In past few weeks, Indian financial markets have placed significant hopes on the recovery in macro fundamentals post announcements of much delayed reforms in a few non-critical areas of the economy. The chart below shows the extent of damage already done to Indian macro fundamentals and the extent of ground which India needs to cover before it can become fighting fit again.
Chart 1: IMF estimates of Twin Deficits
The above chart shows that India needs to quickly announce meaningful reforms in sectors that are constraining the growth of India – Roads, Ports, Power, Education and Health. The current set of reforms announced potentially create further capacity in airlines, insurance and urban retail sector – all three sectors are already plagued with overcapacity or are constrained by misplaced regulations – which unfortunately are not yet addressed by the current set of reforms.
Unless India gets its growth engine back on track, simultaneously controls inflation, and produces positive real rates of returns for fixed income investors, the current optimism will not produce sustainable results.