There has been in the past year (or more) a constant stream of commentary from many about whether India still belongs to the league of nations (rather, an acronym of nations) that defines the next set of investment opportunities for global investors after the developed markets, the next set of drivers of global growth. The fact is that India has always stood out among these countries as a very different beast, one that does not run consistent current account surpluses, one that does not grow by exporting commodities or by keeping an undervalued currency. It is time to stop questioning India's place in the investment universe and start looking broadly at the EM context, where things do not look as rosy and investors could do much worse. The point is not just that; rather that India is bound to do very well in the context of the rest of the EM universe slowing down because India is driven differently. There are growth issues globally, no less coming from the lack of demand in the developed economies, but it helps to understand why India's growth rate has come down and why optimism is warranted.
India's foreign trade position has consistently gotten worse and so has it's contribution to the GDP (the blip in Q1, 2012 is what it is, a statistical blip). A corollary to this is the steep rise in domestic consumption and the rise in the fiscal deficit. A weak and unsustainable fiscal policy has led to high preference for consumption, consequently high inflation and then a preference for savings in Gold and Real estate compared to financial instruments. As the government consolidates its fiscal position and as inflation comes down, we could see a reversal in the current account position of the country, adding to GDP growth, without a disproportionate impact on consumption (thus consumption will slow, but not in direct proportion to the fall in the CAD). The reasons for this belief are:
a. Fall in Gold imports: The RBI has recently said (and the Economic Survey reiterated) that if Gold imports grew at the same pace as in the rest of the world, the current account deficit's contribution to GDP would be 0.3% better. We feel this will be even higher as cooling of gold price and reducing inflation, plus increased attractiveness of financial instruments will lead to a below par growth in gold imports and we wouldn't be surprised by a long term de-growth in gold imports - accounting for 27% of gold consumption without holding proportionate income is not sustainable, despite India's love for Gold (this is happening in the current financial year). Gold is unproductive savings and cutting out Gold from the savings channels holds multiple benefits, especially to capital formation. The multiplier impact of not having large gold imports and wealth stored in gold are underestimated by economists. In my opinion, Indian's own too much of it and this maybe a risk to watch out for, especially for those who give some credence to wealth effects (though wealth effects, especially on consumption have been understood to be overrated).
b. Slowdown in Oil Imports: India's dependence on global oil is well known and the rise in oil prices and domestic subsidisation has continuously detracted from growth. India has undertaken some measures to rationalise consumer pricing of oil products and this should have some impact on consumption, especially through imcreasing efficiency of usage. Already this is visible in surveys showing reduction in the growth of discretionary spend and even in auto data, people's preference for efficient cars is being seen again. There is need for a complete deregulation of diesel prices and this will be done slowly but surely. The price impact of oil should come down too as current indications are of higher output globally, not accompanied with as great a surge in demand. The boom years of oil has delivered significant investment in oil fields, even marginal ones, and that will keep a check on oil prices and commodity prices in general. In addition, there is good reason to assume that all those inflationistas buying commodities and gold should have at least started to learn their lessons. Mark Dow makes a good case here. Price stabilisation of imports is very important as a majority of rise in imports (non-gold) in 2011-12 was due to increase in unit value rather than quantity (Economic Survey 2012-13).
c. Revival of exports: An interesting point made by the recent economic survey is that while India's export performance link to REER is not clear, it shows a remarkable correlation to global growth (Economic Survey 2012-13, Chapter 7, pp 150-152). India has been hard hit by the slowdown in Europe. In fact, the reduction in exports to Europe can account for a significant amount of export slowdown (followed by the slowing of activity in China). However, we see exports to other parts of the world rising. With some recovery seen in China and the US, the wild card remains Europe. We must reiterate that the US, long suffering from contraction in demand is now not doing that badly! The latest data is clearly showing an economy that is spending on capital goods, ready for incremental demand. That is all good news for exporters, including the software variety.
The terms of trade vs. Europe have improved significantly because of the INR depreciation vs. the EUR. The ground is set for revival in growth to Europe, whether Europe will respond to the lack of domestic demand there remains to be seen. We should also see a policy push from the government for revival of exports, whether in the form of tax breaks or cheaper credit as the problem with exports is well recognised in policy circles.
With the above in mind, there is very high probability for a lesser drag from exports in next year's GDP. However, it is quite difficult to imagine India running sustained CA surpluses (and a mercantilist India may not even be advisable).
