India’s reform story looking less and less convincing
Most governments in developing economies, to say nothing of those in advanced ones, would be over the moon with an annualised growth rate of 7 per cent in the second quarter.
To put things in perspective, the International Monetary Fund (IMF) expects the average growth rate for emerging market (EM) economies this year to be 4.2 per cent, down from 5 per cent in 2013 and only slightly lower than the average rate predicted for Southeast Asia’s economies.
In relative terms, India’s economy is booming and is expected to outpace China’s this year.
Yet when it comes to economic data, market expectations are everything - especially in India which has been perceived by investors as one of the more promising (and less vulnerable) EMs following the emphatic victory of the charismatic and business-friendly Narendra Modi in parliamentary elections last year.
Not only is India’s economy slowing - growth was 7.5 per cent year-on-year in the first quarter - investors were anticipating a stronger expansion.
The slowdown would be less of a concern if real progress was being made to liberalise and modernise the country’s economy. Yet the expansion has lost momentum just when Modi’s government has failed to push some of its key reform measures through India’s unruly parliament and at a time when investor sentiment has been deteriorating - partly because of the broader sell-off in EMs but also because of a gradual loss of confidence in Modi’s ability to overhaul India’s economy.
The MSCI India equity index fell nearly 9 per cent in dollar terms last month, a steeper decline than in several other emerging Asian economies and on a par with the drop in the EM-wide index.
Moreover, the rupee, one of the most resilient EM currencies over the past two years, has lost 13 per cent against the dollar since mid-May, almost as sharp a depreciation as that suffered by the Turkish lira, one of the most vulnerable currencies.
After 16 months in power, Modi, who was feted by investors because of his success in attracting foreign direct investment during his previous stint as governor of the state of Gujarat, is proving to be something of a disappointment.
How did this happen and what needs to be done to put India’s economy on a firmer footing?
Politics is partly to blame.
Investors underestimated the ability of the opposition Congress party, which suffered a crushing defeat in the lower house of parliament in last year’s election, to stymie the government’s legislative agenda in the upper house. Congress has held up the passage of a nationwide goods and services tax (GST) - despite championing the reform when the party was in power - deemed essential in order to overhaul India’s chaotic system of local and state taxes.
Just as worryingly, the government has been unable to spur much-needed investment, particularly in infrastructure.
A vicious circle has arisen in which heavily indebted industrial businesses are finding it difficult to fund large infrastructure projects which have either stalled or face long delays.
This is putting further strain on India’s ailing state-owned banks - which account for roughly three quarters of lending - which are themselves burdened by the rising share of non-performing loans. While the government has just injected a further US$11 billion into the sector, state lenders’ capital requirements are more than double this amount.
Analysts also point the finger at public banks’ poor corporate governance, exacerbated by political meddling in their lending decisions. Privatisation would help resolve some of these issues but would risk creating an even bigger ruckus in India’s parliament.
Modi’s failure to reform India’s much-criticised land acquisition law - which is fiercely opposed by the country’s small and poorly educated farmers but is crucial for infrastructure development - is another conspicuous impediment to faster growth.
Still, unlike many other EMs which are either overly reliant on speculative inflows of foreign capital or whose policy regimes are not perceived to be credible, India is much less vulnerable than in the summer of 2013 when, along with Indonesia, it was the focal point of market concerns about EMs. “We believe most of the risks are external in nature,” notes Bank of America Merrill Lynch (BAML).
Yet the fact that India, which is still viewed as one of the most promising developing economies, is struggling to reform shows that investors got ahead of themselves.
Whether Modi will be able to prove the growing number of sceptics wrong is an open question.
Nicholas Spiro is managing director of Spiro Sovereign Strategy