Global Economy 2015 – India Report (#74)

Continued from Global Economy 2015 - India Report (#73)

Narendra Modi is too astute a politician to try and change India overnight, in spite of the grand promises he made during election. And, in spite of the criticisms levelled at him for moving too slow since he has come to power (10 months), he will bring about change in a carefully calculated and methodical way, side stepping for the time being the real dangerous political land mines.

As the latest Budget 2015 shows, tabled recently by the Finance Minister Arun Jaitly (shown above), PM Modi will build on attainable successes rather than upsetting the whole apple-cart by taking on the tough fights too early, which his government may not win at this time, like labour reform. The changes proposed in the Budget were a perfect example of that carefully calculated advance towards the long end-game. This is why we are optimistic about India’s impending change. We would not have been as hopeful if we had seen him take on too much too soon. India’s required changes are too formidable for any government to rush them. Constructive changes will only come to India with well thought out investment and people-centric policies, applied consistently, over time.

The government has initiated the direction of the change and it is manifest in the Budget. Ease of investment and economic development, simplification of the tax regime, particularly the long pending GST (goods and sales tax). These are the fundamental thrusts of the budget - and incredibly - a social security net for the poor.

Particular emphasis is going to be placed on investment in infrastructure and manufacturing, with the government promising to ease if not entirely remove previous obstructionist road blocks in bureaucracy, permitting, and land acquisition. The development of electrical energy, both from fossil fuels and renewables, are of particular high priority, with solar power being singled out for special emphasis. The numbers touted as targets are ambitious, almost bordering on the incredulous. That is a long standing Indian government tradition with almost every government that has come to power in the past, and this government has not deviated from that political tradition. Still, if the numbers are overwhelming, so are India’s socio-economic challenges.

The Charts below show the infrastructure projects hitting the wall after the crash of 2008, and falling off the cliff after that. The total amount, in U.S. dollar terms, of all the industrial and infrastructure projects in India that stalled out in the past 6 years, is estimated to be in excess of US$250 Billion. This number shows the ground that India needs to re-cover to have moved forward at all.

Even though the Government of India had actively invited foreign investment after ‘opening’ the economy in 1991, and perhaps because of the reforms being forced upon them by the IMF and other foreign bankers after its near default, the attitude of India towards foreign investors remained somewhat hostile. Incentives and guarantees offered to compensate for ‘India risks’ were systematically pulled back or revoked after being issued, and when those risks manifested themselves, compensation and fair treatment was practically non-existent. This and other internal problems of India resulted in a mass exodus of large foreign investors, particularly in infrastructure, by the late 1990s.

In the meantime, a decade earlier, China had laid out clearer and more welcoming rules of engagement in the sectors it wanted to develop, had held to them, and executed most effectively. This resulted in an unprecedented amount of foreign investment flooding in, for decades, which assisted China in building its economic miracle, and its historic and stunning leap from poverty to genuine ‘Super Power’ status.

In the following Charts one can see the dramatic jump in China’s FDI (Foreign Direct Investment) in 1991, and India’s negligible inflows. That trend continued to widen over twenty years, as shown in the 2nd Chart. The miserly attitude of India (encouraged by entrenched public and private sector interests) cost India hundreds of billions of dollars in investment capital that would have driven perhaps a Trillion Dollars in GDP expansion over the past two decades, making it a much larger and richer economy today. However, the Indian idea of a good deal was a “win / lose” - for the foreign investor, rather than a “win / win”. As a result India lost to China badly. On almost every measurable metric China is far ahead of India. And even though, on the face of it, India had so many entrenched advantages - western-style governing systems, the wide spread use of the English language (hundreds of years of head start), closer western relationships and a more advanced industrial base - India squandered its strengths and developed its weaknesses to a point that it took a potential default crisis to jolt it on to the path of development. While a democracy, India’s Civil Service generally worked against the people it was supposed to be serving, and became the new oppressors that the Indian people had suffered so much to free themselves from. India sank under its own oppressive governing and exploitive system, while China broke from the past and whole heartedly embraced the future, dumped the Marxist economic model and became capitalist. India is now going to attempt the same, under the new Modi Government.

The current government wants to correct the previous mistakes. Narendra Modi, shortly after being elected, in his trips to the United States, Australia and several other countries, spoke not only to the major industry in all these countries and invited them to come and invest in India, but made serious effort to connect with the Indian Diaspora settled in these and other countries. He appealed directly to them to reinvest in India. In his speeches he was forthright in acknowledging the pain previous government attitudes and policies had inflicted on all foreign investors (Indian or others), and promised a changed attitude and a more welcoming business environment. He promised rational policies that were good for India and the foreign investor (a win/win). His speeches got their attention, his actions will get FDI.

