These are fast-tracking investment approvals, lowering stressed assets, expenditure control, improving productivity of rural employment and controlling inflation
Morgan Stanley said, the Narendra Modi-led Indian government is very keen on working to fix the macro problems that have been at the heart of deceleration in GDP growth and high inflation. "As the government continues to deliver on the right policy measures and returns on investment improve, it will reinvigorate animal spirits and the corporate sector will have incentive to lift capex. Indeed, we expect that GDP growth on a quarterly basis will accelerate to 7.2% in the quarter ending March 2017 from 5.7% for the June 2014 quarter, and CPI inflation will head towards the Reserve Bank of India (RBI)’s comfort zone of 6% by December 2015. This would mean that inflation would have come closer to the RBI’s comfort zone after eight years," Morgan Stanley said.
Last week Morgan Stanley said it held a four-day macro due diligence trip and met several key policy makers, business leaders, rating agencies and independent consultants. "We learnt that while policymakers are focused on fixing four key macro problems with traditional measures as well as innovative use of technology, the path to sustained transition to high growth and moderate but stable inflation is dotted with challenges," it said in a note.
Morgan Stanley said it believes that the sharp deterioration in India's productivity growth was the result of a series of poor policy choices, including, maintaining a high fiscal deficit, pushing for high rural wage growth, maintaining negative real rates, and deterioration in the business environment amid general policy uncertainty and a slow pace of decision making in the executive branch.
“We already have evidence of revival in the productivity dynamic in the form of a pickup in GDP growth to 5.7% in June 2014 quarter from 4.7% in FY2014, while inflation has decelerated to 7.8% from a persistent 9-10% during April 2009 to December 2013 period,” Morgan Stanley added.
Here are the five key takeaways from Morgan Stanley's interaction...
1. Fast-tracking investment approval process (Project Monitoring Group) and improving investment
Investment approval process – A number of hurdles have led to a deterioration in capex over the past three years. The poor business environment since 2010, a weak political environment under a coalition government, the emergence of corruption scandals since 2010, and investigations related to such cases had meant that the governmental machinery had become risk-averse and had almost ground to a halt in its decision-making process. This led to existing projects getting stuck for want of clearances, and lack of transparency meant that businesses did not know at what stage or because of which issue the project was stuck.
2. Improving business environment leading to lower stressed assets
Morgan Stanley said, one of the factors that has held back investment in the economy has been weak corporate balance sheets and asset quality in the banking system. "Our conversations with banks and credit rating agencies indicate that corporate balance sheets remain weak and asset quality is still a concern. However, there are early signs of a reversal in credit quality thanks to the improvement in macro stability and economic growth outlook. Recent changes in the RBI’s regulations have helped banks’ efforts to make progress on asset quality," it added.
3. Implementation of Expenditure Management Commission’s recommendations and GST
“In our meetings,” Morgan Stanley said, “government officials recognized the importance of remaining on the path of fiscal consolidation.” It said, "Policy makers are optimistic that the FY2015 central government budget deficit target, set at 4.1% of GDP (we project 4.3%), will be achieved with help from lower oil subsidy burden (near zero subsidy on diesel) and upside from divestment receipts even though indirect tax revenue growth could be a bit lower than estimated. Indeed, the sharp declines in government expenditure growth over the past two months have increased the probability that the government’s target fiscal deficit of 4.1% will be met. Government officials also indicated that some saving on food subsidy can be expected in FY2015 (budget estimate of 0.9% of GDP, or Rs1,150 billion) via better management of food grain stocks. The government has offloaded more than 10 million tonnes of food grain in the open market, which will help reduce the storage cost and procurement has also been slightly lower because the centre did not allow states to provide a bonus over and above the minimum support prices (MSP)."
4. Rural employment program to be linked to productive assets
Policy makers recognized the need to maintain moderate growth in rural wages and the need to link the national rural employment guarantee scheme to creation of durable assets with linkages to rural or agri-economy. The Ministry of Rural Development has allowed states to change the wages to material ratio from 60:40 to 51:49, which will help the governments take up more asset-creating work under the National Rural Employment Guarantee Scheme (NREGS).
Moreover, over the last few months the rate of increase in rural wages has moderated to around 12-13% (coming closer to nominal GDP growth). The government has not intervened further with wage-setting under NREGS and the one-time catch-up effect of market wages to NREGS wages has started to fade.
Morgan Stanley, said, "We believe that government efforts to link the scheme to creation of productive assets will help to ensure that increase in rural wages is in line with the productivity growth, tempering the inflationary pressures arising out of increase in wage growth. In our view, moderating rural wages is key to improving the inflation outlook in a sustainable manner."
5. Government and RBI maintaining vigil on inflation trajectory
According to the note, government officials remained cognizant of the urgency to control inflation and were optimistic that the deceleration in inflation over the last few months should be sustained. Government officials indicated that recent steps to reduce the fiscal deficit and efforts to improve supply-side response, such as revival of stuck projects, should help in lowering non-food inflation. Food inflation pressures are something that the government officials are tracking very closely. Currently, with better management of food grain stock (open market sales) and lower hike in minimum support prices, encouraging states to delist vegetables from the APMC act, officials remained optimistic that food inflation should be largely contained, Morgan Stanley added.
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