Investments relative to Consumption needs a lift
The problem as defined by experts that India needs an investment boost is somewhat understating the reality. India needs a very significant boost to investment spend, enough so that it outpaces growth in domestic demand. Only then can it create all the conditions needed for a sustainable period of growth, without risking inflation and that includes a lot more of the population. Note that it does not require that consumption falls off a cliff or that government spend accelerate immensely. All it needs is the right incentives and policy framework and let market forces take care of the elimination of supply side constraints. The period from 2004 to 2008 is a reminder of what can be achieved if this happens.
India's return to high single digits of growth demands judicious investment spend; it needs infrastructure, power, new industry and revival of manufacturing. It needs lowering of artificial barriers to entry that prevent competition and let entrenched players exercise pricing power. On top of that it needs a rise in savings rate and consequently a rise in formation of productive capital (thus less savings stuck in Gold). India definitely cannot afford wasteful infrastructure spend the kind seen in China - it just doesn't have the capital for it - but there are many low hanging fruit to be had. This is not difficult to achieve. There are funded projects that are stuck because of land acquisition or clearance issues. These are definitely not insurmountable. Clearing them gives an immediate boost to the economy and also tells the world that India is ready for business.
It is difficult to emphasise it too much, but getting investment going is the only way to get India out of its low growth funk and get the benefits of development to wider segment of people, bringing poverty levels in India down.
Efficiency Gains and other positive surprises
There is a decent amount of realistic policy input that can drive efficiency and productivity gains in the economy, all of which can have dual impact on the economy, both in terms raising growth and reducing inflation. Recent efforts on resolving the impasse on much delayed implementation of goods and service tax are very welcome as implementation of GST can improve manufacturing and business efficiency very significantly. As infrastructure investment is prioritised, efficiency gains are inevitable, whether they come from transportation or better supply chains or lower turnaround times. Another positive surprise can come from established industry that is facing supply constraint of raw material. A clear example is the power sector, where installed capacity is running at sub par load factors because either coal or natural gas is not available to process. Similarly, the exploration and mining industry is facing hurdles to expanding capacity because of arcane government policy. This is changing incrementally and while it was a detractor in the past year, it should become a sharp positive contributor in the next.
For long (most of the decades after independence), India struggled with the so called Hindu rate of growth of 3% to 4% and this period was dominated by socialist and populist policy, insurmountable bureaucracy, absent entrepreneurship, high taxes and investor apathy. While there is always the chance of populism coming back (the last 4 years are a testimony to a partial return to such a state), most post liberalisation characteristics of India's growth are irreversible. As such, while the present state of GDP growth is dismal, it is hard to get lower in terms of growth rate for India. The long term growth of India is not in doubt and from here on, neither should the short term. How this will impact stock market returns requires another deeper introspection. Many studies have shown that growth and stock market returns are not that linked, but if there is a market where we have seen a higher correlation it is India.
India's problem is the CAD.
A disproportionate amount of blame is put on the lack of investment and not enough on the current account deficit for the slowdown in the economic growth rate. It is clearly visible in the chart below:
a. Fall in Gold imports: The RBI has recently said (and the Economic Survey reiterated) that if Gold imports grew at the same pace as in the rest of the world, the current account deficit's contribution to GDP would be 0.3% better. We feel this will be even higher as cooling of gold price and reducing inflation, plus increased attractiveness of financial instruments will lead to a below par growth in gold imports and we wouldn't be surprised by a long term de-growth in gold imports - accounting for 27% of gold consumption without holding proportionate income is not sustainable, despite India's love for Gold (this is happening in the current financial year). Gold is unproductive savings and cutting out Gold from the savings channels holds multiple benefits, especially to capital formation. The multiplier impact of not having large gold imports and wealth stored in gold are underestimated by economists. In my opinion, Indian's own too much of it and this maybe a risk to watch out for, especially for those who give some credence to wealth effects (though wealth effects, especially on consumption have been understood to be overrated).
b. Slowdown in Oil Imports: India's dependence on global oil is well known and the rise in oil prices and domestic subsidisation has continuously detracted from growth. India has undertaken some measures to rationalise consumer pricing of oil products and this should have some impact on consumption, especially through imcreasing efficiency of usage. Already this is visible in surveys showing reduction in the growth of discretionary spend and even in auto data, people's preference for efficient cars is being seen again. There is need for a complete deregulation of diesel prices and this will be done slowly but surely. The price impact of oil should come down too as current indications are of higher output globally, not accompanied with as great a surge in demand. The boom years of oil has delivered significant investment in oil fields, even marginal ones, and that will keep a check on oil prices and commodity prices in general. In addition, there is good reason to assume that all those inflationistas buying commodities and gold should have at least started to learn their lessons. Mark Dow makes a good case here. Price stabilisation of imports is very important as a majority of rise in imports (non-gold) in 2011-12 was due to increase in unit value rather than quantity (Economic Survey 2012-13).