Once outside investors develop trust in the new regime and in the Country itself, and in policies that are economically rational, stable, and not subject to the whims of changing political parties and ideologies of the day, it could open a flood gate of foreign direct investment (FDI) into the key sectors that India most needs to develop. FDI has already started to pickup since the election, even though it still lags China.

The Indian stock market has been downright euphoric in anticipation of - and since PM Modi’s election.

Unlike the U.S., Japan and the Eurozone stock markets, India’s markets were not driven by extraordinary stimulus and ultra low interest rates, as rates were above 8%, and are still above 7%, but more so by India’s economic outlook, with the election of a majority government that could push through its reform and development agenda, under the leadership of a strong willed and politically astute Prime Minister.

And the GDP growth rate is recovering as India’s economy accelerates from years of unwieldy coalition governments, reform roll backs, policy paralysis and rampant corruption. (Chart Source: Euromoniter International).

Foreign Exchange Reserves have grown to a healthier level.

India’s troublesome inflation rate has declined steadily in the past months as the Governor of the Reserve Bank of India, Raghuram Rajan, raised interest rates sharply to combat inflation rate running above 8% (Chart below). That decisive action, coupled with the more recent sharp drop in oil prices has helped push the inflation rates down, allowing the Reserve Bank to cut rates early (surprising markets) to help stimulate additional economic growth.

Repo Rate: The interest rate that the Reserve Bank charges Indian Banks, that then set the lending rates to the public. Indian businesses have desperately needed lower interest rates to compete more effectively with an external ‘zero’ rate Western World.

India’s Current Account deficit was most troubling as it almost reached 5% of GDP in 2012-2013. In 2014, with the Government and the Reserve Bank determined to bring the percentage down, and with the fortuitous sharp drop in oil and commodities prices, the ‘Current Account Deficit’ has dropped sharply, giving the Indian Government much relief and the Reserve Bank much greater room to maneuver in its bid to boost economic growth. The commodities price drop was fortuitous for the Modi Government.

As the Current Account deficit had deepened in 2013, becoming one of the worst of all the major economies, the Indian currency, the Rupee, went into a free fall in May of 2013 (see chart below), forcing the government to sharply curtail imports, and the Reserve Bank to aggressively intervene in the international foreign exchange markets by buying the Rupee and raising interest rates. Since then, as the political, economic and commodities fundamentals improved in India’s favor, and the current account deficit steeply reduced, the Rupee has stabilized.

India’s Purchasers Manufacturing Index (PMI) a leading indicator of economic activity has slowly started to rise since the second half of 2014 (see Chart below) and is expected to improve further as the Prime Minister boosts manufacturing in India, under his cornerstone development policy of “Make in India”.

In our view, the newly elected Government of India under Prime Minister Narendra Modi, is coming to power with something more to prove beyond the usual, ‘we can do a better job’ political platform of most incoming governments. This Government is made up of people with a palpable sense of wounded pride in India’s inability to achieve its rightful place among the top nations of the World. That dissatisfaction is stemming from India’s current status as a significant albeit largely dysfunctional Nation. Additionally, in this government there is a deep awareness of India’s past historical greatness, it having been the wealthiest Country, and a leading global scientific, philosophical and spiritual giant that had deeply influenced its neighbors and the World beyond, in the past.

This government is hungry to restore the former glory of India, and that is the catalyst that has been missing from all the previous governments. This driver is going to be the guiding light of the Prime Minister, to whom this is more of a personal mission than just a political governing exercise. And while the job of transforming India is almost ‘Mission Impossible’, we feel this government is going to take a real serious stab at it. And in that is the possibility of India’s limitless potential for itself and the World. India’s transformation to a generally functioning modern Country, as the 3rd largest global economy (in real terms and not by PPP) will transform the World as we know it.

A modern India will become a true giant in economic and political terms, changing all the equations and parameters as they are now. A developed India will change the balance of power dynamics in Asia, becoming a true counter balance to the rise of China’s economic and military power, and will draw in even more of the West’s economic power to the East. This shift could take place in the two terms (10 years) of this government being in power. The caveat being that the government does not get overwhelmed by the morass of India’s entrenched bureaucracy, and powerful internal vested interests, and its more extreme elements in the Hindu National Cadres that form a big part of the BJP political Party. And then there are always of course, external forces, namely Pakistan and China that would view a much stronger and effective India as counter-productive to their own interests. These challenges, internal and external will test the government, however in our view, the leadership is dedicated and experienced enough to manage most of them and still be able to move India forward in a meaningful way in coming years.

