Market direction to depend on steps taken to accelerate growth: Nilesh Shah

Changing the orbit of Indian GDP growth from current 7 per cent to a higher level is what markets are expecting from the new government

The removal of political uncertainty is always welcome from a market point of view. Today's mandate shows the maturity of voters in choosing a stable government. Now, with the uncertainty behind, the market will focus on steps taken by the government to encourage investment and give a push to consumption, which is hitting a soft patch. 

The market is looking at the second term of 'Modi Sarkar' to build on the foundation laid in the last term. India has good macro indicators, including low inflation, better tax compliance, fiscal prudence, high FDI and a manageable current account deficit if oil remains at current levels. Now, the market believes that the stage is set for accelerating growth to higher levels by tackling challenges like the revival of investment and support to consumption growth. Changing the orbit of Indian GDP growth rate from the current 7 per cent to a higher level (eventually, to double-digit growth) is what markets are expecting from the second term of the government.  

Markets are pricing in double-digit earnings growth over the next few years. From a risk-reward point of view, the market is delicately balanced. The direction of the market will depend on the steps the government takes to accelerate growth.

Here’s my wish-list for the government:

National goal of 10 % GDP growth rate

Today, India looks like an orchestra, where each performer is playing their own note. While the orchestra is playing music, it is sounding like noise in the absence of coordination. Judiciary, for the right reasons, has taken corrective steps like cancellation of coal mines, iron ore mines etc. The fallout has been loss of jobs, costly imports and a drop in investment. Regulators have tightened money supply and raised real borrowing costs to bring down persistently high inflation levels. The government has pursued a path of fiscal prudence to bring stability to the economy. However, the side-effect has been slower growth. It is important that government, judiciary, regulators and entrepreneurs play as a team to achieve the national goal of double-digit growth. 

Rule of law & ease of doing business 

Rule of law is critical for entrepreneurs taking risk to set up businesses. We have laws, but their interpretation remains a challenge. Cheque-bounce is an offence under the law, but businesses aren't able to benefit due to issues with its execution. The government has to create a business-friendly environment to encourage entrepreneurship. While there is a constant need to change policies in today’s disruptive world, it is also important to give businesses adequate time to settle down with their implementation. 

Trade deficit with China

Our trade deficit with China, measured as a percentage of GDP, is higher than what US has with China. The government has to make China buy goods from India and lower the trade deficit. 

Availability of credit 

Currently, money supply growth is at the same level as 1960s when the number was in the lower single digits. There should be adequate liquidity in the banking system to achieve the credit growth rate required to support GDP growth, without compromising on inflation. The RBI has tools like Open Market Operations (OMOs), FX Swap and cash reserve ratio (CRR) cut to create this liquidity. The government should pursue the path of fiscal prudence and set up a robust credit risk evaluation mechanism to enable the RBI to provide appropriate liquidity to the banking system. 

Transmission of credit

The decline of PSU banks’ market share in incremental credit over the last few quarters shows the side effect of prompt corrective action (PCA) regulations and NPA clean-ups, which were necessary to protect the banking system. A lack of capital as well as willingness to lend has also constrained PSU bank’s credit delivery. The government must recapitalise PSU banks to start the lending cycle. With the start of IL&FS' defaults last year, the NBFC sector is facing severe refinancing challenges, forcing them to cut back on credit disbursements. A backstop facility on the lines of TARP will ensure that the liquidity crisis doesn’t escalate into a solvency crisis in the NBFC sector.

Cost of credit 

Real interest rates in India are higher than nominal interest rates in most parts of the world. Entrepreneurs suffer from four layers of taxes viz. income tax, dividend distribution tax, capital gains tax and tax on dividend income. Margins aren’t adequate for entrepreneurs to bear real interest costs of 5-10 per cent. The government must take appropriate measures to lower interest rates. A bold step, like inclusion in Global Bond Index, can bring in FX flows from FPIs that can help lower yields. 

Disruption in supply chain

Due to the US-China trade war, many manufacturers are shifting out of China. The new government should work aggressively to bring those manufacturers to India. The presence of Amazon and Wal-Mart, which are large buyers of such goods, should be fully leveraged to influence such manufacturers to shift base to India. Supply chain disruptions due to the tariff war is as big an opportunity for Indian manufacturers like Y2K was for India's IT Industry.  Longer term direction of the market will be determined by how the economy shapes up and earnings growth accelerates. India has reposed faith in ‘Modi Sarkar’ to shift growth to higher levels.

Nilesh Shah is MD & CEO, Kotak Mutual Fund. Views expressed are his own.