The last column on real estate which appeared on January 19, 2015, stuck a chord with a lot of readers. Given that, I thought it made sense to dwell a little more on this topic and the “spin” that real estate wallahs try to give it. One logic that I have heard being given over and over again is that India has too little land and too many people. Given this, real estate prices can never fall. They will only keep going up ad infinitum and hence, you need to invest in real estate and earn a perpetual return. This is the most widely used logic to justify high real estate prices in the country. But a little bit of number crunching basically tells us that there is nothing right about this theory. Let’s look at India has “too many people” theory first. As per the 2011 census, India has an average of 382 people living per square kilometre. When it comes to density of population India is ranked 33rd in the world. Let’s compare this with Japan. The country has 336 people living per square kilometre and is ranked 39th in the world. Japan had a huge real estate boom in the 1980s. The boom came to an end towards the end of the 1980s and prices fell big time after that. As George Akerlof and Robert Shiller point out in Animal Spirits: “Urban land prices…in Japan (where land is every bit as scarce as it is in other countries)…fell 68% in real terms in major Japanese cities from 1991 to 2006.” And if real estate prices could fall in Japan, which has a slightly lower population density than that of India, they can in India as well. Even in India real estate prices have fallen in the past. It’s just that people don’t rememember about it anymore. As Manish Bhandari of Vallum Capital wrorte in a report titled The End game of speculation in Indian Real Estate has begun: “The previous deleveraging cycle in year 1997-2003 witnessed price correction by more than 50% in Mumbai Metro Region (MMR) property.” And this was just a little over a decade back. Bull markets lead to bad memories and theories justifying high prices. In fact, real estate prices have been falling in some parts of the country. A December 2014 newsreport in The Economic Times suggested that “secondary market prices of properties in posh South Delhi localities have fallen 25-30 per cent over the last one year as a pileup of inventory and need for money turn many investors into desperate sellers.” “Compared with peak prices, the discount is as much as 40 per cent, say brokers,” the report added. Another important point here is that the consumer sentiment seems to be turning against real estate. Recently a buyer sentiment survey was carried out by IIM Bangalore and Magicbricks. A report on the survey in The Economic Times said that: “[The survey] orecasts that the homebuyers expect real estate prices to drop over the next six months. In fact, the aggregate Housing Sentiment Index (HSI), measured across the 10 cities, dropped sharply by 29% in the 3rd quarter of 2014-15 to 81. (An HSI score of 100 suggests the prices would remain static).” Now compare this with another survey that the business lobby ASSOCHAM had got done in June 2013, which said: “Over 85 per cent of urban working class prefer to invest in real estate saying it is likely to fetch them guaranteed and higher returns.” So, the sentiment clearly seems to be changing. And there is no greater danger to the price of an asset class than changing sentiment of those who want to invest in it. The second theory offered is that India has very little land to house its huge population. Again a little number crunching tells us that this is not correct. The Indian Institute for Human Settlements in a report titled Urban India 2011 esimates that “the top 10 cities are estimated to produce about 15% of the GDP, with 8% of the population and just 0.1% of the land area.” Economist Ajay Shah in a May 2013 column in The Economic Times did some number crunching to show that India has enough land to house its millions. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.” One corollary of this theory is that as cities expand they will take away land from agriculture and that will create a problem as well. Again this is a specious argument. Data from World Bank shows that around 60.3% of India’s land area is agricultural land. The bank defines agricultural land as “share of land area that is arable, under permanent crops, and under permanent pastures.” In fact, only the United States has more agriculural land than India. As India Brand Equity Foundation, a trust established by the Ministry of Commerce and Industry points out: “At 157.35 million hectares, India holds the second largest agricultural land globally.” Only, the United States has more agricultural land than India. Take the case of China. India has more arable land than China. This, despite the fact its total area is only a little over 34% that of China. Hence, agricultural land near the cities can easily be diverted towards construction of more housing without it having any signficant impact on agricultural production. The basic problem lies in the fact that too much black money has gone into real estate and has driven up prices ( as I wrote in the last column) to previously unimaginable levels. This has led to builders and politicians who back these builders to sit on a huge amount of unsold inventory instead of cutting prices to clear it. They have got used to these high prices. Also, so much money has already been made that sitting on inventory till prices start to recover, doesn’t seem like a bad idea at all to them. As an article in The Caravan magazine pointed out few years back: “There isn’t a bubble of real homes…If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes.” And this is because the ill-gotten wealth of politicians and their cronies has found its way into the sector through “benami” means over the years. However, there continues to be demand for reasonably priced property even in big cities. Only if there was someone trying to fulfill this unmet consumer demand. To conclude, it is worth sharing this example that Ruchir Sharma talks about in his book Breakout Nations: “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.” And this is where the real problem lies.