Thus, with lots of challenges facing it, at this time, India presents extraordinary and extensive opportunities in the development and modernization sphere, of all basic infrastructure and support systems required for a functioning society. To build India its basic infrastructure that is desperately required now, the government estimates expenditure requirements of a $1.0 Trillion in the next few years, and most of that must come from outside of India, where there is almost limitless money looking for a decent yield, with quantifiable risks, and where the cost of money is so much cheaper.

In its drive to make India a manufacturing and modern economic giant, the government envisions 50% of its vast rural population (currently 70% / 840 Million) to eventually move to cities. If this were to happen in the coming years, it would mean a shift of over 300 Million people to urban centres. The scale of development in cities and related infrastructure that would be required to accommodate such a move in the coming years boggles the mind. It would parallel China’s building boom of the past two decades, which has been called unparalleled in history. It would seem, in that context, history may repeat itself.

By 2022, India plans to house all its people. The undertaking of a true ‘Mission Impossible’.

The Government of India, in its latest Budget 2015, has announced plans to spend $137 Million over five years to modernize its railways, one of the most extensive in the World. According to the Indian Railways, it transports over 8 Billion passengers annually, or over 23 Million a day. The modernization of the Indian Railway is a priority of this government in its bid to allow people to move freely and efficiently.

To modernize India, the government has made the expansion of the internal transportation system, railways, roads, highways, bridges and overpasses, as priority targets for development, in its first term.

Additionally, very ambitious targets have been set for the generation and distribution of electricity. The emphasis is on large coal fired plants to provide base load power, to be counter balanced by one of the World’s most ambitious mass solar energy development plans undertaken by a country. India is a huge net importer of energy, and its oil import bill is almost a 1/3 of its total cost of imports. The government wants to reduce its dependence on, and its cost of imported energy, by extensively developing renewable energy: wind, small hydro, bio-mass, and particularly solar energy.

Apart from the development of critically needed infrastructure, the government is also focusing on social development, recognizing the extent to which vast numbers of Indians have fallen behind the rest of the World, in terms of basic living standards, education, proper skills training, healthcare, sanitation and opportunities for advancement. Therefore the government is determined to modernize India through the improvement in overall literacy rates, in upgrading the quality of basic and secondary education, by formalizing skills training, by creating better jobs through industrialization, modernization and wider use of technology in government processes and interconnection of the disparate regions of the country. The government has targeted 100 “smart cities” through the extensive use of information and green technologies, and plans to make these as a model for the new cities to be constructed, as India moves from a largely agrarian society to an industrial-urban one.

In its bid to industrialize and modernize India, the new government hopes that there will be a substantial reduction in abject poverty of the approximately 400 Million people that still live as “India’s poor”. There can be no restoration of pride and even a partial return to India’s former glory and might, if such a large percentage of its citizens number as the World’s poorest. To start the effort, the Prime Minister mandated that bank accounts be opened in the names of the poor (hereto impossible) wherein any assistance by the government can be deposited directly into the accounts of the people, rather than be routed through the corrupt and inefficient system of distribution employed thus far, where the benefits never reached those that needed them. In the last Budget, the government has additionally announced the formation of a social security safety net for the poor. The uplifting of the masses out of mass poverty will increase India’s internal consumption base dramatically, thus growing its economy into the 3rd largest globally.

In pursuing such an ambitious socio-economic agenda, the Prime Minister is meaning to transform India. In that bid, he is wooing skills, technology and investment from the rest of the World. A lot of the raw material, initial skills and investment must come from abroad, and therein are the extraordinary opportunities for an over-developed, over-supplied, economically-contracting, growth and yield-seeking West. India could be ‘the next China’ to the World, as China peaks.

As stated in our recent Global Economic Report 2015, the global financial system is overloaded with debt that poses a growing threat to the global economies. Another major correction or collapse of the financial system (we think inevitable) will devastate the global economies and usher in perhaps years of sub-par growth. India will be hit hard in such a scenario, but it’s less than optimally-globally-integrated-economy, coupled with its large internal consumption and growing internal requirements, will protect it, and help it recover faster. Systemic corruption, capital formation and consistency are India’s true challenges. The newly elected government plans to tackle all three.

India stands on the cusp of being able to manifest its potential and become ‘Great’ once again. It seems to have the right leader for that mission. Now, if Indians can only stay out of their own way, dump the old baggage of internal dysfunction, discord and corruption, and embrace the future unfettered from the negatives of their past, India can surely advance to its proper place in the World.