c. Revival of exports: An interesting point made by the recent economic survey is that while India's export performance link to REER is not clear, it shows a remarkable correlation to global growth (Economic Survey 2012-13, Chapter 7, pp 150-152). India has been hard hit by the slowdown in Europe. In fact, the reduction in exports to Europe can account for a significant amount of export slowdown (followed by the slowing of activity in China). However, we see exports to other parts of the world rising. With some recovery seen in China and the US, the wild card remains Europe. We must reiterate that the US, long suffering from contraction in demand is now not doing that badly! The latest data is clearly showing an economy that is spending on capital goods, ready for incremental demand. That is all good news for exporters, including the software variety.
The terms of trade vs. Europe have improved significantly because of the INR depreciation vs. the EUR. The ground is set for revival in growth to Europe, whether Europe will respond to the lack of domestic demand there remains to be seen. We should also see a policy push from the government for revival of exports, whether in the form of tax breaks or cheaper credit as the problem with exports is well recognised in policy circles.
With the above in mind, there is very high probability for a lesser drag from exports in next year's GDP. However, it is quite difficult to imagine India running sustained CA surpluses (and a mercantilist India may not even be advisable).
Investments relative to Consumption needs a lift
The problem as defined by experts that India needs an investment boost is somewhat understating the reality. India needs a very significant boost to investment spend, enough so that it outpaces growth in domestic demand. Only then can it create all the conditions needed for a sustainable period of growth, without risking inflation and that includes a lot more of the population. Note that it does not require that consumption falls off a cliff or that government spend accelerate immensely. All it needs is the right incentives and policy framework and let market forces take care of the elimination of supply side constraints. The period from 2004 to 2008 is a reminder of what can be achieved if this happens.
India's return to high single digits of growth demands judicious investment spend; it needs infrastructure, power, new industry and revival of manufacturing. It needs lowering of artificial barriers to entry that prevent competition and let entrenched players exercise pricing power. On top of that it needs a rise in savings rate and consequently a rise in formation of productive capital (thus less savings stuck in Gold). India definitely cannot afford wasteful infrastructure spend the kind seen in China - it just doesn't have the capital for it - but there are many low hanging fruit to be had. This is not difficult to achieve. There are funded projects that are stuck because of land acquisition or clearance issues. These are definitely not insurmountable. Clearing them gives an immediate boost to the economy and also tells the world that India is ready for business.
It is difficult to emphasise it too much, but getting investment going is the only way to get India out of its low growth funk and get the benefits of development to wider segment of people, bringing poverty levels in India down.
Efficiency Gains and other positive surprises
There is a decent amount of realistic policy input that can drive efficiency and productivity gains in the economy, all of which can have dual impact on the economy, both in terms raising growth and reducing inflation. Recent efforts on resolving the impasse on much delayed implementation of goods and service tax are very welcome as implementation of GST can improve manufacturing and business efficiency very significantly. As infrastructure investment is prioritised, efficiency gains are inevitable, whether they come from transportation or better supply chains or lower turnaround times. Another positive surprise can come from established industry that is facing supply constraint of raw material. A clear example is the power sector, where installed capacity is running at sub par load factors because either coal or natural gas is not available to process. Similarly, the exploration and mining industry is facing hurdles to expanding capacity because of arcane government policy. This is changing incrementally and while it was a detractor in the past year, it should become a sharp positive contributor in the next.
For long (most of the decades after independence), India struggled with the so called Hindu rate of growth of 3% to 4% and this period was dominated by socialist and populist policy, insurmountable bureaucracy, absent entrepreneurship, high taxes and investor apathy. While there is always the chance of populism coming back (the last 4 years are a testimony to a partial return to such a state), most post liberalisation characteristics of India's growth are irreversible. As such, while the present state of GDP growth is dismal, it is hard to get lower in terms of growth rate for India. The long term growth of India is not in doubt and from here on, neither should the short term. How this will impact stock market returns requires another deeper introspection. Many studies have shown that growth and stock market returns are not that linked, but if there is a market where we have seen a higher correlation it is India.
