Guest Comment: Can India Be Unshackled?

Via Pension Pulse.

My friend, Mehran Nakhjavani of MRB Partners was kind enough to provide a guest comment, Celebrity Yoga, Tear Gas and Reform: Can India be Unshackled?:

India
arguably owes its existence as an independent democracy to a
charismatic guru who made the rulers of the day squirm with his
uncomfortable questions. It took some 50 years of for the movement led
by Mahatma Ghandi to topple the British Raj, but the current
anti-corruption protest led by guru Ramdev is asking for something far
simpler. While Ramdev and his supporters were greeted this past weekend
with a display of force worthy of the colonial masters in their day, his
essential demand is merely for the rule of law to be applied equally to
India’s feckless and bloated public sector, as well as to the private
sector that feeds at the trough of privileged access to bureaucrats and
their political masters.

That
India’s government feels so deeply threatened by simple demands to
crack down on corruption speaks volumes. India’s burgeoning middle class
has in recent years taken a huge leap forward in its access to higher
standards of living and a better quality of life, but along with more
income and more information comes less tolerance of the shenanigans of
an incestuous and venal ruling class. For as long as the only route to
social and economic advancement lay through the door of dealing with or
being employed by the government, this middle class was co-opted into
the self-serving game. But for the past decade or so, the path to
advancement, and the escape from caste and social limits, has come via
education, technology and business savvy (all of which are in plentiful
supply in India) and fortunes have be made without needing access to
government connections.

The
disgust over a telecom scandal that has exploded in recent months is by
no means the first in Indian history. However, this episode is shaping
up to be a social mutiny because of three factors: the emergence of a
large middle class as noted, the rapid dissemination of incendiary
details of the scandals via social media, and most importantly, the
gathering storm over the immediate cyclical prospects of the economy.

The inflation tiger is out of its cage

Indian
policymakers are frozen in the face of an inflation tiger that has
already escaped its cage. They are pinning all their hopes on the
ability of the central bank to choke off price pressures with monetary
policy. But they remain absolutely incapable of supporting monetary
policy with the requisite fiscal tightening. Watching this slow-motion
train wreck, India’s middle class has every right to fear the
consequences: a credit squeeze and a further delay in being able to
afford a new home, along with less attractive job prospect to match
their hard-won educational qualifications.

India’s
inflation is the highest among emerging markets, and it can’t blame
food prices for its problems: headline inflation currently outstrips
food CPI by 1.5%. The mounting inflationary pressure has come
despite a cumulative 200 bp of tightening by the Reserve Bank of India
(RBI) since March last year which has had a moderating effect on
monetary expansion, but which has not prevented a dramatic expansion of
credit growth to the private sector. In addition to the CPI, asset
inflation is a mounting problem, with major city home prices rising at a
compound annual growth rate of 23% since 2007.

There
are, of course, very powerful structural forces driving India’s
long-term economic growth, including a dynamic and globally competitive
service sector, very positive demographic tailwinds and massive pent-up
demand for both capital and consumer goods and
financial services. The key constraint is its infrastructure, which, in
turn, is a reflection of a creaky public sector. To the extent that
investment can debottleneck key chokepoints such
as transportation and energy, the inefficiency of the state does no
more to sprinkle some sand into the gears of economic growth. But the
public sector’s inability to balance its books is a long-term challenge.

In
the current circumstances, with policy rates and bond yields both
ratcheting up as a result of the inflationary surge, the cost of budget
deficits of the order of 10% of GDP generates an appreciable
crowding-out effect for the private sector. The RBI’s policy tightening
is raising the cost of capital for India’s businesses and will continue
to act as a drag on their return on equity (ROE).

Despite
significant underperformance relative to other EM equities, Indian
valuations are still not compelling. Its trailing P/E ratio is still 40%
higher than other emerging markets, and this premium is no longer
justified by a substantial ROE premium.

Conclusions for investors

Avoid
Indian equities. The RBI tightening cycle is in its very early stages
and there is as yet little evidence that overheating pressures are
waning. Typically, investors will seek to front-run economic indicators,
so timing re-entry is by no means straightforward. Three pieces of
evidence will need to be in place or imminent before buying equities:
real credit growth to the private sector lower than real GDP growth;
real policy rates close to potential GDP growth rates; and attractive
valuations within the EM equity universe.

Mehran Nakhjavani

MRB Partners

For additional information about MRB, please see us online at www.mrbpartners.com.

If you would like to receive a copy of our May 17^th Country Report “India: Too Hot to Invest” please contact our Head of Client Relations, Chris Sandfield: [e-mail], or [phone].

I thank Mehran for sharing his insights on India with my readers. I invite institutional clients to contact MRP Partners at the contact info above and get additional information on their research and services.

