The India Puzzle

I got started on this article sometime in last week of January (2012). A combination of factors delayed the completion, lending it some seasoning and a chance to project my views in the backdrop of certain global and local events. To cite a few key events – Sensex moved up a 1000 points (3.46%), while retracting to a modest 1.46% gain (27^th Jan - 6^th April), Congress lost their ‘prince’ly campaign to the Samajwadi Party in decisive UP, further losing their control on the house and a weakened coalition taking away the dexterity to make meaningful reforms. Among global events – US is showing more, if not credible signs of recovery, Euro debt and austerity issues are making less of headlines and a mix of Middle East flash points have oil prices boiling, that has potential to shave the early gains in world recovery.

The View:

I was recently reading an article by Stephen S. Roach (Faculty Member at Yale Univ. & Non-Executive Chairman, Morgan Stanley Asia) where he discussed how India & China would fare in the event of a hard landing, as spillover effect of European debt crises & contraction. He is quite a venerable figure and his inference tilted in favor of China than India. The article was peppered with economic & structural study and hence, in many sense presented a compelling conclusion.

As I delved on this article over few days, I realized that this isn’t the first time that India finished miserably on a comparative chart. Such inferences have had a history and it goes back as far as I can remember. India’s rupee & Sensex being among the worst performers among key emerging & Asian markets in the August-December (2011) period invited further negativity. When the mood improves, the “Asian century” and India’s billion plus demography become its shining jewels.

The basis of my article is not about the volte-face on Indian economy that we read, form opinion and revise opinion. Over past 13 months, I had the privilege to visit over 9 cities in India, recurrently and have an on-ground feel, if not the whole grain. I felt the strength, volatility and vulnerability of urban middle-class & the relative resilience of not-so-urban to villages in India.

In a rather simplistic world view, I see two images of India -

• Those who read India’s report card in Sensex/Nifty & GDP data (and have their sense, sensibilities built around it), which I call the FII View.
• Those who see in the short & long term challenges as BAU/emerging opportunities, the Ground View.

India – the FII view

There is some sort of comfort in numbers. India’s billion plus diverse demography, with large middle class and young population, with GDP per capita at $1,100 representing  good headroom for growth. There is certain enchantment in these numbers that present economic opportunity with the assumption of India’s demographic credentials remaining functional with its legacy corruption among government functionaries remains tolerable.

The substratum that binds the positive view is the health of developed economies - the providers of capital. A not so good health can spring back the capital, no matter the underlying emerging market attraction. 

The rationale behind a FII to write a check to an emerging or, developing country takes refuge in GDP growth data, equity indices with a scoop of country risk premium and if that jumps some hurdle rate, well the mathematics supports the transaction. (I do not intend to make this look simple as billions of dollars do not just move, without a risk x-ray, but just to cite an illustration.)

The FII money as opposed to FDI, is volatile. Emerging countries, the ones with net import (imports exceeding exports) love them, rather need them, to salvage their Balance of Payment (BoP) situation. A sad BoP situation coupled with grim fiscal deficit (spending exce.eds income), which is also an emerging market (with exceptions, of course) phenomena has multiple impact. It puts strain on currency which falls in value, further making imports dearer and exports don’t catch up faster*, making the fiscal deficit situation miserable. This does not always lead to tailspin as Central Banks intervene through currency sales, open market operations (OMOs) among others to cushion such shocks.

[*Technically a depreciating currency should help exports, but these gains are short-term and erode with time, as smart buyers/observers in importing countries tend to ask for discounts in the face of depreciating currencies thus, slicing off some of the gains of exporters.]

Now as the FII flows grow, the BoP situation improves and so does the currency and the Government’s fiscal’s health. Since, FII flows run into billions of dollars, their inward and outward flow create deep impressions. Stephen Roach’s remark in the beginning of this article reflects how such views calibrate countries on their abilities or, deficiencies.

As the size and dependence on FII flows grow, the calibration of India will be subservient to economic metrics, equity, debt and money markets. As the Nifty/Sensex and government bond yields gyrate, the picture of India tends to synchronize. In a perfectly sunny day in India with good corporate earnings and improved inflation numbers, some US jobless claims data, the Greece crises, or some oil spike can cause risk aversion, making the Sensex fall and enough ink in financial press on emerging market risks.

