Soaring animal spirits can make Modi’s task easier

When expectations are strong enough, they become self-fulfilling. If enough people think land and stock prices are going to rise and all of them start buying, the price of land and stocks will indeed shoot up. If all businessmen fear a recession and stop investing that itself will cause a recession.

I argued in these columns in earlier months that Narendra Modi, if elected as prime minister, would face so many structural barriers that he would not be able to accelerate the economy much in the short run. That argument has become much weaker. Within ten days of the election results, expectations of better days have zoomed so much that they could become self-fulfilling. What economists call “animal spirits” have soared in expectation of quick decisions, better governance, and business-friendly policies.

Policy changes take time to have an impact. But soaring animal spirits can produce quick results. If consumers suddenly consume more, investors suddenly invest more, and bureaucrats suddenly start moving files in expectation of better days, economic growth will automatically accelerate, and the days will indeed get better.

Consider the stock market. The sensex started soaring just before the results came out, and is now up almost 10% in a fortnight. Even this grossly understates the phenomenal mood transformation. Many truly beat-up stocks — public sector banks, infrastructure companies, real estate companies — have zoomed 50% or more. This newspaper has often advised investors to go for quality stocks. That has proved bad advice in the last fortnight — the most beat-up companies have zoomed most of all.

For instance, a big company like GMR Infrastructure was viewed as untouchable a month ago. Not only has its share price shot up 50%, there were only buyers and no sellers at all for the stock last Tuesday. By Friday the daily turnover hit a mind-boggling 17 million shares.

Such a boom has effects beyond the stock market — it transforms the real economy. A major problem in the last year was that even when large infrastructure projects got all clearances, nothing happened because the promoter companies could not raise fresh equity or debt for these projects. Many companies had been kayoed by the collapse in GDP growth, failure of regulators to increase tariffs, and failure of state governments to pay massive dues. These companies had huge losses and bank debts they could not service, and were battered to pulp by stock markets.

Indeed, their bad debts were huge enough to threaten to bankrupt the public sector banks that had lent them money. These banks urgently needed recapitalization to keep lending, but the fiscal crisis meant the government lacked the money to recapitalize them.

There seemed no quick solutions to these deep structural problems: a hard long grind seemed to lie ahead. But the post-election surge of animal spirits (and stock markets) suddenly looks like greatly reducing these structural problems, even before Modi announces any new decisions or policies.

The surge in share prices of big infrastructure companies mean they can once again tap the equity and debt markets to finance their cleared projects. Their coming revival has hugely eased worries about repayment of bank loans, and hence of the health of banks. If bank loans that earlier seemed imperiled become sound again, the banks’ capital adequacy will suddenly look fine. They will be able to expand lending without waiting for recapitalisation. Faster economic growth spurred by animal spirits will boost tax revenue, reducing the fiscal deficit and thus helping curb inflation.

Animal spirits have generated such an inflow of dollars that the rupee has strengthened to Rs 58.50, from Rs 68 last August. This will reduce the price of imported goods and to that extent curb inflation. The RBI does not want the rupee to strengthen further as this will hurt exports, and so has decided to ease the controls it imposed last year on gold imports. It is likely to do the same for dollar remittances abroad by Indians. A problem of too few dollars has become one of too many, so the RBI will encourage Indians to invest surplus dollars abroad.

There remain formidable structural barriers to economic revival, such as the new land acquisition law, entrenched food inflation, inflexible labour markets, excessive subsidies, and bureaucratic fear of being prosecuted for honest decisions. El Nino may cause another drought. The tapering of quantitative easing by the US Federal Reserve may once again induce a flood of dollars out of all emerging markets, including India. Much hard work lies ahead for Modi. But by galvanizing animal spirits, he has made his task much easier.