Over the last six months the Indian financial markets have been one of the best performing financial markets across the globe. Both the Indian stock market and the Indian rupee have outperformed developed and peer emerging markets.
A few different reasons can be attributed to this. The Federal Reserve Bank in the US did not taper its bond buying program in September last year giving a respite to emerging markets globally; the Reserve Bank of India took some aggressive steps to adjust interest rates; it also came up with the NRI deposit scheme to add to reserves; the Government of India took measures to reduce fiscal and current account deficits amongst others; and there is a sense of optimism about India because of the elections happening right now with a new government likely to be known on 16 May.
But the situation was very different six months ago. Indian stocks and the rupee were among the worst performing in the world; Indian growth plunged below five per cent for the first time in a decade; foreigners and locals were selling stocks and any rupee denominated assets; India’s current account deficit had bloated to its highest level ever; inflation was getting worse; and India was under the threat of losing its investment grade status as a downgrade of its credit rating was looking imminent.
For a country that was the poster child of emerging markets and the most vibrant democracy for the better part of the 2000 to 2010 decade, it was a rude awakening.
India’s troubles are often blamed on the external shock which came from the Global Financial Crisis (GFC) in 2008, and some of this is true. But the massive decline in India’s economic standing is due to the terrible governance and flawed fiscal and economic policies run by the incumbent UPA Indian Government.
India was relatively insulated from the 2008 GFC as its reliance in terms of trade was quite limited on the external sector and in fact, the rupee, stocks and growth saw a smart rebound in 2010/2011- where growth picked up to 9.3 per cent of GDP in 2011.
The main reasons for India’s economic plight were the government’s abandoning of fiscal discipline, unforeseen corruption and scandals, lack of any seriousness to reduce subsidies or to carry out reforms and the undermining of investor sentiment by tinkering with tax and investment policies repeatedly.
India’s fiscal deficit ballooned from 2.5 per cent of GDP in 2007 to 5.9 per cent in 2012. Its current account deficit widened to $85 billion last year as the Government made no effort to reign in subsidies and that fuelled consumption.
India’s inflation rose dramatically from an average of five per cent prior to 2008 to eight per cent post that. Coupled with this, there were tremendous supply side shortages due to lack of investments which were crowded out by higher interest rates and a slow and painful process of getting clearances from the Government’s various ministries. The number of scandals that occurred in India, especially their scale, in the past four years was also quite unprecedented, further undermining sentiment and growth.
In the last six months, the picture has improved quite dramatically: some of it is due to the fact that the Reserve Bank of India, under its Governor Raghuram Rajan, has done a tremendous job not only of focusing on inflation and inflation expectations, but also making sure the loss of confidence in the rupee is reversed – their handling of the NRI deposits, oil swaps and the reduction in rupee volatility is commendable.
The Government has also done a little bit of damage control: the fiscal deficit has come down by more than 1.2 per cent; India’s current account deficit is much lower now as gold imports were heavily restricted and oil subsidies were rationalised. Additionally, investing in India was made simpler with foreigners given access to the Indian debt markets for the first time.
Unfortunately, these reforms are not only small in comparison to what’s needed, but they have come from the ‘back to the wall’ sort of scenario, not from a position of strength. In fact, every reform measure or policy action taken by the Indian Government in the last couple of years has been a firefighting exercise, instead of taking some of these decisions earlier when they had a full mandate after the 2009 elections, when sentiment, capital and investment was gunning for higher Indian growth. The reduction in the fiscal deficit has come on the back of reduction on revenue spending (which has hurt capital expenditure) and less from subsidy reduction. The clearance of projects for investments is still quite slow and real investment spending has hit a low of six per cent average growth in the past four years.
The buoyancy of the Indian financial markets and the turn in investor sentiment is, to a great extent, also attributed to the hope that the new government that will come in will be a reformist, strong and stable government, that will focus on the impending policy and governance reforms which are much needed to have a sustained scenario of growth and prosperity for India. According to all opinion polls it seems there is a more than a fair chance that the NDA-led alliance will form a government under the Premiership of Narendra Modi.
The results of Indian elections have been difficult to predict to say the least, especially if you see the surprises from the past two elections, but a high anti-incumbency factor, promise of growth and reforms and a much larger voter turnout with more than 80 million first-time voters have led to these expectations. The clearer the mandate, the easier it will be for the central government to carry out the much required reforms. In case there is a large dependence on multi-coalition partners, or in the scenario of a Third Front government with a lot of regional parties, the implementation of these policies will become more difficult and uncertain. It could also lead to a correction and resetting of expectations in the financial markets.
Investors are hoping that a new reformist government will take the helm after the elections, says hedge fund manager Ashish Goyal.
The incoming government will have its task cut out, as foreign and local investors have shown a lot of faith in the pending government already even before the elections have finished. Indian stock markets are trading at all time highs and have received almost 30 per cent of the global emerging market inflows in 2014. The rupee is one of the best performing currencies this year and the hope is of a growth turnaround.
Some of the things that the incoming government needs to focus on are:-
– Creating an environment that encourages infrastructure investments and other private sector investments especially in manufacturing
– Clearing roadblocks in implementing the Goods and Services Tax (GST)
– Sustained focus in bringing down the fiscal deficit, current account deficit and inflation
– Focus on agricultural reforms both on the supply side and land reforms increasing productivity and yield
– Rationalising of tax and investment policies, making them transparent and clean so as to attract the right international capital where needed
– Work closely with state governments as a lot of the stalled projects are under state government control and they are a key player in India’s growth
– Deal with a possible increase in defaults in corporate India due to the last five years of subpar growth and high interest rates and hence a worsening of asset quality in the banking system. Banks might need a higher capital injection.
– Work closely with the Reserve Bank of India under Governor Raghuram Rajan to continue effective monetary and fiscal policies.
The new government will have the backing of the financial markets as long as it’s not a fractured coalition, but it will have to deal with the economic reality of anaemic growth, high interest rates and an outsized task of continuing on the path of fiscal reform while still trying to jump start capital expenditure (capex) and investment spending. As long as it keeps up to its promise, the markets will give India and its new government the benefit of the doubt and hopefully this will reign a new decade of robust growth for the Indian economy.
Ashish Goyal is a Portfolio Manager with BlueCrest Capital Management (UK) LLP, a member of the BlueCrest investment management group, based in London. He is also an alumnus of The Wharton School of Business and the first blind trader in the world. The thoughts in this piece are his own and do not represent the views of any member of the BlueCrest group. He can be found tweeting @insaneodyssey
Read more exclusive insightful pieces on the Indian general election 2014 from experts in different industries here.
India entered the seventh phase of its general election today, 30 April. The nine-phase six-week long election, which began on 7 April, is now in its fourth week. Polling is underway in 89 constituencies in seven states and two union territories, including Gujarat, Punjab, Bihar, West Bengal and Uttar Pradesh. BJP Prime ministerial candidate Narendra Modi, who is contesting the Vadodara seat in Gujarat, cast his vote in Ahmedabad today, sparking a row as he did do so, as flashed his party symbol, the lotus, at the polling booth. Indian law bans candidates from canvassing within 100 metres of a polling area. The Election Commission has now ordered action against Modi and the media that televised it.