In­dia’s in­ter­reg­num

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Naren­dra Modi stands as In­dia’s most pow­er­ful prime min­is­ter in 30 years with a man­date to pur­sue a pro-eco­nomic growth agenda. The rea­son to stay with the most com­pelling trade in emerg­ing mar­kets is that a clear re­form im­pulse has been ar­tic­u­lated while the cap­i­tal spend­ing cy­cle is show­ing signs of life. The prob­lem for in­vestors is that key choices on fis­cal con­sol­i­da­tion and spe­cific re­form ini­tia­tives may not be an­nounced un­til a budget speech ex­pected in early July. Na­ture hates a vac­uum so it is not clear how the in­ter­reg­num plays out.

Here’s what we know. In­dia faces a stagfla­tion prob­lem. Growth in the year to March came in just be­low ex­pec­ta­tions at 4.7% while in­fla­tion re­mains stub­bornly high with CPI in April at 8.6%. To ar­rest the malaise, Modi has promised stream­lined and more ef­fec­tive govern­ment. Hav­ing a clear par­lia­men­tary ma­jor­ity means less need to dis­pense pa­tron­age so he has shrunk the size of his cab­i­net and will clip the wings of min­is­ters by re­quir­ing im­por­tant mea­sures to be fun­neled through the cab­i­net of­fice. It is hoped that cen­tral­iz­ing mea­sures over­come the bu­reau­cratic in­er­tia that has left big projects in limbo. To this end, the new Min­istry of Fi­nance has sub­sumed the for­mer Min­istry of Cor­po­rate Af­fairs, and will be headed by Arun Jait­ley, a close Modi con­fi­dante.

Such moves au­gur well, but Jait­ley faces a more im­me­di­ate headache in the shape of a po­ten­tial credit rat­ing down­grade. The rat­ings agencies had warned that In­dia could lose its in­vest­ment grade rat­ing un­less a sta­ble govern­ment was formed. Now the at­ten­tion will turn to the fis­cal con­sol­i­da­tion ap­proach to be pur­sued. In­dia has been in breach of its self-im­posed 3% fis­cal deficit cap since the 2008-09 fi­nan­cial cri­sis and the pro­vi­sional es­ti­mate points to a fis­cal deficit of 4.5% in the year end­ing March 2014. How­ever, Jait­ley’s first budget could see the pro­vi­sional num­bers blow-out even fur­ther as the new govern­ment strips away ac­count­ing mea­sures used by the out­go­ing govern­ment to make its fis­cal man­age­ment look bet­ter than it was. Hence, the budget speech will have to out­line a vi­sion for eco­nomic growth, while also of­fer­ing a cred­i­ble path­way to fis­cal con­sol­i­da­tion.

What is un­clear is whether game-chang­ing re­form ini­tia­tives can be un­veiled next month. With­out a par­lia­men­tary ma­jor­ity in the sec­ond cham­ber the Modi-led govern­ment will face dif­fi­culty leg­is­lat­ing on di­vi­sive is­sues such as la­bor mar­ket re­form, food pro­cure­ment or lib­er­al­iz­ing mea­sures to sup­port the mori­bund man­u­fac­tur­ing sec­tor. More likely, we’d ex­pect the an­nounce­ment of a goods and ser­vices tax, which has broad po­lit­i­cal sup­port.

Such cau­tion will un­doubt­edly dis­ap­point some in­vestors, but it should be re­mem­bered that grand pol­icy ini­tia­tives only go so far. Sus­tain­ing the cap­i­tal spend­ing up­turn de­mands im­ple­men­ta­tion rigor. And this re­quires the cen­tral govern­ment to use moral sua­sion over state gov­ern­ments which have the power to block projects. State gov­ern­ments are of­ten un­will­ing to cede their own fis­cal au­ton­omy, cre­at­ing In­dia’s ver­sion of “grid­lock”. Our as­sess­ment is that the new ad­min­is­tra­tion is the best placed in years to break this. Hence, cor­po­rates in sec­tors such as in­fra­struc­ture could face the un­fa­mil­iar sit­u­a­tion of pol­i­cy­mak­ing be­ing a help rather than a hin­drance. Those firms which have spent re­cent years re­pair­ing their bal­ance sheets are fairly well placed to se­cure fund­ing to restart stalled projects and even­tu­ally take on new projects.

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