Structural reforms like increasing FDI limit for certain sectors, deregulation of petrol and diesel are seen pushing India's growth in medium term, says Morgan Stanley's Manoj Pradhan.
Investment focused structural reforms over past one year will drive India’s growth, believes Manoj Pradhan, Global Economist at Morgan Stanley. While most emerging markets are struggling with growth issues, Pradhan believes that India and Mexico are the only two countries that are doing it right by focusing on structural reforms.
“I think India’s structural reforms for the last eight to nine months have had the advantage that they have single mindedly trying to focus on investment.. I think India has structural issues as well but given where it is along the development cycle these are not as severe as some of the other economies in the world,” Pradhan said.
After growing at average 8-9 percent, Indian economy slumped to 5.3 percent in 2012-13, lowest in a decade on policy paralysis and overall slowdown across industries. In order to rejuvenate growth the government has set up a Cabinet Committee on Investment (CCI) to remove infrastructure bottlenecks and allow faster clearances of large projects. Various other structural reforms include deregulation of diesel prices, partial decontrol of petrol and liberalising the FDI norms for various sectors. In earlier report Morgan Stanley had noted that India’s initial phase of recovery would be driven by an improvement in growth mix and productivity growth rather than a big rise in investment to GDP or headline GDP growth.
Below is the verbatim transcript of Pradhan’s interview
Q: First, wanted to start with your view on India and how would you be looking at the macro environment since possibly the start of 2013?
A: I will talk about India in the global and the emerging market context. To juxtapose against an emerging market (EM) theme for the last year end change investors have correctly started viewing emerging markets with concern. About eight months ago we talked about this quite dramatic change in the stance but at that point in time there still wasn’t overwhelming or over reaching agreement that emerging markets needed structural reforms. If one looks at Europe, we know that structural reforms are introduced only when cyclical tools don’t do any help. EM now wherever one looks every single large EM is now running structural reforms which means they have realise that the growth model has to change. Many of them have very severe structural issues, I think India has structural issues as well but given where it is along the development cycle these are not as severe as some of the other economies in the world.
India was probably a very different one. While emerging markets had constraints on almost every side, India’s cyclical problems relative to the rest of the emerging market were extremely deep probably one of the deepest in the EM were. At the same time, in a theme that resonates across the rest of EM cyclical tools have not been very much in use. So, one of the things to look at say in Brazil – 500 basis points of rate cuts by the central bank while growth actually fell 6 percent at the same time.
One of the more recent phenomena that has been taking place is, China’s credit growth has been strong but the economic growth has not followed suit. So in many places these standard cyclical tools have not been helping, In India’s case it is because they really have no room to go. Inflation has been very high though it has fallen off recently and that means the rate cuts cannot come in aggressively. Part of the reason that we believe that inflation has been high as my colleague Chetan Ahya has written many times is, that the fiscal solution that was applied to the great recession was too aggressive and created a sustained problem so one can’t have easy fiscal policy, If one takes aside monetary and fiscal policy the only solution one has got left is structural reforms. India and Mexico are the two countries that are doing it right.
Q: But the structural reforms also require a stable policy and in India that seems to be the next question mark so what would you therefore estimate in terms of growth. A bit was done in terms of the diesel price correction and an effort at least to correct the power sector and the oil sector. But do you think they will sustain and in any case what are the growth numbers you are looking at for FY14 and the slightly longer story – is this an 8 percent economy in terms of the next three or four years?
A: The political question is present almost everywhere in the EM world and unless one has got something like a two party structure which has been institutionalised, one will always have very diverse views that are trying to force the issue. I don’t think India is unique in that case. There are of course, outliers in terms of where the political commitment is incredibly strong. China’s policy makers have a very solitary and single minded view of where they need to go. Administrations in the developed markets were also moved. I don’t think this is a problem that is unique to India. It will be an impediment to some of the progress that could have been made. But what is crucial about India’s policy making is that unlike many other parts of the world where they are trying to use infrastructure projects that are just very broad based, I think India’s structural reforms for the last eight to nine months have had the advantage that they have single mindedly trying to focus on investment. Whether that will pay-off or not remains to be seen – none of these issues can deliver growth in six months, eight months even one year or two years. So, whether the fruit of those reforms will be borne or not really is not possible to see in the short-run. Over the medium-term I don’t think we have anything but a choice. One of the reasons for that is the demographics as well.
Q: The global monetary easing – what in your paper you call monetary easing part III. How are you looking at this asset price increase. Would you say that the underlying growth in the United States, where the growth is the best actually, commensurate with the kind of asset price increases that we have seen or do you think that it will play out later on in the year in some ugly form?
A: We need a two day discussion to really get into that. We call this a third edition of the great monetary easing. The first one is obviously when the great recession was, QE1, QE2. What’s different this time is part of the trigger has been what Banks of Japan done. If one had looked across the US, they have now probably not brought forward lot of tapering that had to be done off, the European Central Bank (ECB) has cut rates and has shown a commitment to ease further as and when required. EMs almost everywhere have eased with a few exceptions.
I think the asset price story is an integral part of this because about four years ago the transmission mechanism in the developed market world were impaired - so if you cut rates, you couldn’t pass on the rate cuts because swap spreads widen so dramatically. Now what has happened on the EMs side, is that some of the credit transmission mechanisms there are impaired as well. So, the only remaining mechanism that still works is probably the asset price story - stock markets going higher, creating a feel good factor of optimism and inflation expectations rising higher taking real interest rates down and hence incentivising investment and spending.
Q: You wouldn’t worry that a bubble is round the corner in any of the asset classes. It is very stack in Europe; yesterday’s numbers indicated recessionary conditions, even Germany disappointed and yet the DAX is at an all time high. Will there be a sudden pullback? Do you think that this easing and its consequences will result in benign asset performance for some time now maybe for better part of 2013?
A: To answer your question I will use something that you said before, and one of the things that you said before is the outlook for the US economy looks very good. This is staggering. Four years ago this economy looked like it is going to take us down into second great depression - just four years now in every economy in the world you pick the US economy which started the crisis off.
In some places the optimistic that remains in place is grounded. Whether stock markets have run too far ahead and whether they have been supported by policy and whether they could come crashing down are still very open questions.
One of the ironic things about a bubble is probably you don’t spot it until it is really blown up and if one tries to track them probably you track them when they pop if they are in place, is very difficult to tell.
Q: Now going forward, you have already spoken about structural reforms being one of the key catalyst for India’s outperformance. Going forward which other structural reforms that global economist or investors would be watching most keenly for India to take forward more aggressively?
A: I think one of the issues is that global investors have not being paying much attention to India and the cyclical problems that India has relative to its peers, the current account deficit, the very stubborn inflation which has thrown its cycle out of sync with the rest of the EM world have really been sticking points with most of the investors I have spoken to, to an extent that most of them had not paid attention to the structural reform story that is ongoing. That I believe in and colleague Chetan Ahya also believes is a very important part of the driver of growth. If one wanted to see more of the resilience that one want to see out of India, I think one would need to see structural reforms driving investment, that investment growth leads to better spending, better spending leads to an improve fiscal position and that leads to more productive allocation of resources which would bring inflation down in the medium-term. These are the dynamics we need to see on the ground.
People will slowly get convinced but that is probably the good thing. The last thing India needs is a huge flush amount of cash coming into its economy and making people complacent here again.