India's slowdown and a chronic lack of responsibility

The Indian born head of Honeywell Technology Solutions recently said that ‘Indians have this attitude of blaming somebody, including God’; in other words, they are quite adept at avoiding responsibility. While obviously a generalisation based on Mr. Mikkilineni's personal experience, it is not completely unsubstantiated as is borne by the current state of business, economics and polity in India.

Let’s begin with industry. For a number of years now Indian businesses have not only been flourishing in an environment of rising prosperity of the domestic consumer (unleashed by the liberalisation and reform process that started in 1990s) but have been staggering beneficiaries of the debt boom that was fuelling the pre-financial crisis goldilocks scenario. Indian businesses had entered the cycle in the early part of the decade with significant cost advantages (especially in the context of technology and business process outsourcing), an undervalued currency, rising access to cheap funding and an under-served domestic consumer. As incomes rose and demand grew, so did costs of production. With revenue growth still attractive and cost of capital still low, businesses could derive gains from financial leverage even as growth in operating leverage slowed. The global financial crisis could very well have not happened for India. But slowly and surely capital became scarce and cost of capital grew in line with the rates of inflation. Indian businessmen have had to come to terms with what their colleagues have in the rest of the world come to accept as a fact of life – the business cycle. 


The global financial crisis had a clear culprit; the dip in the cycle in 2011 needed new scapegoats. Who better to blame than the politicians? The same ones that had for over half a century inflicted socialistic pain on the Indian masses, nevertheless still ensuring that their nexus with the very same corporate creatures provided a stable business environment to industrialists and ensured maintenance of their profit margins.


We are not reforming enough and definitely not a rapid enough pace is the general complaint you hear from the most eminent of tycoons. For some reason they have decided that the sole purpose of government is to transfer exceptional, effortless profits to them so that they can quarter after quarter announce 20% plus earnings growth at analyst conferences. India's revenue growth story has been so strong that every other manner of ensuring corporate success has been sidelined. The corporate sector has its task cut out for it - work on improving productivity and cutting costs.

Economic policy and the poor management of it, has no less of a hand in the current state of despondency of investors in India. That responsibility is shared by policy makers in the government as well those seemingly independent of it (like the Reserve Bank of India). The current troughing phase of the Indian business cycle would have, in our opinion, come upon us earlier than it has actually happened. That is in part why the adjustment of expectations and and the impact of it is steeper now than we would probably have seen earlier. Inflation in India has been above the RBI’s stated tolerance zone now for 6 years. Even in 2008, in the depths of the financial crisis, most measures of inflation refused to go below this tolerance level. Where there were clear indicators of easy monetary conditions domestically (accepted that it was a tough credit environment globally), how should we view the RBI’s decision to slash policy rates to propagate negative real interest rates? Undoubtedly, the common man is paying the price for policy makers ignoring inflation. Furthermore, in late 2009 and 2010, when inflation really started to run amok, the central bank stuck to its measured pace; even skipping rate rises at a few policy meetings (whether under pressure from industry and politicians is another blame shifting exercise)! 


The less said of fiscal policy the better, though it is a fact that the management of it was definitely starting to get better last year after a tremendous and unnecessary overspend in the crisis years. That 2011 has been a politically inconvenient year and the government has once again dug a grave for itself epitaphed in corruption means things may not get better on this front. We now face a similar environment in public finances as we do in the corporate sector. Tax growth is falling sharply and government's inefficiencies in framing public policy is leading it to borrow increasingly large sums to meet cash flow needs. The current bind, both politically and financially, could make it desperate enough to be inventive and bite the bullet when it comes to making sound fiscal policy. This in effect could at worst mean higher taxes, if rationalisation measures like GST implementation continue to fall into the political abyss.

India's politicians in even the best of times have never done India's economic potential any justice. Hence the phrase that 'India grows despite those who govern it'. We all know that good economics is good politics (the phrase from the 80's Clinton election campaign comes to mind: "It’s the economy stupid!"). But where politicians continuously fail is timing economic gains with political gains. And when this timing is out of sync, it always is the case that short term populist policies that worsen economic efficiencies and have poor long term economic consequences triumph. After all, why should the ruling party stick its neck out to open up the retail sector to competition and foreign capital, when it knows that the benefits from it to the consumer and farmer are clearly longer term, and will have little impact on the upcoming state elections or for that matter the general elections in 2014? In fact the closer we get to general elections, the less chance this policy has of any approval, unless there is short- term political benefit to be derived from it. The food security bill, a quick and effective vote gathering measure, is so much more important to them. The tragedy of it is that it obviously again makes it easy to transfer extraordinary gains into the hands those who can pilfer grains or hoard them and a new circle of profiteering starts in earnest. It is true we need to pressure the politicians, check their tendencies to create inefficient, opaque systems and force them to consider longer term economic action, but this will not be achieved by blaming them, only by actively supporting those who commit to the right policies.


What India Inc and Indian entrepreneurs have is a fantastic opportunity set ahead of them and it is a great time to be reorganising themselves and restructure their businesses to be innovative, competitive and lean. It's the time to consolidate as there is excess fragmentation and poor margins in many industries (Infrastructure is a case in point) and for businessmen to know their core competencies and stick to them rather than try to put their fingers in every hot pie and then get burnt. It’s time for shareholders to keep a strong tab on ‘promoter’ tendencies to dilute the value added of the businesses - they need to stop them from continuously diluting minority interest and engage management to stop their empire building tendencies. Additionally, the investor community needs to learn that India, despite its high savings rate is more like the west than China. Clamouring for or expecting policy bailouts are short term solutions that lead to inefficiencies building on each other and lead to grand failures - China could be standing at the edge of one of them. 

What the current investment environment demands is not for investors to shun India (those who do so do at their peril), but to revisit how to invest in India. The top-line growth story is still as fantastic as ever. With a 34% savings to GDP ratio, there is depth in this economy to withstand financial shocks. The culture of entrepreneurship and desire to succeed is not in doubt, the ways and means are. The regulatory framework on which India Inc. is being built is strong and getting stronger (one only has to look at the recent track record of SEBI's actions and the new Companies Bill to take heart). We need not doubt the macro or continuously fret at the politics, but we need to be more micro in building our investment cases. Private equity valuations need to respect the risk of the venture and not pay a premium for revenue growth that India provides. Public equity investors need to respect more the quality of management, its respect for minority shareholders and its ability to manage financial and operating leverage rather than create short term value through financial jugglery or some of parts valuations. 


Investors in general need to price in the risk of a business cycle and as there will be many such bumps on the way. The current pricing of equities in India is starting to reflect that already. It is not the decoupling that investors in India had hoped for, but it is the kind that will deliver to India it's own investment case, separate from any other country, developed or emerging. It will give India a new set of entrepreneurs, a sharper set of investors and hopefully before things get any worse, a responsible set of politicians. At the dawn of 2012, let's toast to that!