It is that time of the year when stock brokerages forecast their Sensex/Nifty targets for the next year. A few such reports have landed up in my mailbox and the highest forecast that I have come across until now is that of the Sensex touching 37,000 points by December 2015. I was thinking of writing a piece around these forecasts, until I happened to read an interview in which big bull Rakesh Jhunjhunwala said that he would disappointed if the Nifty doesn’t hit1,25,000 by 2030. Nifty currently quotes at a level of around 8,500 points. The logic offered by Jhunjhunwla is very straightforward. He said that the earnings of stocks that constitute the Nifty index will grow by fifteen times over the next fifteen years. And that would take the Nifty to a level which is fifteen times its current level ( actually 15 times 8500 is 1,27,500, but given that Jhunjhunwala was talking in very broad terms let’s not nitpick). Hence, Nifty will be at 1,25,000 by 2030. How reliable is this forecast? Not very, is a straightforward answer. A period of 15 years is too long a time to make such a specific forecast on the stock market or anything else for that matter. There are many things that can go wrong during the period (or go right for that matter). Hence, such forecasts need to be taken with a pinch of salt and seen as something that has an entertainment value more than anything else. In matters of forecasts like these it is important to remember the first few lines of Ruchir Sharma’s Breakout Nations – In Pursuit of the Next Economic Miracles: “The old rule of forecasting was to make as many forecasts as possible and publicise the ones you got right. The new rule is to forecast so far into the future that no one will know you got it wrong.”Jhunjhunwala has done precisely that. If earnings have to grow by 15 times in 15 years, the Indian economy also needs to grow at a breakneck speed. Over a very long period of time, the companies cannot keep growing their profits unless the economy grows as well. For 15% earnings growth to happen, the economy needs to grow at a real rate of 8-10% per year (the remaining earnings growth will come from inflation). The trouble is that this kind of rapid long term economic growth in countries is an extremely rare phenomenon. As Sharma points out in Breakout Nations:“Very few nations achieve long-term rapid growth. My own research shows that over the course of any given decade since 1950, only one-third of emerging markets have been able to grow at an annual rate of 5% or more. Less than one-fourth have kept that pace up for two decades, and one tenth for three decades. Just six countries (Malaysia, Singapore, South Korea, Taiwan, Thailand, and Hong Kong) have maintained the rate of growth for four decades, and two (South Korea and Taiwan) have done so for five decades.” In fact, India and China which have been among the fastest growing countries over the last ten years, were laggards when it come to economic growth. “During the 1950s and the 1960s the biggest emerging markets – China and India – were struggling to grow at all. Nations like Iran, Iraq, and Yemen put together long strings of strong growth, but those strings came to a halt with the outbreak of war…In the 1960s, the Philippines, Sri Lanka, and Burma were billed as the next East Asian tigers, only to see their growth falter badly,” writes Sharma. Long story short: Rapid economic growth cannot be taken for granted and given this forecasts like Nifty touching 1,25,000 at best need to be taken with a pinch of salt. Indeed, Jhunjhunwala had predicted in October 2007that the Sensex will touch 50,000 points in the next six or seven years. Its been more than seven years since then and the Sensex is nowhere near the 50,000 level. In October 2007, India was growing at a rapid rate. At that point of time it was almost a given that the country would continue to grow at a very fast rate. In fact, this feeling lasted almost until 2011, when the high inflation finally caught up with economic growth and the first set of low economic growth numbers started to come. Also, Jhunjhunwala and most other stock market experts did not know in October 2007 that more or less a year later, the investment bank Lehman Brothers would go bust, and the world would see a financial crisis of the kind it had never seen since the Great Depression. The stock market fell rapidly in the aftermath of the crisis. Once this happened the central banks of the world led by the Federal Reserve of the United