The market’s reaction to NDA’s election victory was very positive, and the continuous stream of reformist noise from the government has kept the market momentum strong. With 50 days complete for the Modi government, we do an early assessment of its tenure. Looking at early steps, we believe the government is on the right path to improving administrative efficiency, increasing infrastructure spend, resolving various policy and planning bottlenecks and controlling inflation. With this backdrop, we continue to believe that we could witness acceleration in GDP growth and correspondingly an improvement in India Inc's ROE (return on equity) going forward.
Towards a more efficient bureaucracy: As soon as it was sworn in, the new government focused on getting the administrative machinery functioning again—the government has reduced multiple levels of approvals, downsized the Cabinet, emphasised time-bound and transparent decision-making and sharply increased the accountability of bureaucrats and ministers alike. While the government could be taking time to think through a few critical decisions—the gas price hike, for instance—it has not shied away from taking politically difficult but fiscally prudent steps like the railway fare hike.
‘Minimum government, maximum governance’ on its way: Fulfilling its poll promise, the Modi government is already reducing various layers of bureaucracy to improve efficiency.
* It has abolished several group of ministers (GoMs) and empowered GoM (EGoM) committees, and reduced the decision-making process by cutting out layers of consultations. It has also appointed one of the smallest Cabinets in past 16 years with several ministers holding related portfolios.
* Further, in a note through the Cabinet Secretary to various ministries, the Prime Minister has asked all ministries to identify at least 10 rules that can be scrapped to simplify the system.
* Significantly, the focus of the new government is on accountability. During his first meeting of cabinet, the PM instructed all his ministers to spell out an agenda for the first 100 days in office and subsequently ensure their time-bound delivery.
* The Project Management Group (PMG), constituted under the previous government, focused on approving clearances for stuck projects; the new government has asked the various departments to closely monitor the status of cleared projects. The onus of monitoring projects (155 projects worth R5.5 tn have been cleared so far) has shifted from the department of financial services to the PMG, headed by the Prime Minister.
* Administrative changes in the central ministries–senior bureaucrats have direct access to the PM–focus on accountability with ministries required to make presentations on targets and achievements.
* The Budget announced an eBiz platform that will make all business and investment-related clearances available online with an integrated payment gateway.
Controlling the system leakage—Expanding the Aadhar Unique Identity Project: The government will expand the Aadhar unique identity project (UIDAI), raising the enrolment target to 100 crore (from 70crore), expanding the Aadhar-based Direct Benefits Transfer (DBT) schemes (e.g. direct transfer of LPG subsidies into beneficiary accounts) and also linking other projects such as the e-passport system with the Aadhar project.
Kick-starting the investment cycle: The government appears poised to kick-start the investment cycle, but overall, proposals have been modest at best. In the budget, the government promised to achieve 25km/day of road construction in FY15–a big jump from 8km/day in FY14. Issues with three critical railway links for coal transportation–stuck for a long time on various issues–are being resolved with at least one project now on track. With the ministries of power, road and transport and environment on the drawing board for new policy path for their respective sectors, more developments may emerge in the coming months.
o Longer-term measures include FDI liberalisation in defence, insurance (composite cap on both raised from 26% to 49%), railways and real estate (eased minimum entry requirements, etc), which will improve fund-raising for capital projects; and proposed high-speed and bullet-train networks on the PPP model.
o The budget allowed complete tax pass-through of Real Estate Investment Trusts (REITS) and an additional, Infrastructure investment trusts (INViTS) of a similar structure in the infrastructure sector. This is a long-term positive for attracting cheaper long-term financing for commercial real estate and infrastructure projects.
o The budget relaxed the terms for issuance of debt funds used for infrastructure investments by banks and IFCs
(infrastructure finance companies). It allowed banks to raise long term funds for lending with minimum regulatory requirements on CRR/SLR and PSL (cash reserve ratio/statutory liquidity ratio and priority sector lending).
o Future tax law amendments will not be applied retrospectively and all fresh cases of tax disputes arising out of retrospective amendments of 2012 will be examined by a high level committee (HLC) before any action is initiated.
o Reduction in tax litigation: resident tax payers can obtain advance ruling in respect of income tax liability above a certain threshold. The Budget has proposed setting up additional benches for tax dispute resolution and a HLC to regularly interact with trade and industry to ascertain areas where tax laws require clarity. Changes to transfer pricing regulations to simplify the system were also introduced in the budget and the finance minister vowed to further rationalise India’s arcane direct and indirect taxation regime.
Fiscal consolidation targets maintained: Despite a tough macro environment, the government has set a steep fiscal consolidation path, targeting a fiscal deficit of 3% by FY17. While the revenue targets could be optimistic, the government’s intent is in the right direction. Our economists believe that fiscal policy is now in sync with monetary policy and expect a sharp decline in CPI in H2 2014.
The reform path is long and valuations are full: We believe the reform process will be long and windy and the outcomes will have delayed discernible impact on output. Our economists expect GDP growth rate of 5.6%/6.4% in FY15/16, and in that context, we now find the markets expensive—our market-implied growth rate model suggests the markets are currently trading one standard deviation above mean. Hence, our view is that the markets are likely to consolidate near term. Our stock preferences are Coal India, TCS and Axis Bank. Over a longer term (three years), we would take any weakness in the market as an opportunity to increase our exposure to domestic cyclicals.