Modinomics and Indian financial markets
The rupee redenomination last November may add $265 billion in new deposits into the Indian banking system and penalise 'black money' hoarding.
It has now been three years since Narendra Modi swept the BJP into power in the 2014 general election with the highest majority since Rajiv Gandhi's election on a sympathy vote just after his mother's assassination three decades earlier. Modi's reputation a pro-business reformer as chief minister of Gujarat preceded him while a succession of sordid corruption scandal eroded the last vestiges of political legitimacy for Congress under the ostensible rule of "Mr Clan" Dr Manmohan Singh. Modi's rule has proved to be a game changer for the Indian economy. The Goods and Services Act (GST) has the potential to add a full percentage point to India's GDP growth rate, now a stellar 7 per cent. Modi also deregulated diesel and natural gas prices and moved to end retrospective taxation of foreign investments. Modi reformed the coal mining sector and instituted transparent auction regime on telecom spectrum.
The rupee redenomination last November had major execution flaws but will add $265 billion in new deposits into the Indian banking system and penalise "black money" hoarding. The bankruptcy law is mission critical to defuse the non-performing loan time bomb at the heart of India's predominantly state owned banking system.
Political metrics and financial markets have both vindicated Modinomics. In 2017, the Indian rupee has appreciated 4 per cent against the US dollar to 64 as I write. The Sensex index of India equities scaled 30,000 and India now trades at the highest valuation metrics in Asia, up 18 per cent in the past twelve months. Above all, Modi's BJP win in the state elections in Uttar Pradesh, India's most populous state and set the stage for BJP dominance Rajya Sabha (upper house) and a victory in the 2019 general election. To add insult to injury, BJP even beat Aaam Aadmi Party (AAP) leader Arvind Kejrival, an anti-corruption zealot, on his home turf in New Delhi local elections.
However, the ancient Greeks believed in the concept of "hubris", (the idea so brilliantly presented in Sophocles plays) that excessive pride precedes a great fall. Modi has taken political and economic decisions that could prove disastrous for India's future as a liberal, secular parliamentary democracy. Modi selected a communal leader like Yogi Adityanath as the chief minister of Uttar Pradesh. He has not repudiated his own support base in the RSS, whose activists assassinated Mahatma Gandhi in January 1948. Modi has imposed price controls on airline tickets, medical devices and pharmaceuticals. He sacked Dr Raghuram Rajan, arguably the finest Indian monetary economist alive, as Governor of the Reserve Bank of India.
The strong US April jobs data ensures two more Fed rate hikes in 2017. The UK snap election will mean Mrs May will be reelected with a large Conservative Party majority in the Commons. These factors, coupled with BJP economic advisor Arvind Subramanian's aversion to a strong rupee since it hits Indian export growth, leads me to position for a fall to 65. However, despite the $15 billion in offshore money attracted to Dalal Street in 2017, I doubt the RBI will cut interest rates as local banks are flush with deposits due to last November's banknote reforms. The monsoons will also boost food price inflation and GDP growth has been robust. This means the RBI will be on hold in the next four months while the Federal Reserve increases rates by at least another 50 basis points. The Indian rupee could well slip to 65.40 before the bullish uptrend resumes.
India faces multiple economic challenges in 2017-18 that the Prime Minister cannot ignore. Private sector capex is still mediocre. The Indian banking system's non-performing loan crisis must be resolved. India must offer a credible privatisation programme to attract foreign direct investment. The twin deficits must be narrowed. Above all, India must implement labour reforms that no Congress or BJP government since independence has bothered to confront. The Nifty now trades at 19 times earnings, making it the most expensive stock market in the world. Earning growth of 15-17 per cent is all too possible, thanks to PSU banks, metal producers and auto makers. Yet if Trump enacts major tax reforms, Modinomics should accelerate its reform momentum to ensure the world's financial passage to India.