States, printed and pumped money into their respective financial systems. The idea was to flood the financial system with money so as to maintain low interest rates and hope that people borrow and spend, and in the process get economic growth going again. That happened to a limited extent. What happened instead was that big financial institutions borrowed money at low interest rates and invested it in financial markets all over the world. In the Indian case the foreign institutional investors have made a net purchase of Rs 3,19,366.35 crore in the Indian stock market between January 2009 and November 2014. During the same period the domestic institutional investors sold stocks worth Rs 1,27,280.1 crore. The massive financial flows from abroad have ensured that the BSE Sensex has jumped from around a level of 10,000 points to around 28,450 points, during the same period, giving an absolute return of around 185%. The point being that despite this massive inflow of money from abroad, the BSE Sensex is nowhere near the 50,000 level that Jhunjhunwala had predicted in October 2007. Over the long term a lot of things can go wrong and which is what happened after 2007. To conclude, let me ride on Jhunjhunwala’s forecast and make my own forecast. Jhunjhunwala has predicted that the Nifty index will touch 1,25,000 points in 2030. This means the Sensex will cross 4,16, 420 points in 2030. How do I say that? The Sensex currently quotes at around 28,450 points. In comparison, the Nifty is at around 8,500 points. This means a Sensex to Nifty ratio of around 3.33. Hence, when Nifty touches 1,25,000 points, the Sensex will touch 4,16,420 points (1,25,000 x 3.33). For the sake of convenience let’s just round this off to 4,20,000 points. I know, the world is not so linear. If forecasts were just about dragging a few MS Excel cells, everybody would be getting them right. But then it is the forecast season and everyone seems to be making one, and given that even I should be making one. And if in 2030 I am proven right, I will search this column and tell the world at large that I said it first way back in late 2014 on The Daily Reckoning. To conclude, dear reader, remember you read it here first. That’s the trick and I know how it works.
Ruchir Sharma is the head of emerging market equities and global macro at Morgan Stanley Investment Management. He generally spends one week per month in a developing country somewhere in the world. In 2012, his book Breakout Nations – In Pursuit of the Next Economic Miraclebecame a best-seller. The paperback version of the book was recently published. The book among other things pointed out that the most important factor behind decade long economic boom in the emerging markets, a worldwide flood of easy money, had been largely overlooked. That era of easy money is now coming to an end, believes Sharma. “My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can,” said Sharma. In this free-wheeling interview he speaks to Vivek Kaul. Recently you wrote an article in the Foreign Policymagazine titled “The Rise of the Rest of India”, in which you talk about Indian states that have done well over the past few years. What are the factors that make for a breakout state among the Indian states? A very simple definition is that the state has been able to consistently grow above the national average over a five to ten year period. Often you can associate that growth to some change in policy or leadership which has taken place. It is the same as the concept that I have used in my book Breakout Nations. What is the concept of Breakout Nations?
It is about which are the countries that are likely to grow faster than the emerging market average and compared to other countries in the same income group, over a five year period. The same concept I have applied to the states in India. The question I have tried to answer is which are the states which have grown above the national average for a five to ten year period. Often this growth is associated with some leader who has to come power. Which are the states right now you feel are the potential breakout states or have already broken out? The states where the most impressive results have been seen are Gujarat, Bihar, Madhya Pradesh Odisha, Chhattisgarh, Delhi etc. These are the places where typically you have seen growth. The ones where the most impressive delta or change has taken place, have basically been Bihar, Odisha, Madhya Pradesh, Chhattisgarh etc. That area has done well. What about Gujarat?
