Forget Delhi polls: Modi-Jaitley must focus exclusively on 3R's — reform, reform, reform

Regardless of what happens in the Delhi elections in February, for Narendra Modi and Arun Jaitley 2015 should be a year for good economics, not indifferent politics. For, the writing on the economic wall is clear: global growth is slowing, which means that India’s economic revival depends on what we do here, and not on good luck from abroad. Oil prices have given us an unexpected bonanza, but globally growth has slid on cheaper oil.

It is thus time for the three R’s: reform, reform, reform. Or else we will be where the world is headed with the fourth R – recession.

Yesterday (14 January), the World Bank cuts its global growth target for 2015 to 3 percent from 3.4 percent six months ago, and the IMF could do the same next week. The World Bank’s Chief Economist, Kaushik Basu, was quoted by Bloomberg as saying that even the current forecast could be revised downwards, since the only economy growing soundly is the US.

Basu said: “The global economy today is much larger than what it used to be, so it’s a case of a larger train being pulled by a single engine, the American one. This does not make for a rosy outlook for the world.” The Bank cut its forecast for the euro area to 1.1 percent (from 1.8 percent earlier), for China from 7.2 percent to 7.1 percent, and for Japan from 1.3 percent to 1.2 percent.

Ruchir Sharma, head of Morgan Stanley Investment Management (Emerging Markets and Global Macro), has outlined the downside risks as essentially China. The reason: its contribution to global growth in 2014 was 33 percent while the US’s had fallen to 20 percent, down from the 33 percent of 1994. 2015 is seeing a US revival, but a simultaneous Chinese slowdown means last year’s faster engine is slowing.

So where does that leave India, which is expected to grow at 5.5 percent, according to the Mid-Year Economic Analysis put out by the Chief Economic Advisor in December?

Basically, it means if we don’t do something ourselves, growth won’t revive to 6 percent or more in 2015-16 – as is being widely predicted. The World Bank, in fact, has also lowered its growth forecast for 2016 from 3.5 percent to 3.3 percent. This means no pick-me-up for India from favourable global winds even in 2016.

We have to lift ourselves up on our own. Ruchir Sharma makes the consequences of not pursuing reforms in India clear: a stock market fall, which has implications for companies and government, which expects to raise large sums of money from disinvestment.

In an interview to NTDV telecast yesterday (see here ), Sharma presented a slide which showed that markets rise in Year 1 of hope (Modi’s election in 2014), but Year two performance depends on reforms. The historical record shows that when reform happens, the markets rise by a further 20 percent in Year 2; if it doesn’t, the markets could crash 12 percent. He says 2015 will be make or break for the Indian economy, even though he expects growth to improve due to favourable oil prices.

This is the message Modi and Jaitley need to take to heart, and not what happens in Delhi, where the Aam Aadmi Party is expected to put up a good show, and possibly even win. February’s budget is the only window available for setting the year’s economic agenda. After February, the NDA’s focus ought to be on getting key legislation — for which several ordinances have been issued — passed. This means, even politics must be focused on getting the legislative agenda through parliament, even if it means letting the BJP’s short-term political interests slide for a while.

The other key points Sharma made were the following:

One, a key reform should be the devolution of more power to states. This also means the transfer of more resources to state, which the Finance Commission (which submitted its report in November) is bound to recommend. Modi has to make federalism central to his growth agenda.

Two, along with emerging markets, Indian growth too should be better. But exports will be tough to push through when global growth is slowing.

Three, Sharma also see competition for capital flows — into equity and debt — this year. This makes reforms doubly important or else the other emerging markets will get more flows. Without reforms, foreign institutional flows will stay shy.

Four, commodity prices are likely to remain low for an extended period. Sharma said that usually commodities boom for a decade and then lie low for the next two. This has huge implications for oil. It means the era of cheaper oil has begun, and it is not just a short-term 2014-15 surprise.

Five, the collapse of global inflation due to cheap oil means India is not likely to see any spike this year. Now you know why Raghuram Rajan lowered the repo rate today (15 January).

Six, stock market wealth is shifting back from energy and commodity industries to technology . Now you know why Flipkart is valued at $10 billion and Tata Steel just over $6 billion.

Between the World Bank’s growth forecasts and Ruchi Sharma’s crystal ball, the message for Modi and Jaitley is clear. In 2015, we have no option but to drive reforms back home if we want to see achche din.

On the upside, it also means raising public investment to restart the investment cycle. The proposal, made tentatively in the Mid-Year Economic Review, now has its raison d’etre.