PM’s three resets
Over the past six months, I have highlighted in my columns that Prime Minister Narendra Modi is trying to reform the Indian economy along three specific dimensions:
- Altering the subsidy regime – by cutting the quantum of subsidies and by moving subsidies to the Direct Benefit Transfer platform –and thus adversely impacting ruralconsumption;
Why structural reforms entail short-term pain?
Structural reform usually entails short-term pain as economic agents (workers, bankers and businesspeople) struggle to cope with the altered rules of economic adjustment. As the OECD’s economists put it in 2012, “…it takes time for reforms to pay off, typically at least a couple of years. This is partly because their benefits materialise through firm entry and increased hiring, both of which are gradual processes, while any reform-driven layoffs are immediate.”
Britain under Margaret Thatcher, India after the 1991 reforms and Indonesia after the East Asian crisis give us a clear picture of what is likely to happen to India as Modi’s economic resets hit home:
- In the UK, Thatcher began the economic reform process in 1980. GDP growth initially fell to -2per centdue to these reforms but then recovered from 1982 onwards. In particular, investment initially suffered under Thatcher as she kept monetary and fiscal policies tight. As inflation expectations were brought down, private investment gathered pace.
These exampleshave a common feature: economic growth and investment nosedive during the initial phase of reform, as the rules governing the economy are radically altered by reform and economic agents struggle to adjust to this change. Gradually, the reforms put the economy on a sustainable growth path against the growth fuelled by excessive government spending (as was the case with Britain in the 1970s and India in the 1980s) or by unsustainable external funding (as was the case with Indonesia in 1997).
Growing evidence of economic pain in India in FY16
On the basis of my trips to various parts of India (Delhi, Lucknow, Patna, Hyderabad, Pondicherry and rural Maharashtra) over the past three months and based on Ambit’s economic analysis, it seems reasonably clear that the PM’s resets are now beginning to bite as:
- The real estate sector faces a broad-based multi-city pull-back in prices (down between 5-20 per cent YOY in most Tier 1 & Tier 2), in transaction volumes (down by over 50per cent cumulatively over the past three years) and in new launches (down by 50-80 per cent YOY). Note that real estate capex accounts for 10-15 per cent of Indian GDP and that over the past 10 years, one in three non-agri jobs in India have come from this sector.
Hence, I believe that GDP growth in FY16 will be lower than the 7.3 per cent clocked by India in FY15. As this becomes evident over the coming months, I reckon consensus will have to sharply scale back its expectation of 7.8 per cent GDP growth and double digit Sensex EPS growth in FY16. If contemporary India follows the robust template for economic reform established in other economies, such a scale back in growth expectations is more likely than not to be accompanied by a pullback in the Sensex.
Saurabh Mukherjea is CEO - Institutional Equities, at Ambit Capital and the author of “Gurus of Chaos: Modern India’s Money Masters”. He writes here in his personal capacity.