Gujarat has done well. But Gujarat was already doing well in the previous decade. Its impressive that it has done better from a higher base. Similarly for Maharashtra, growth rates have been okay, but in the last couple of years they have begun to fall. And Maharasthra is so dependent on the legacy industrial base or the whole golden triangle of Mumbai, Pune and Nashik, that I don’t know how to call it a breakout state necessarily. Does the Indian constitution need to be re-jigged to give Indian state more economic power? I’d say that maybe later but to me that is not the big thing. India has three lists, central, state and the concurrent list. And the big thing in India which has happened is that a lot of the issues which were in the state list and the concurrent list have been usurped by the the centre over time. And this has got to do with environment, mining, labour and even things like food. The whole culture needs to be a collaborative culture rather than the centre deciding or one leader deciding that okay these are the five things that India is going to do. We have had centralised leadership in the past. We have had the Indira Gandhi days. Now you can argue that is that what you want? Economic growth wasn’t great during that period. You can argue that it sowed the seeds of secessionist movements rather than bringing the country together. So I am not sure this heavy handed centralised leadership is what works for a country like India, where the polity is so diverse. How can this be tackled? The first thing you can start doing is by giving the power back to the states. India’s constitution envisaged a federal structure. It is just that over time particularly the 1970s and the 1980s, a lot of the state powers were usurped by the centre in the name of centralisation and in the name of the the secessionists taking over. Using that kind of cover, a lot of power was usurped. The whole point is that when you have national schemes, you have to give much more flexibility to the states. For example, the planning commission is now talking about 10% discretion to the states. That can be increased to 30% or 50%, rather than the criteria and the mandates being set by the centre. In a recent column for the Financial Times you wrote “The irony is profound…Voters are wondering aloud how their “breakout nation” became a “breakdown nation”, seemingly overnight.” That’s right. Can states be breakout states when the country is in a breakdown mode? Of course not. The national average is ultimately summation of the states. The only reason for optimism that I still find is that at the state level things are a bit better. State level leaders understand how to succeed in various parts of India rather than having a one size fits all national policy. Having said that, there are issues at the state level as well. Many states have their own crony capitalists. At times they are autocratic and anti democratic. But my entire point is that there is a ray of optimism. Five years ago we were drawing straight lines stating that India’s GDP growth has been 8-9% and if it continues for 10 years where will we be. If it continues for 20 years where will we be and so on. Today it is hard to be optimistic on the country because there is so much negativity which is going around. To me the breakdown is a perception thing more than a reality. Are there things that can be done to set it right? One flaw to me is this culture of lack of accountability. If you look at India today the lack of accountability starts of from this whole separation of party and government. This has really been one of the fault lines of India which is that to run a country with a division between party and government is really very difficult. It fosters a culture of lack of accountability. Could you elaborate on that? There is this perception that has been for years now that there are something things which when you ask the people in the party, that why they are not being done, they say its the government’s responsibility to do this. And you ask the government and they tell you we don’t have the political power to do it. That lack of accountability then just flows down, with everyone being busy protecting their own turf and not taking any collective responsibility for anything. So that fault line to me for one needs to end, which is that you can’t have the separation of the party and the government. Also the fact is that if you look at the world what you see is that technocrats have not been very good as heads of states. What do you mean by that? They have been very good as support staff. But as heads of states if you look at Latin America and Asia, in the past, there are more examples of mass based leaders being successful. This is because reforms are political in nature. You can’t have them being administered by technocrats. Technocrats neither have the political understanding nor the political capital to implement reforms. Reforms need to be sold to people. Hence they are political decisions. Given this, you need a mass based leader at the top. So that brings me to the logical question. Is that leader Narendra Modi? See I am not sure of that. I don’t want to get into this thing about who it should be or who it shouldn’t be. My entire point is the fact that you have mass based leaders at the state level. The states are not run by technocrats. The breakout states that I speak about are run by politically smart people, who understand what needs to be done for development, and who get that connection of what is good economics and what is good politics. They see the bridge between the two. To me its about mass based leaders. Whether India can have this at the national level, I am a