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 17th Country Report “India: Too Hot to Invest” please contact our Head of Client Relations, Chris Sandfield: chris.sandfield@mrbpartners.com, or +44 (0) 20 7073 2792.
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.
