Modi govt capable of much better performance: CLSA’s Rajeev Malik


Unrealistically high public expectations of the Narendra Modi government, coupled with its inability to revive domestic private-sector investment and enact the goods and services tax (GST) bill offset the administration’s successes in attracting foreign direct investment (FDI), improving India’s global visibility and advancing financial inclusion, Rajeev Malik, senior economist at securities house CLSA, Singapore, said in an interview ahead of the government’s second anniversary. Edited excerpts:

How do you see two years of the Modi government. What are the positives and negatives? How do international investors gauge the performance of the government?

Prime Minister Modi’s two years should be judged in the context of five parameters.

First, how has the government fared relative to expectations, not relative to the previous government. After all, there were good reasons why the UPA-II (United Progressive Alliance-II) was booted out.

Second, Modi’s election victory was not about getting another average, above-average or a pedestrian prime minister. It was about electing someone with impressive credentials as an economic administrator who would be transformational in ushering in quick and substantial, favourable change.

Third, the retooling of the Indian economy cannot be done in two or five years.

Fourth, expectations were unrealistically high and the government unfortunately did not manage them in order to ensure delivery that generated positive surprises.

Finally, there is a bizarre belief that anything less than a 100% strike rate is a failing grade for Modi. This partly reflects high expectations, clamour for change and faith in Modi’s ability. The fact of the matter is that no government can deliver on everything, and Modi doesn’t have a magic wand.

Overall, government initiatives have moved in the right direction, with a few significant achievements, but the pace has been uneven and slow. There is still an aura of disappointment because of the unrealistically high expectations, absence of revival in investment, little progress on GST and the absence of rapid job creation.

There are pockets of high energy—roads, power, FDI, increased global visibility, more intensive use of technology to improve financial inclusion and to cut subsidy leakages.

But there are also areas of disappointment—agriculture, where the government woke up rather late to the severe agrarian crisis; education, which continues to be an enigma; railways, where delivery so far is lagging the positive sound bites; and water, where there has been a whimper of a policy response to the evolving gargantuan national-level crisis—beyond just because of poor rainfall.

The central government deserves high credit for the absence of high-level corruption though the same cannot be reportedly said for many states. It is unclear how much of the anti-corruption drive is also affecting investment. Still, a “cleaner” level playing field will be a huge long-term positive even if it extracts an economic cost in the short-term.

I’ve not been surprised by the slow and uneven delivery as I’ve always emphasized that stratospheric expectations were bound to be disappointed. However, the confrontational, rather than the collegial, political management, especially with respect to the legislative agenda, has been disappointing. Also, the government has limited talent bandwidth but fresh intake of talent has been largely absent.

Finally, it is somewhat odd that the prime minister of the world’s largest democracy believes mainly in one-way communication. Modi perhaps could do with a competent media advisor. Good work that is being done by the government is often masked by tangential events or comments and the verbal volleyball that follows.

There has been a healthy downshift in expectations. With the more pronounced pro-poor, pro-rural and pro-agriculture approach in the FY17 Budget, Modi has made a “leftward” shift much earlier than anyone expected. Political and economic expediency appear to be behind that shift. Given that he has avoided tough—but much needed—decisions in the first two years, he is unlikely to favour them in the second-half of his term.

Frankly, the government is capable of much better performance. It appears to have underestimated the complexity of its economic inheritance while also overestimating its ability to turn things around quickly. Modi can’t ignore the needs of the rising number of young aspirational voters. Meeting those needs will require higher, sustainable growth. Admittedly, change is frustratingly glacial in India. But it often rewards the patient and those who don’t complain about the noise when opportunity knocks.

A year ago, you said the broader game plan of the Modi government was to “engineer a strong foundation in the first couple of years even if it means moving slowly”, and added that this “would pay dividends in the second half of the government’s term” and “pave the way for an improved economic backdrop which should also aid re-election.”

My take on the synergy between the political and economic game plans remains unchanged. Politicians don’t wake up in the morning to rush to announce reforms, including unpopular decisions. They are most concerned with re-election. Some reforms enter into political equations because they strengthen the probability of a favourable electoral outcome.

Financial markets look for instant gratification, as if the real economy works as quickly as the rushed conclusions bombarded in media, especially social media. Improving economic growth with a few imbalances sets a positive backdrop for the Modi government to extract a favourable dividend in the next election. That might appear too far into the future for many investors, but politicians are unlikely to lose sight of it.

It is still too early but, more likely than not, Prime Minister Modi will get re-elected for a second term given the current lack of viable competent alternatives. Barring any accidents, economic growth should be better in the second half of Modi’s current term and palpably felt by the aspirational voter. However, it won’t match the unprecedented annual average growth of 9.5% in FY06-08. Don’t overlook that growth spurt was unsustainable, and the fallout from some of those excesses is still being corrected.

We may have a normal monsoon this year. How critical will be the recovery in agricultural output towards boosting headline gross domestic product (GDP) growth?

