A Turning Point Of Investment Revival

Will the investment climate witness a turn around in the coming months? The convergence of several positive developments of the last few weeks, especially after the presentation of the Union Budget, seems to be reviving hopes of an investment recovery.

Witness the sustained surge in the Sensex by over 9.2 percent from a low of 23,192 on 17 February to 25,337 on 23 March . The foreign institutional investors (FIIs) are seen to be returning to the equity market; they have already infused US$ 2 billion in the current month so far in contrast to the withdrawal of US$ 4 billion during April-December 2015-16.

Maybe they are enticed by the sentiments expressed in the Economic Survey that amidst gloomy global landscape, “India stands out a haven of stability and an outpost of opportunity”. Maybe they are enthused by the International Monetary Fund chief Christine Lagarde’s statement that “India’s star shines bright” amid global economic challenges. She also holds that “over the next four years, even with a slightly declining momentum, India stands to deliver nearly two-thirds of global growth”. Apart from such positivism, what are the ground level developments of the recent weeks?

First, contrary to the expectation, the first half of the budget session of Parliament has turned out to be productive – the government has been able to get several crucial reforms legislations passed, in particular, the Aadhaar Bill and the Real Estate [Regulation & Development] Bill. There are renewed efforts to get the GST Bill through in the second half of the budget session. There is also the possibility of The Insolvency and Bankruptcy Code, 2015, which was introduced in the winter session, being passed.

Second, alongside its commitment to follow the path of fiscal consolidation, the finance minister has taken a bold initiative to cut sharply the interest rates on small savings schemes across the board in the range of 40 to 130 basis points. At the same time, the consumer price index (CPI) inflation rate has been reasonably anchored in (5.2 per cent on year-on-year basis in February 2016].

This would have several positive outcomes. One, it creates immediate space for the Reserve Bank of India to ease key policy rates (some observers believe that the Governor would front-load the interest rates policy by effecting a deeper cut of 50 basis points in the repo rate). Two, it improves the efficacy of the transmission mechanism. Three, it reduces the interest burden on public borrowings of the governments.

Four, it improves the relative competitive position of banks in deposit mobilization. Five, it creates favourable conditions for the corporate bond markets (easing cost of raising such funds). Six, it propels a change in asset preferences of households from fixed and falling income financial products to more risky equity and mutual funds markets.

Third, the government is reportedly restructuring the bureaucracy with a view to provide top priority to the implementation of key developmental programmes. With so much of promised private (including foreign) investments and budgetary allocations for public spending on some of these schemes, the implementation and follow-up actions would be of vital importance for their success.

Fourth, the government’s UDAY [Ujwal Discom Assurance Yojana] scheme is seen to be a comprehensive power sector reform. UDAY covers the entire value chain, and is gaining acceptance amongst states, where the real action is expected.

This would unlock financial and operational gains to distributors and states and would also improve capacity utilization of power generation units. At the same time, the improved financial performance of discoms would ease pressures of stressed assets on the banking sector.

Also, there are now reports about the government formulating a financial package to help revive the steel sector and also prevent bank loans advanced to steel companies from turning bad. This sector has been severely hit by a combination of adverse factors: weak demand, slump in prices, competition from cheaper imports and delays in project execution.

Fifth, India’s current account deficit (CAD) to GDP ratio at 1.3 percent during the third quarter (Q3) of 2015-16 continues to be comfortable. In absolute numbers the deficit was just around US$7.1 billion, which was lower than US$7.7 billion (1.5 per cent of GDP) in Q3 of 2014-15, and US$ 8.7 billion (1.7 per cent of GDP) in the immediate preceding quarter (Q2).

The cumulative CAD in the April-December periods of the current financial year has shrunk to US$21.9 billion [1.4 per cent of GDP] compared to US$26.1 billion [1.7 per cent of GDP] in the corresponding nine months of the previous year. This contraction in CAD was primarily on account of falling trade deficit, reflecting the slump in the overall foreign trade in the wake of falling international crude oil and other commodity prices as well as sluggish world trade.

Even in the midst of dismal foreign trade trends, there is, however, a positive fall out. Thus, alongside positive sentiments about India’s growth prospects and widely acclaimed good budget, capital inflows are likely to increase further. FIIs are reported to have infused ~US$2 billion into the equities market so far during this month. Besides, India is being looked upon as an economy with sound macro-economic fundamentals.

With increased capital inflows and narrowing down of the trade deficit, RBI may be comfortably placed to strengthen its forex reserves, currently around US$354 billion. In turn, this would strengthen the RBI’s armoury to steer the rupee’s exchange rate management in the event of any major volatility in the global financial and currency markets.

Already, the exchange rate of rupee has gained remarkably (3 percent) in a span of less than a month from its recent low of US$ = Rs.68.74 on 26 February to US$ = Rs.66.54 on 22 March. This, once again, could be good news in managing inflation, if the rupee were to retain its present strength in the coming months – the rupee cost of POL and other essential imports could ease further.

Last, the Finance Ministry, the RBI and banks together are now found to be working with better coordination and commonality of purpose to resolve the problems of NPAs and stressed assets. Admittedly, the magnitude of the problem is huge.

According to the Crisil Ratings, stressed assets of the banking system would rise to over Rs. 7 trillion (or 11.3 percent of total loans) by March 2017, from about Rs.4 trillion (or 7.2 percent of total loans) as on Mar 2015.

The entire cleaning up operations of the Indian banks’ balance sheets is going to take at least three to four years. But to the extent this process gathers momentum in the current year, it would gradually overcome the prevailing “risk aversion” tendencies of banks and also provide some relief from their acute resources constraints.

Simultaneously, if the Finance Ministry strictly adheres to its goal post of keeping the fiscal deficit target of 3.5 percent of GDP intact in the ensuing year, then it would generate enough resources space for the private sector to crowd in.

In substance, there are some welcome positive vibes. The RBI’s monetary policy on 5 April, which generally offers its own comprehensive review of the economy and outlook for the ensuing year, would obviously now be of crucial significance.