The Indian Economy, Rupee and Modi: The Past and Future

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- Have government reforms been successful?

- What has, or is, their impact likely to be over time?

- What new reforms is Modi mulling if he wins the election?

One of the main factors driving the Indian Rupee at present is political uncertainty surrounding the Indian general election which began on April 11 and is still underway.

Analysts have said that a Modi win should support the Rupee because financial markets view his reformist agenda positively.

The Modi government’s economic reforms were aimed at modernising India’s thriving - but in certain areas outmoded - economy.

The question many voters will be mulling over when they go to vote is whether the reforms have actually helped. The answer is probably affirmative for the long-term as they have laid the foundation for a more modern economy, but they were terribly disruptive in the short-term, according to analysts at Actis Asset Management, a multi asset emerging market investor.

One of the best known reforms was aimed at transforming a primarily cash-based economy to one that was more digitally-friendly. It was argued this would help to eradicate corruption, counterfeiting and organised crime.

The first step was to get the population to open bank accounts. This was done primarily by steadily phasing out higher denomination bank notes from circulation and thus forcing those owning them to deposit the money in a bank account.

‘Demonetisation’ as it was called, actually let to a temporary slowdown in the economy as it disrupted whole sectors including the agrarian rural economy which was almost entirely cash-based prior to the reform.

“Demonetisation had a profound impact on business activity across categories and incomes of the poor...The biggest impact was seen across discretionary categories such as consumer durables in which demand declined by 50% in the days following demonetisation. Unorganised labour in the country, which is largely paid in cash saw a large drop in incomes and significant layoffs,” say Actis Asset Management in a recent note on the economy.

Several other reforms accompanied the phasing out of high denomination bank notes, including a law prohibiting charges for card payments of below $30 ticket size; accelerating the deployment of card acceptance terminals, and the facilitation of low balance saving accounts of which 275m have been opened.

The hit from demonitisation was to the rural poor mainly but not all the effect was negative.

“The impact of the push for digital payments has been significant – in case of Actis’ portfolio company Pine Labs, the largest processor of retail merchant payments in India, transactions have been growing at c.30% every year. The pain of demonetisation though has been considerable and focused on poorer people. Taken together this is a mixed outcome,” say Actis.

Another well-known reform was the introduction of a goods and services tax, or GST as it was know. This was designed to help improve revenue collection as India’s tax bureaucracy was old, corruptible, overly complex and inefficient.

“GST implementation had initial teething troubles including an unstable IT platform and complex filing requirements. It also disrupted activity in the months before rollout with businesses cut production and liquidated inventories as they prepared to adjust to the new system. This led to economic growth temporarily slowing to 5.7% in the quarter prior to the rollout from 6.1% in the preceding quarter. Growth subsequently quickly recovered to 6.5% and 7.2% in the following quarters,” says Actis.

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Overall the reform has probably been a success as the evidence is that more revenue is being collected via indirect taxation and the GST than before, and this is likely to help India.

Another Modi reform was to clarify and codify complex insolvency and bankruptcy laws in to the Insolvency and Bankruptcy Code (IBC). One major benefit of the reform was the shortening of the time it takes businesses to dissolve operations from 4-5 years to 270 days. This also further improved India in the ‘ease of doing business’ rankings.

A further reform brought in by the government was to the Indian real estate sector.

“Whilst customer needs have improved transparency and best practice, comprehensive regulation for the sector was missing,” say Actis. “The Government plugged this gap by implementing The Real Estate (Regulation and Development) Act, 2016, commonly referred to as RERA.”

The act supplied both a ‘code of conduct’ and greater transparency and comparability via a standardisation of metrics, practices. It also introduced a regulator to enforce compliance.

The reform appears to have been well received and so seems a success.

A key factor which helped facilitate reform was strong government - Modi’s BHP party enjoyed a large majority and this enabled it to push through some of the less-well-liked reforms, or those which were expected to cause the most disruption in the short-term.

If it wins a second term the government is planning to make further reforms, especially in the area of the labour market and direct taxes.

The main reform of the labour market will centre on incentivising the creation of permanent jobs rather than temporary jobs as India's antiquated laws tend to encourage the latter.

Yet reform so far has been slow because of fierce opposition, both from within Modi’s own party and from opposition parties.

“Crucial reform has remained elusive. Most recently, the Government had to scale back its effort to increase the maximum number of workers that can be laid off without seeking the Government’s permission from 100 to 300. In our view, labor law reform will a key area of focus for the Government if it wins another term, in its efforts to unshackle businesses and drive sustainable job creation in the country especially in the area of manufacturing. More wood to cut here” say Actis.

A further reform on the agenda is the intended simplification, modernisation and digitalisation of the country’s income tax collection. The main aim will be to make self-assessment easier and simpler to enhance revenue collection and reduce fraud.

Assuming the BHP wins another term with a clear majority the Rupee ought to kick higher in the short-term at the expectation of further reforms, however, the real benefit from these changes may not be felt for several years. The impact is systemic and secular, therefore, if anything they improve the longer-term secular outlook for the Rupee.

“Our verdict-the Modi government rates a pass on reforms to date. A clear mandate would allow further progress. Yet as always with fundamental reform the time horizons for success may well be longer than the attention span of financial markets,” say Actis.

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