Thematic Report

India reboot

by Mahesh Nandurkar & Abhinav Sinha / Nov 8, 2019


Multiple structural reforms over the past few years have helped reboot the Indian economy, elevating its growth outlook. Lower inflation is driving interest rates down while the insolvency code and NPL clean-up are making banks’ balance sheets healthier. The tax system has seen a major overhaul with GST changing indirect taxation and the huge corporate tax cut a fillip for direct taxes. Many of these changes can be traced back to Narendra Modi’s policies to create a more assertive and stable government. The housing market has borne the brunt of these changes but is now close to bottoming out. We expect a powered-up economy to emerge over the next few years.

The Modi government began to reboot the economy early in its first tenure. Inflation has since trended lower, by 5ppts on average, over the prior decade. Amendment to the RBI Act makes inflation containment an irreversible process. Lower inflation is structural and attributable to farm productivity improvement and should take interest rates to near all-time lows by 2020. But disinflation is growth negative in the near term and its adverse impact is visible in rural incomes.

Forcing banks to recognise NPLs and the landmark Insolvency and Bankruptcy Code have helped cleanse their balance sheets. These moves also triggered creative destruction across several sectors such as real estate, infrastructure and telecoms. The outcome is improved corporate behaviour and curtailed crony capitalism. The ongoing consolidation of state-owned banks from 26 to the proposed 11 by March 2020 has curtailed expansion, but makes the banking system healthier overall to drive future growth.

GST implementation not only simplifies India’s tax regime (cutting the categories from over 100 to five) but also reduces inter-state trade barriers. While the expected tax-compliance gains are still elusive, the shift to a more organised structure has impacted small businesses negatively. The Real Estate Regulation Act has also made business difficult for non-compliant smaller developers. In addition to hurting non-bank financial companies, a weak housing market has suppressed job creation. Thankfully, improving affordability and falling inventory should help the industry bottom-out soon.

On the positive side, India’s rank in the Ease of Doing Business Index has improved from 141 to 63 in five years. This coupled with a large cut in the corporate tax rate should drive FDI in manufacturing. A stable currency should also attract yield-chasing foreign capital in Indian infrastructure and commercial real estate. As the disruptive impact of structural reforms fades, economic growth should rise. Corporate earnings should also get a commensurate reboot onto a double-digit path.