Are the recent reforms sufficient to change the perceptions about the economy? 

The Indian economy has clearly witnessed a change in investor sentiment since the release of last issue of K-Buzz. The economy this month presents a mixed bag of reduced GDP growth expectations and elevated inflation on the negative side, but improved Index of Industrial Production (IIP), a much stronger investor sentiment and a currency that has appreciated over the prior month in a meaningful manner as positives.

Except the IIP, the other positive developments (and the inflation numbers) are the outcomes of the GoI’s first set of policy reforms, announced on 13 September 2012. The rupee, after attaining a trough of 57.33 in August 2012, appreciated to 52.93 on 18 October 2012. While the WPI-based inflation rose to a 10-month high of 7.8 percent in September 2012 (up from 7.5 percent the previous month), this is largely due to diesel price hike¹.

The GoI announced policy reforms geared towards boosting foreign investment and reviving economic growth². This underlines its intent of providing a policy boost to the sagging economy despite the political opposition at home, and an uncertain economic environment across the globe.

Phased announcement of reforms – a ‘step-chart approach’ to growth

KPMG in India perceives the GoI’s phased announcement of policy measures as meaningful steps towards encouraging higher economic growth. These policy announcements served the dual objective of indicating initial intent towards containing the spiraling fiscal deficit and promoting foreign investment inflow – both in specific sectors and the economy at large. The measures proposed include:

• Increasing the FDI cap for the insurance sector, from 26 percent to 49 percent
• Opening the Indian pension sector to foreign investors allowing 49 percent FDI
• Amending the Forward Contracts (Regulation) Bill to permit increased institutional investment
• Relaxing norms for foreign NBFCs in specified activities to increase fund inflow through the diversification of business
• Making amendments to the Companies Bill; one key provision is the alignment of interest rates on inter-corporate loans to G-sec of comparable maturity.

Reforms – heralding an inflection point to new beginnings

KPMG in India is of the view that once enacted, these reforms mark an inflection point to sustainable FDI flows in future, though several hurdles remain in the passage of legislative amendments as well as the economic realities on the ground, especially at present (no flood of airline investment is foreseen in the immediate term, as an example).

The foremost positive impact of these reforms has been on improving investor sentiment leading to a bounce back in the declining currency and an up-move in the equity markets. This is also evident from the moderation of the 10-year G-Sec yield, which varied between 8.13-8.17 percent in October 2012 compared to a range of 8.14-8.27 percent in August 2012³.

Besides, some improvement has also been recorded in the Business Confidence Index (BCI), according to National Council of Applied Economic Research-MasterCard Worldwide Index. Though on a quarterly basis, the index declined by 6.2 percent in 2Q13 from 1Q13 (the survey may have been conducted prior to announcement of reform measures), it continues to be higher in 2Q13 as compared to 4Q12 and 3Q12⁴.

However, legislative enactment of some of the announcements, together with further reform measures including legislation on land acquisition, GST implementation, and labor laws would be the key to realizing meaningful benefits in the years to come.

The reform measures announced thus far will have a limited impact in the near term on the economic growth, which is expected to remain sluggish in the 5-6 percent band, but have certainly helped, turn around the perception about the economy. The Government now needs to focus on some other fundamental issues that plague the Indian economy, such as low productivity, especially in agriculture and industry, high inflation, high interest rates, weak domestic investment, and meaningful reform in the land acquisition and indirect taxes arena. A combined improvement in these factors is the key to placing India back on higher growth trajectory.