What Narendra Modi govt can do to spark economy before 2019 elections: Report

Narendra Modi-led government will complete three years in power next month on May 25. The government has two more years to ‘re-energize’ the economy, re-start the investment cycle and accelerate job growth, says a report by the Deutsche Bank.

Investment growth in the country continues to be muted despite sincere attempts of the government. Private capital capex – which constitutes 75 percent of total capex – grew by just 2 percent in FY16.

This has led to muted economic growth and employment creation in the country.

"With urban employment growth stalling over the past few quarters due to slowing investments in E-commerce/internet startups and Indian IT services demand, job creation is likely to take on critical status on the government’s economic agenda as the government enters the last two years of its term," says the report.

The report says that to accelerate private capex, two broad-based policy measures are needed:

Resolution of Stressed Assets

To de-clog the investment cycle, more power needs to be given for faster clearance of projects, authority to bankers to take decision on restructuring assets and better dealing with stressed assets in the banking system.

“We strongly believe by legitimately addressing the above three measures, the government could impart a very strong tailwind to the stalled capex cycle,” says the report.

The government is more in favour of laying a comprehensive framework to resolve stressed assets than building a bad bank, as suggested by the Economic Survey 2016-17. The government’s framework includes giving more power to the oversight committee as well as giving authority to bureaucrats and bankers to take faster decisions on asset restructuring.

The Prevention of Corruption (amendment) Bill

Slow decision-making by bureaucrats in the last few years have led to a delay in project approvals and execution. According to the Economic Survey, this has led to serious governance problems.

“Some provisions of the anti-corruption law seem to be scaring honest officers and pushing them to postpone decisions. The existing corruption law in the country does not distinguish between errors of judgment from decisions that are not in public interest,” elaborates the report.

Existing flaws in the system need to be resolved, which is the second major task for the government.

Amending The Prevention of Corruption (amendment) Bill will allow faster decision-making by the bureaucrats and will help in ease of doing business.

Going by the trend, reforms – which need parliamentary approvals – are usually taken up in the latter half of the tenure. The most important political reforms usually are implemented in the fourth year, the report reveals.

What to expect in next two years?

Acceleration in public spending

The historical data shows that four full-term governments formed in India since 1991 increased its spending in the last two years of the term.

"Government expenditure tends to accelerate led by the Capital expenditure in the penultimate two years of national governments," the report says. Rise in capital expenditure has been accompanied by rise in production of capital goods for previous governments, with exception of UPA-II.

Inflation dynamics favour corporate margins

In last two years of the term, inflation dynamics tend to favour corporate margins.

According to the report: “The pattern of increased CPI – WPI differential can be linked to favorable consumption back drop and can also be extrapolated to supportive margins for downstream companies.”

Indian equity markets outperform emerging markets

Emphasis on economic growth leads to better performance in the equity markets as compared to its peers. “MSCI India (US$) has consistently outperformed the broader MSCI EM index over the last two years of each of past three governments," says the report.

For equity markets, domestic economy sectors and particularly the industrials/capital goods sector the 'final two years' - of every national government since the Narasimha Rao administration in 1991 have thrown up some very distinct trends consistently,” Abhay Laijawala of Deutsche Bank told CNBC-TV18.

The only time when India had underperformed was during the term of Narasimha Rao-led Congress rule due to monetary tightening by the government. When UPA II was in power, deregulation of petrol price and opening up of FDI in multi brand retail in 2012 had played in its favour.

Who are likely to be the biggest outperformers?

Trend shows that capex-related sectors like consumer discretionary and cyclicals are the biggest outperformers during the last two years. On the other hand, telecom and exports tend to be the underperformers.

According to Deutsche Bank, "relative performance dynamics can be directly linked to Government’s pro-growth intent and actions."

It is essential for the government to accelerate private investment cycle – important for both job creation and economic growth - before it goes for elections in 2019.

Deutsche Bank is overweight on IT services, metals, energy and autos. The bank is underweight on telecom, financials and healthcare sectors.