What manufacturing, banking & macro revolutions mean for Modi and markets

On May 16, 2014, the excitement was palpable on Dalal Street. As election results started pouring in giving the Narendra Modi-led BJP a win on its own, the Sensex soared 1,500 points intra-day, one of the biggest single-day gains in history. It crossed the 25,000 mark, and the gains set the stage for the subsequent rally to the 30,000 mark ten months later.

Since March 2015, the excitement and hope have given way to disappointment and some anger. The Sensex gave up almost all of its gains made between May 2014 and March 2015, and briefly traded in the red before rebounding after this year’s Budget. The anger and disappointment are understandable, but also substantially misplaced.

The Modi government could do little about two big reasons for the stress in corporate earnings: successive droughts, and a precipitous fall in commodity prices, which benefited the economy but hammered commodity firms’ earnings and hurt banks’ profitability. The stress building up in the banking system could have been set right long back but the UPA government chose to ignore it. Bankers and the regulator also did nothing.

If one examines Modi government’s two-year track record at the micro-level, one could come away feeling disheartened. Corporate earnings growth is still sluggish and investment is not picking up.

But if one takes back to look at the big picture and examine what Modi government is doing for the economy in the context of what it inherited and the prevailing global headwinds, the story becomes clearer and easier to understand. Three big revolutions are underway and the impact on markets and investors in coming years would be immense.

First is the manufacturing and infrastructure revolution led by targeted infrastructure spending and a slow but steady rise in the country’s manufacturing capabilities. India may not immediately get new steel mills and power plants but will certainly have better and bigger roads, a more efficient railway infrastructure, better public transport and more car plants and smartphone factories. Coal production is going up and the country will soon have 100% power connectivity and possibly 24/7 power. What this could do to productivity and manufacturing output can only be guessed at.

Second is the banking revolution. You could laugh at the usage of banking and revolution together, but the scale and scope of expansion and activity in the industry is impressive. The expansion of banking into rural areas, the reach of Jan Dhan Yojana and the penetration of retail credit into smaller towns and villages and the Mudra programme are making credit available at a scale never seen before.

The story is not great in public sector banks but here again, it appears that a proper framework is being built to professionalise and improve the work culture. The Bank Board, professional CEOs and mergers are the beginning; and with a hawkish RBI unwilling to bend on bad loans, the public sector banks seem set for an impressive turnaround. It will take a bit of time for that to happen though.

Enough has been said about the macro revolution. Low and steady inflation, despite two droughts, healthy revenue receipts, strict fiscal control and a current account in near balance. The last time we had something close to this in a recovering economy was in 2003-04 but that period ended disastrously for the BJP. It is possible that Modi would lose 2019 despite turning around the economy, a repeat of 2004. But if Modi and the BJP can learn the lessons of Bihar and come back strongly in Assam and Kerala, you can possibly trust them to keep the lessons of 2004 in mind when planning for 2019.