paralysis. Modi promised ‘acche din’ to a billion hopefuls. It included investors, who were desperate to see the economy sprinting on the radical reforms path and one-third Indians waiting to come out of poverty.
After 19 months, the dominant mood among economists and investors is that of pessimism, as is reflected in the financial markets. “The reality check on post-election positivity has seen asset markets pare gains,” Radhika Rao, economist at Singapore-based DBS Bank said in a note on Thursday. “While headline growth is at a firm 7%+, on the ground developments are recovering at a more subdued pace,” Rao said. Most economists and economy watchers seem to agree on this.
Is it fair to blame Modi alone for the crumbling financial markets? No. There are global factors at play too (such as the pain inflicted upon oil producing countries due to freefalling crude and the trouble brewing in China) that are beyond Modi’s control. But, is there substance in criticising his government on fading investor confidence in India? Yes. The situation on the ground in the real economy doesn’t look good with a firm recovery remaining elusive in the economy yet.
As a matter of fact, there has been little progress on big ticket reforms (in tax, land and banking), which has clearly tested the patience of investors and rating agencies. Recently, global rating agency, Standard & Poor’s had highlighted this fact saying India’s ratings will stay unchanged until at least 2017 given the lacklustre recovery momentum, despite the small-ticket reform measures that has happened so far.
The fall in financial markets was coming as the Modi wave, which spiked the markets post May, 2014, has been fading fast. It was just a matter of time investors came to terms with what is happening on the ground. Growth hasn’t picked up as expected. The stress in the corporate sector and banking industry, and slowing manufacturing activities throw signals that are hard to ignore. Logically, the government has sharply revised downward the growth target for the current fiscal year to just above 7 percent from an ambitious 8-8.5 percent expected earlier.
Devil in the details
Though India continues to be the fastest growing major world economy at even 7 percent, stress points are emerging on the ground. Most of the major economic indicators that should ideally support the high GDP number wouldn’t do so. “Weak private sector participation, sluggish credit growth and banks’ stretched balance sheets continue to be the main pressure points,” Rao of DBS said.
Why is the economy struggling? There are a few reasons:
For one, the stress on the bank balance sheets due to high amount of sticky assets and paucity of capital have clearly impacted banks’ ability to lend further, in particular to industries, which is critical to reboot the economy. This is a jolt to companies since bank funding constitutes the major source of funds to small and medium companies. Going by the latest RBI data, bank lending to industries has grown by 4.6 percent in the 12 months till October 2015 compared with 7.8 percent in the corresponding period in the previous year.
In the March-October period of the current fiscal year, credit growth to industries has languished at negative 0.3 percent compared with 0.7 percent in the previous year. The worst hit has been medium-sized companies, where bank lending has contracted by 10.9 percent as against a contraction of 1.1 per cent in the same period last year. Clearly, the health of the banking sector doesn’t look good so far.
Arguably, the Modi government has woken up to the banking sector problems (dominated by public sector banks with 70 percent of the market share) quite late, on issues of bank capitalisation and reforms pertaining to the sector. The government remains skeptical about the privatisation of state-run banks. On the other hand, it doesn’t have the ability to feed these banks with capital.
The government’s promised capital infusion of Rs 70,000 crore in the state-run banks wouldn’t suffice to meet their requirements on mandatory bad loan provisions, Basel-III requirements and further credit expansion.
Secondly, the government has failed to revive the manufacturing sector so far with growth across all key verticals experiencing prolonged slowdown. The tepid growth in factory output, also reflected in the core sector growth (fell 1.3 percent in November) and monthly PMI data (to 49.1 from 50.3 in November) indicate that revival in manufacturing activity has remained elusive.
Even though one can partly attribute the recent sharp contraction in IIP to seasonal factors (like that of November when it fell to a four-year low of negative 3.2 percent), economists fear that a visible drop in capital goods production and sequential contraction in most of the manufactured products sub-components raise doubts on the durability of the recent robustness in the industrial output.
Thirdly, reviving the over-leveraged corporate sector is another major challenge for the Modi government. The overleveraged corporate sector is facing severe stress on profitability. A recent note from rating agency Crisil forecast corporate earnings to grow by mere 2 percent in the three months ending December compared with 5 percent in the corresponding period in the previous fiscal year on account of plunging commodity prices coupled with weak investments in the economy.
Fourthly, the fact is Modi is yet to make a significant progress in kickstarting investment cycle. Indeed, FDI has gone up but not as much to boost his flagship ‘Make in India’ and ‘Starup India schemes, let alone his dream of transforming India to a global manufacturing hub.
In a recent note, StanChart spelled out this problem. "We expect investment to slow in Q4, as the private sector investment on the same scale is unlikely and the government is likely to trim capex to meet its fiscal year 16 fiscal deficit target,” StanChart economists said. More worryingly, they warn stalled projects to increase for the second consecutive quarter.
Separately, data from the Centre for Monitoring Indian Economy (CMIE) too warn that fresh investments in projects fell 74 percent in the December quarter to Rs 1.05 lakh crore from Rs 4.06 lakh crore in the corresponding period last year. This leaves the government to take the lead with continued higher spending even at the cost of breaching the fiscal deficit numbers.
Indeed the government has progressed on several small ticket reforms such liberalisation of FDI in certain segments, improving social security network through welfare schemes, promoting financial inclusion of poor through Jan Dhan Yojna coverage, plugging the leakage by covering most of the subsidies under the direct benefit transfer (DBT) and progressing on the bankruptcy code.
But the missing part, so far, is the large ticket reforms such as the crucial Goods and Services Tax (GST) Bill. Though the government has set April 2016 target for the roll out of GST, it appears difficult because the government doesn’t have the numbers in Rajya Sabha to push the Bill and a consensus with the Congress is still not in sight. It is almost sure that the government is likely to miss the April 1 deadline. The inability of Modi government, which is about to enter the third year, to push big reforms has been a major turn off for investors.
The windfall gains from low oil prices have tremendously helped the Modi-government in the last one year to manage the import bill and inflation. But, a prolonged crash in oil prices would impact inward remittances and exports that have fallen for 13 consecutive months, which isn’t good news for the economy.
The bottomline is this: what one is witnessing in the financial markets is the reflection of the weak global (mainly China worries) and domestic growth fundamentals. The Modi magic that worked wonders for stock markets is long dead and gone. It’s time for the government to acknowledge the actual state of the economy and work on solutions.