In August last year, James Lord, an analyst at Morgan Stanley, referred to India, Indonesia, Brazil, Turkey and South Africa as the Fragile Five because of the huge currency sell-off that weakened the economy.
Among the Fragile Five, the keenest interest today is in India as it goes to the polls a few months from now, bringing with it a strong wave of optimism. This buoyancy is being fuelled by the prospect of a stronger government at the centre with a clear mandate towards economic reform and political change — a change that analysts say cannot come soon enough as India urgently needs to push through structural reforms if it is to achieve its long-term growth target of 8 per cent per annum, which it hasn’t witnessed in a while.
The adage that it’s darkest before dawn is one economic heavyweights and political pundits are banking on as the Indian economy recorded its lowest growth rate in a decade at 5 per cent in 2012-13, a significant drop from the 9.3 per cent growth achieved two years ago.
Mixed picture
According to an Ernst and Young (EY) report, India’s GDP rose 4.4 per cent year-on-year in the second quarter of 2013, which was weaker than expected and the lowest rate of growth since the first quarter of 2009. EY anticipates that GDP will expand by 4.5 per cent in 2014, with growth below 7 per cent in 2015-17 — the World Bank predicts growth of 7.1 per cent in fiscal year 2016-17.
In light of this, Standard and Poor’s retained its negative outlook for India over the next 12 months in May last year, with a one-in-three chance of a downgrade. The major risk areas will be high fiscal deficit and heavy government borrowing. Moody’s, on the other hand, has a stable outlook on the country’s sovereign rating, expecting infrastructure investments to rise over the next 12-18 months.
“In terms of medium- to long-term outlook, we see things improving,” says Sanjay Bhandarkar, CEO and Managing Director, Rothschild India. “Given what we have gone through and huge amounts of volatility, we are seeing investor sentiment pick up, which has led to a pickup in investor activity. This is in anticipation of the fact that the worst is behind us. The sentiment can be credited to opposition candidate Narendra Modi possibly becoming the next prime minister and to the current government under whom we have seen a significant amount of contraction in the current account deficit.”
But Bhandarkar points out that irrespective of the political party that comes to power, the need of the hour is to get investment back on track. Sectors that he has his hopes on include consumer goods, information technology, pharmaceuticals and infrastructure.
R. Murali Krishnan, Head of Institutional Equities at Karvy Stock Broking, an integrated financial services company, believes that the overall tone of the economy will remain sluggish for the remainder of this fiscal year with the pessimism flowing into 2014-15 as well.
“This is clear from the struggling capital formation — slowdown in build-up of inventory at the capital goods and intermediate goods sector level, tightness in government spending towards capital expenditure, elevated interest rates, inflation and drop in domestic savings. Trimming of the US stimulus package can further tighten the financing of capital formation from the external front,” he says.
Beating the blues
Recovery can only be a gradual process and will require a strong boost from the government with quick progress on reforms, lowering of interest rates and inflation. “If the interest rates are reduced from the second quarter of the 2015 financial year, we might see an uptick in growth from the fourth quarter. Currently, due to sluggishness in the manufacturing sector, the services sector, which contributes nearly 60 per cent to the GDP, has dropped below 6 per cent. Once manufacturing picks up, the services sector is likely to gain momentum with a lag of at least a quarter. So overall we expect the economy to pick up by the end of 2015,” says Krishnan.
Far from the gloomy picture painted in 2012, a global survey conducted by EY last year has ranked India as the most attractive investment destination today, surpassing China and the US and followed by Brazil in second position. Sectors with the highest level of anticipated dealmaking include automotives, technology, life sciences and consumer products.
While economic change is imminent, so is a political one and for the first time in the country’s history, the two cannot be divorced. The Indian populace has a tendency to prioritise factors other than good economic performance when evaluating incumbent governments — but given the high expectations of the BJP’s prime ministerial candidate, Modi, being able to translate his success as chief minister for the state of Gujarat onto the national stage, perhaps we are finally witnessing a gradual maturation of the Indian democracy.
“So far, from the reaction of the financial markets, it seems very clear which horse they are betting on. Modi has certainly demonstrated his ability for efficient and innovative governance in Gujarat. There is a widespread feeling in the industry that his is a responsive government that delivers on key promises. He has been a proponent of less government and greater governance. His management of the state’s once dilapidated power sector has been touted as a model for others. Large parts of his economic policy ideas are, and ought to be, replicable,” says Krishnan.
Electoral impact
No matter who the punters are putting their money on, the majority are hoping for a definite departure from the policy paralysis of the past three years and political stability arriving out of a decisive verdict that will accelerate economic recovery. “An impossibly fractured verdict of the kind we witnessed in 1996 will be a definite setback for the economy. India cannot afford to lose focus and time at this juncture,” says Krishnan.
And what better testimony to the growing belief that good economics will increasingly make for good politics than the much hue and cry created when Goldman Sachs said in its note titled Modi-fying Our View that “domestic equity investors tend to view Narendra Modi as an agent of change”. To this, Digvijay Singh, General Secretary of the Indian National Congress, commented that investment bankers should stick to what they specialise in — economics rather than political speculation.
But we are missing the bigger picture here — that there is an indelible link between the two, which is why Goldman Sachs had upgraded India’s rating to marketweight from underweight, while Standard and Poor’s will take a call on revising India’s sovereign rating after looking into the economic policies of the next government.
Government expenditure
“We expect the post-election early-cycle recovery to be led by interest rates sensitive vis-à-vis financials, capital goods, power and automobiles as these will be beneficiary to a pickup in government consumption or expenditure and infrastructure project clearances,” says Krishnan.
The 2014-15 financial year is expected to witness an increase in infrastructure consumption with the only rider being that of a stable central government post the elections. The second half of the coming fiscal year will see a pickup in the fast-moving consumer goods (or FMCG) sector owing to the transmission effect of job creation, good monsoons and rise in income levels, say analysts. Likely beneficiary areas will be consumer staples and consumer durables, while export sectors such as IT, pharmaceauticals and auto companies with high overseas exposure may continue to perform on account of global economic recovery.
