Foreign institutional investors share in the expectation of good times, as is evident from the ~80,000 crore they have poured into the Indian stock market in 2013-14. But that may well be because India right now is a more attractive market than many others for the investment funds earmarked for emerging economies.
Regardless of what is driving these anticipations, the reality is that an economic turnaround is going to take longer than the short horizons of market players. Their expectations of a coming boom fuelled a 19 per cent rise in the Sensex in a year when economic performance was worse than at any time in the past decade. This stock boom may well continue for some months after the results are announced - which may be as misleading as the fall in the stock market after the 2004 election just before an extraordinary period of high growth, and the sharp rise after the 2009 general election that marked the beginning of a torrid time for the Indian economy.
The key to economic revival lies in restarting the productive investment engine, because the slowdown in growth has a lot to do with the sharp decline in infrastructure and corporate investments. The gross investment numbers are misleading, because they include the accumulation of inventories and valuables (basically gold), which do not add to growth potential. If one looks at the numbers for gross fixed capital formation (GFCF) as a proportion of gross domestic product (GDP) at current market prices, the decline was from 31.7 per cent in 2009-10 to 30.4 per cent in 2012-13. Within this the share of direct investment by households as a proportion of GDP went up from 13.2 per cent in 2009-10 to 14.1 per cent in 2012-13 - since this goes mainly towards construction, plant and machinery, investment has grown even more slowly than GFCF. The trend continues; the advance estimates for 2013-14 show a further decline in GFCF as a proportion of GDP at current market prices to 28.5 per cent.
The reduction is particularly marked in the private corporate sector, whose gross investment as a proportion of GDP declined from 10.2 per cent in 2009-10 to 8.4 per cent in 2012-13. Part of the reason for this was the decline in corporate savings, which as a proportion of GDP fell from 8.4 per cent in 2009-10 to 7.1 per cent in 2012-13. The numbers for 2013-14 will be even worse.
A recent study by the International Monetary Fund (IMF) looks for explanations for this sharp fall in investment growth and the decline in new project announcements from around 10 per cent of GDP in the 2004-08 period to barely one per cent of GDP now.* It also argues that project delays have become worse.
A closer look at the data presented in the IMF study suggests that the 2004-08 period was exceptional, when new project announcements rose to very high levels and project delays fell sharply. The period before 2004 looks very similar to the one after 2009, though the last two years have been exceptionally bad.
The study asserts that "heightened uncertainty regarding the future course of broader economic policies and deteriorating business confidence have played a significant role in the recent investment slowdown". It attributes only a small role to high interest rates, which have been blamed by many for the slowdown. It points out that real interest rates during the recent period may have been 300 basis points lower than during the 2004-08 boom. But this argument needs to be tempered, since what matters for corporate profitability is the inflation in manufactured goods. The inflation in food prices does little to mitigate the burden of high nominal rates.
Will a stable government led by Mr Modi be able to change this soon enough?
The Bharatiya Janata Party appears to believe in lowering interest rates and will certainly lean hard on the Reserve Bank of India. But it also has to bring down inflation, which will remain a worry given the 70 per cent chance of an El Nino event this season; an interest rate cut may work against that. The other constraint is the need to maintain interest rates at a level that will keep flows from non-resident Indians - these flows have been booming over the past couple of years - coming in. But some cosmetic reduction in interest rates will come and may help to boost confidence.
A more important argument is that a business-friendly government that does not carry the baggage of scams and scandals will reduce policy uncertainties and revive confidence. But even this reason for optimism needs to be tempered with a dose of reality.
The policy uncertainties that need to be resolved involve matters such as the tax treatment of transactions by foreign investors, which has roiled sentiment; pricing decisions such as those on gas; and a few others that could be addressed in weeks. But much of the rest involves a long haul. Changes in the system of environmental clearances, forest rights and land acquisition will require legislative measures, and that will take time. Moreover, many of the bottlenecks are at the state level or imposed by court orders that the Centre cannot influence as readily. Investments have also been held back by supply constraints (take, for instance, coal) and by slow demand growth, particularly for capital goods.
For all of these reasons, the chances are that the initial euphoria over a business-friendly government will give way to a correction in the mood in stock markets and corporate boardrooms in a matter of months after the election. The fact is that the slowdown is owing not just to the paralysis in decision making but to deeper factors such as the fiscal and current account deficits, which will take years to correct. Does the "vikas purush" have that much time to prove his worth?
*"Disentangling India's investment slowdown", Anand Rahul and Tulin Volodymyr, IMF working paper WP/14/47
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