As I try to dissect into this volatile view with the negative data, it is opportune to correct that I do not question the wisdom behind the view from money managers. It is only to clear the perspective that individuals and corporate operating outside the financial industry need to look at this image of India with certain detachment and not fully subscribe. The image created by FIIs is clustered around their eligibility to invest in India’s equities, select category of Government and corporate bonds. It has a certain objective and cannot be extrapolated to represent the general view.

India – the Ground View

Well, I intend to keep this simple. The Ground View is India with its imperfections and frustrations, yet with the commitment that an office-goer labors traffic to reach his work, expounds moral values to his children in changing times, believes in India’s diversity and is vulnerable. This is my view from the roads and meetings with people who saw opportunity in the long list of India’s challenges.

Coming to India’s challenges, well we see it everywhere. Pick up a newspaper or, switch on any news channel and you are in company. Inflation is cutting through every sector and touching every individual. The food inflation in the light of record production does sound anti-logic, but it is true. A consuming and populous India is choking its roads, providing support to global oil prices, creating shanty towns for those in the periphery, has an alarmingly high unorganized labor force, proliferating educational institutions with insufficient skilled staff and its research and development expenses both at GDP level and corporate levels are meager to say the least.

The Silver Lining -

In the packed morning flights to Indore, Raipur, Bhopal, Baroda, Jaipur, Ahmedabad other than the metros, I have found vibes of commerce and enthusiasm. When I travelled in these cities, the real estate development looked as much at home in Chennai, Kolkata, Mumbai, Bengaluru or Delhi. The hike in excise duty, service tax does chip away corporate and personal earnings, but it is getting swallowed with endurance to work harder and save more.  

In many state Government offices, I met bureaucrats and their push towards transparency in procurement and providing citizen services using technology was sincere, and I can tell you the progress is faster than historical rates, or if we stop viewing the world from 3G speeds.

There is Gujarat that has got its Chief Minister on the cover of Time magazine, for modeling the state to attract business – manufacturing primarily and the state’s governance arms seem to have a development-friendly tag. There is working machinery that is pushing improvement of minimum wages through work creating schemes like NREGA. While there is tangible evidence that it has also pushed wage-inflation into India’s rural pockets, on positive side it is slowing down the the exodus into cities and towns from nearby villages. To reduce social distribution losses, there is a move to transfer subsidies, govt. benefits to the beneficiary bank accounts. The financial inclusion measures are working to create such an infrastructure to enable such transfers. In another incident, the promoter of a small pharma company shared that a political party is raising party funds through cheques, against cash which had losses along the way and made it difficult to account such a transaction. With the roads being laid for tax reforms like Direct Tax Code & GST, the web of esoteric and multiple-taxation is giving way to this simplification.

My current engagement with Government entities is solidifying the thought that for a country to grow, capitalism needs to be complemented with sound Government that creates policies and framework for creating social & real infrastructure, fair play and equitable distribution. India’s judicial activism is enabling a country to safeguard its laws.

Private consumption is growing, which supports and defends India’s consumption story. Recently China changed gears to accept a lower growth rate, with emphasis on domestic consumption than be a producer to the world. The outgoing Premier Wen Jiabao underlined this approach for China’s sustainable growth. Mr. Roach’s article that I mentioned earlier may not have imagined such changed alignment for China, while discussing merits or, does not factor that China’s development, banking, to its currency is State sponsored, but as I mentioned before, it takes comfort in foreign exchange reserves numbers, trade surplus numbers et al.

Endwords –

Countries in Asia and other developing parts of the world cannot be seen in numbers, the way jobless claims data or, housing sales data proxies in developed markets. The data efficiency aside, the growth undercurrents do get tempered by global and local developments, but are fundamentally intact and aided by good policy, there is so much work-in-process and work-to-do.

Whether we choose FII view or, the Ground view, India will remain a puzzle. Each side is distinct and with a purpose.