India has become less sensitive to monsoon vagaries but consecutive poor rainfall seasons have sapped economic energy. Modi’s first two years in office had the benefit of an economic windfall from the collapse in global crude oil price. This facilitated the much-needed macro stabilization but two consecutive deficient monsoons weakened rural demand. The rain gods, however, appear to be finally smiling on Modi. Now, forecast of an above-normal monsoon has kindled hope for a rural consumption revival and a GDP upgrade because of higher agricultural production. Revival in rural demand will complement the boost to private consumption from the implementation of the Seventh Pay Commission (recommendations).

Frankly, it is still early days for internalizing the precise economic impact of a good monsoon. A lot will depend on the actual quantum and distribution—both spatial and temporal—of rainfall in the four-month season beginning June, with July being the most crucial month. A timely and favourable distribution of rainfall could boost headline GDP growth to break above 8%. The anticipated monsoon-driven improvement in GDP growth will be welcome but would be temporary at best. The more important factor affecting the sustainability of the growth rebound is still-subdued aggregate investment, due mainly to the weakness in private capex.

Will the push in public capex be successful in reviving the overall investment cycle?

As Prime Minister Modi nears his two-year mark later this month, convincing signs of an imminent upturn in private capex cycle remain elusive. A sustained investment upturn remains a vital missing ingredient in India’s growth. This is especially relevant for India as it remains supply-constrained and a higher speed limit on sustainable growth will occur only when the economy’s aggregate supply is enhanced. The capex revival will be gradual and uneven, a far cry from the unprecedented acceleration in FY04-08.

Stalled projects have increased recently despite stepped-up public investment and a jump in inbound FDI. There is a pick-up in activity in roads, power and railways. However, fiscal discipline limits the boost to public capex and inbound FDI is a mere 7.5% of GFCF (gross fixed capital formation). Higher public investment cannot offset the downshift in private capex, which faces both external and domestic headwinds. These include low commodity prices, weak world demand, low capacity utilization, and slow healing of the asset quality problems of banks. Indeed, stronger investment will be the last piece to fall into place in India’s growth dynamics. This is bound to disappoint investors hoping for an early turnaround.

What is the outlook for growth? How do international investors look at India’s GDP numbers?

The building blocks of India’s next economic upturn are gradually—but unevenly—falling into place. Most macro imbalances have been addressed and stabilization is entrenched. This should pave the way for sustained growth acceleration. However, the improvement in growth dynamics will be protracted, affected by a changing mix of external and domestic headwinds and tailwinds.

GDP growth is likely to be 7.5-8% this year and next—this doesn’t include the impact of a favourable monsoon. Consumption will be the key driver. The government has taken several welcome steps that individually are unlikely to push the growth needle. However, the cumulative and collective impact of these over the next two to three years will be favourable.

The over-8% growth in real non-agriculture GVA (gross value added) in FY15 and FY16 raises questions about the credibility of the revised GDP or GVA data. The current disconnect between the impressive reported headline economic growth and the still-subdued corporate earnings is quite palpable. On the expenditure side, it is hard to conclude that the Indian economy is growing at the over-7% pace as indicated by the revised official data without any meaningful inputs from investment and exports, and despite the adverse impact of the first back-to-back deficiency in rainfall in three decades.

Given the nature of revisions, comparing the old and new GDP data is like comparing apples and oranges. Economies growing at 7-7.5% pace have a spring in their step which is conspicuous by its absence. The overestimation in GDP growth, crudely in the range of 1.5-2.5 percentage points, is probably because of the GDP deflator being lower than it should be.

What do you make of Reserve Bank of India governor Raghuram Rajan’s ‘country of the blind’ metaphor to describe India’s position as the one bright spot in global economy?

Governor Rajan, like any capable and independent-minded central bank governor, isn’t a public relations officer of the government. My sense is that all he was trying to indicate is that India looks relatively better-off because the rest of the world is bad. Few would disagree with this assessment. Today’s situation is vastly different from the favourable mix of domestic and external factors that prevailed in the stellar growth period in FY04-08. India then was a sought-after destination despite other countries doing well.

Frankly, how literally Rajan’s words are taken is dependent on the person and the purpose. Investors were clearly less bothered by this episode than some politicians.

Rajan is a breath of fresh air with his frank, thoughtful and independent views. There is a tendency in the political establishment in India—as it is in many other countries as well—to overplay the positives. This can risk complacency, which can compromise the pace and scope of unlocking of the growth potential. India has been here before; it should be avoided at all cost.

It is important that Rajan is offered—and he accepts—a second term when his current term ends in early September. This isn’t because he is irreplaceable—no one really is—but because he has good relevant ideas to improve India’s economic well-being. This fits well with Modi’s long-term agenda as well, though, perhaps, not with others who were pushing for quick-fix solutions of aggressive interest rate cuts.

Financial markets, especially the currency and fixed income markets, have immense confidence in Rajan. If he isn’t there for a second term, markets will have to undergo a period of adjustment. Modi shouldn’t overlook that Rajan’s successor will have big shoes to fill. A key worry will be the adverse reaction of investors if his successor is assessed to be less independent and less committed to delivering low inflation. Frankly, the government should announce its decision sooner rather than later.