Comments

[nameman]

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[chindit13]

The site should leave some of Leo's posts up longer, especially this one. India is a subject which not only deserves a lot of discussion, but there are a number of folks here with intimate knowledge of this land that holds 16-17% of the planet's population. Give them time to see the post and come comment. Just a suggestion.

[CEOoftheSOFA]

I'm trying to get some work done in Mumbai right now.  There's too much red tape and corruption.  That's what is holding back the entire country.

[falak pema]

The grapes of people's wrath still have to grow and ripen in burgeoning India. As a military super power the added complication of potential enemies on two fronts makes India's industrial play complicated. It needs the ME energy pipeline to feed its economy. It is constrained by the enmity of its chaotic, turbulent neighbor Pakistan, who could blow up any day, nuclear capability and all. It sees China now placing its pawns in Burma through access to their ports. If the Western economies go into tail spin and depression the resultant consequences, for the infighting for RM and geo-political power, amongst these big EM players will be dynamite and of incalculable world consequence...another potential black swan on the horizon...

[virgule]

I heard today that Myanmar may have granted the permission for China to build a new pipeline, from the Bay of Bengal into South China, for easier access to middle-east supplies. That would certainly shake geopolitics in the region. Anyone has any info on this?

[chindit13]

This is old news. It is already under construction. There are two pipelines that will run parallel to each other. One will carry natural gas from deposits in the sea off of Myanmar's Yakhine coast to Kunming.  The second will carry crude oil from the Middle East, carried from the Gulf on tankers, and able to avoid 14 extra days of sea travel through the Straits of Malacca (and also avoid the risk of pirates there).  Because of the length of the lines and the fact that they run through areas where rebel ethnic groups have but a weak ceasefire agreement with the government in Nay Pyi Daw, security of the pipeline will require the use of more than 35% of the total army of Myanmar.

Incidentally, India has purchased a 12.5% stake in the project, while Myanmar and China own the majority.

[PY-129-20]

You're absolutely right, falak. Don't get me wrong on India. I like the great culture, the people and the history of this country, although I found it more often very irritating, but this grim outlook worries me.

I still believe that the next world war will not be started in Europe again. I think the next will be triggered in Asia and it will be devastating.

There are so many border conflicts. Somewhat ironic to hear this warning from a German and a French (Est-ce que tu es francais, falak?) guy - but I think, we've got some experience. Unfortunately.

[nathan1234]

For every Rs.100 invested/speculated in the Indian stock market, approx Rs.80 is FII money as I understand it. One can kiss the market goodbye when the FII's exits

[s0lspot]

Nathan, what's FII please?

Thanks

[King_of_simpletons]

Foreign Institutional Investment (Investor).

http://www.investopedia.com/terms/f/fii.asp

[Tense INDIAN]

...The Indian GOvernment is learning a lot of that "CONTROLLED OPPOSITION " ...thing tried and tested so many times by the Elite....

and about Indian equities ...heres what I think.....

http://markettechnicals-jonak.blogspot.com/

[ebworthen]

"While Ramdev and his supporters were greeted this past weekend with a display of force worthy of the colonial masters in their day, his essential demand is merely for the rule of law to be applied equally to India’s feckless and bloated public sector, as well as to the private sector that feeds at the trough of privileged access to bureaucrats and their political masters."

Let us hope Ramdev and the Indian people, who are at least getting off of their couches, have more luck at this than the peasants of the U.S. who seem all to eager to pretend their masters mean them well and that a bounteous cotton crop is a good thing.

[Mr Sceptical]

I totally agree with chindit13. India does not get enough attention. Demographically India is far better placed than China and in the coming years growth rates will prove that. Corruption and inflation are the biggest dangers, that need to be dealt with. People will need to change their attitude, and I think with time, it will prove to be right.

With younger generation becoming more and more aware, we can just hope that political power will come into the young generations hands, for India to become the topic of the decades to come

[Parth]

Well at least Indias central bank raises interest rates. Also more and more outsourcing jobs are moving to India, recently some British public sector jobs moved.

My H-1 crew who recently moved here says its raining jobs in India (3 to 5 offers per english speaking worker), Of course the stock market is volatile and will collapse, but it will recover too. Indias problem is always the masses in its villages. 

[chindit13]

In the last year I've spent a lot of time in India, trying to peel back the layers of this onion (onion prices up 17.5% y/y), and see what makes the country tick.  It's a long learning curve.

One thing that seems to stand out, however, is that unlike the US where the shananigans of the banksta class remain largely unknown by what everyone here calls The Sheeple, in India everyone knows the government is as corrupt as the monsoon is long.  Similar to the US, though, the populace usually does nothing about it, neither at the polls nor in the streets.  That is why this latest protest is particularly interesting.

Waiting for ORI to step in and offer his views.

By the way, Leo, good change of subject.  India does not get enough press around here on ZH.