bit more sort of doubtful about. But do successful state level leaders transform into national leaders? It has never happened. Never. That’s the staggering point. Many leaders have tried to go out. The list is a long one. From Sharad Pawar to Mulayam Singh Yadav and even someone like a Mayawati, they have all tried to build a national footprint but they have never been able to succeed. Often having strong regional roots is a liability at the centre because then they begin to associate you only with one particular state. Even in the Congress I find it fascinating that there is so much talk as to who could be the next candidate for Prime Minister. I would think that logically it should be a chief minister rather than any of the national leaders. But no one comes to my mind when I think of the Congress chief ministers… Exactly. Logically we should argue that by any chance if Sheila Dikshit wins the next election then she should be the automatic choice for being the next PM candidate assuming that Rahul doesn’t want the top job. Someone like her should be the top person for that job. You need someone with a mass base, who understands politics. What has suddenly gone wrong with the rupee. Between January and May it yo yoyed between 53.5 to around 55.5 to a dollar. But after that it has fallen dramatically... A lot of it has to do with this fault line across emerging markets which is the fact that all countries with a high current account deficit have really taken a big hit as far as their currencies are concerned. The whole game began to change, as is well documented by now, after the Federal Reserve decided that it wants to think about tapering off its quantitative easing. After that the the US interest rates have risen a lot. The 10 year interest rate has gone up by 100 basis points since May. This has obviously led to people evaluating how much money they want to put up internationally. But is the rupee falling just because of the Federal Reserve thinking about going slow on money printing? The fact is that we have our own domestic problems which are compounding the whole thing. There is a sense that no one’s in charge and that we have an election coming up. There is a sense that it will be very hard for the government to make tough decisions to remedy this situation. Also, some of the problems have not been fully appreciated or recognised. One thing that we are just about coming to realise is that corporate India has too much leverage. It is very concentrated leverage amongst a few companies. Do you see the rupee falling more? We are in the midst of a panic and magazine articles have their own time cycles. In panics I just can’t say where these things will stop. Can we say that the rupee is falling because the rupee is falling? It’s a global panic now. The train has left the station and you can’t now catch it. And where it stops I don’t know. That is the sense I get. This is not say that this is not our problem. If we did not have a large current account deficit we wouldn’t have this problem today. But the fact that we have a large current account deficit and are being punished globally for it, is just a reality. Should the RBI try and stop the rupee’s fall or let it find its own level? I don’t think that we have a local solution anymore. All that the RBI can do is to moderate the fall. But we have seen with other currency attacks that when currencies are under panic foreign exchange intervention can be very ineffective. The classic case was the British pound in 1992. What India can do is to figure out how to correct these things over a period of time, which is what we should think about. RBI or whoever it was in charge in Delhi was doing much worse before. They were following this bureaucratic impulse that you come up with this one decision all the time to show that you are doing something. Is India anywhere close to Thai crisis of 1998, where the country more or less ran out of foreign exchange? I don’t think that it is as extreme as that. What happened in Thailand was a very extreme situation. Their short term debts and current account deficit were larger than what we have. Having said that one thing that I have known about crises is that you only know about these things post facto which is that after every crisis you come up with new factors to add to the list of the things that you should watch out for. I think that is the whole point. If you look at the past crises this does not seem as dire as what we saw in East Asia in 1997-98 or in India in 1991. But my only caveat here is that you always come up with the real reasons post the crisis. Economic theory has it that as the currency depreciates exports go up and imports fall. But in the last two years as the rupee has fallen, our trade deficit(the difference between imports and exports) has gone up dramatically. How do you explain that? The recent fall of the rupee has been very sharp but before this the rupee was adjusting for the high inflation we have had for such a long period of time. Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist. What are the other impacts of a falling rupee? One of the factors that has been under-appreciated in this drive to see the currency go lower is that there is a negative effect also on the huge foreign exchange loans taken by the corporates. So even though there is not much that can be done to stop the rupee’s fall you can’t at the same time wish that you can just devalue your way to prosperity because there is a negative feedback loop which takes place. And a lot of exports are import dependent… Yes. There is a negative feedback loop because the corporate sector is heavily indebted in foreign currency. So that is the problem. So there is a corporate debt crisis brewing up. You have pointed out in the past one in four Indian companies does not have enough cash flow to repay its debt. How do you see that playing out? Those companies are just going to be shunned for a long period of time. People are now just investing in the 15-20 big companies and keeping away from the rest. India has lost a major competitive advantage. India’s advantage that used to be quoted to foreign equity investors, particularly portfolio equity investors, was how we have a huge number of companies to invest in. That has shrunk incredibly now. Some of these companies are not going to be able to survive, that’s the harsh reality. Oil prices are at an all time high in rupee terms. What sort of impact will that have on the fiscal deficit. The finance minister said today(on August 27, 2013, the day the interview was taken) that come what may the government will meet the fiscal deficit target of 4.8% of GDP. Can we buy that? We achieved the target last year. But you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that. Or the government will have to raise diesel prices. Currently, they are Rs 9-10 behind on the under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target. So can the government meet its fiscal deficit target? Of course they can. But the price unfortunately in this case will be economic growth. If they don’t increase diesel prices they have a problem. If they do increase diesel prices they have a problem. Exactly. That’s the negative feedback loop I talked about. The days when you could just move the exchange rate from x to y and hope that exports will pick up, is a very simplistic solution. It does not take into account the negative feedback loops that can arise in terms of corporate debt denominated in foreign currencies and also the fact that the oil import bill gets considerably worse. There is a small cottage industry that has sprung up in trying to explain why the current fall of the rupee is due to international factors. How much of the rupee’s fall is due to international factors and how much of it is due to local factors? Probably we can divide it 50:50. As I said, the fact of the matter is that if we were not running a current account deficit today, we would not be having this panic. Sure there would be some sell off because all emerging markets are under pressure. Growth forecasts across emerging markets have been downgraded regardless of their current account deficit. Nevertheless, it is ironical that the Chinese currency is up for the year. The currencies of some of the countries like Mexico and Philippines have fallen very slightly because they don’t have current account deficits. It is a very current account deficit centric problem that we are currently seeing now. But the current account deficit did not appear overnight. This is the irony, that the crisis has been badly managed. These fault lines have existed for a while. The current account deficit has been going up continuously over the last two to three years above levels which most economists consider to be sustainable. And we ignored that. In our desire to keep growth artificially high in 2009 and 2010, we engaged in a lot of stimulus government spending. We let our fiscal deficit blow out. We violated the FRBM (Fiscal Responsibility and Budget Management Act) and have never ever gone back to that. The Prime Minister has ignored so many fault lines. Could you elaborate on that? He dismissed crony capitalism as being something which possibly is the right of passage that any country going through an early stage of development will have to go through. Every such country will have its own robber barons. So what is the big deal that India does? He dismissed the rise in inflation by saying that rise in food prices are a sign of prosperity. He kept on going on about how savings and investment ratios are so high that growth is unlikely to ever dip below 8-9%. And on each one of them any sort of serious economic analysis would suggest that these arguments were flawed. And this had a huge impact?
We know that if you have crony capitalism it can lead to a backlash against wealth creation. Look at issues like the ban on iron ore exports, the mining of coal etc. Some of this is because we have had crony capitalism and that has led to a backlash against wealth creation and that has led to these bans to start with. What about the inflation argument offered by Manmohan Singh? The whole business about inflation rising because of a rise in prosperity is a real myth. Why has China not seen this massive inflation problem despite 30 years of great growth? Why did Korea and Taiwan did not see any sustained inflation pressure? Or even Japan during there very high growth phrases? Why? This is a total myth. India’s inflation rankings have deteriorated considerably. Our inflation used to be always below the emerging market average for the last 20-30 years. It’s only in the last three to four years that we have been way high than the emerging market average, not just bit higher, but way higher. Also, other countries with high savings and high investment have also seen a growth fall off. The Soviet Union’s investment to GDP ratio was 35% before the collapse. It was all bad investment. This is what happens when there is too much academic focus on things. In a recent column in the the Financial Timesyou wrote “A not so funny thing happened while the world was watching for an emerging market crisis to erupt in China. The crisis erupted in India instead.” Could you elaborate on that? For the first half of the year a lot of focus was on China. China has had a massive credit binge over the last five years. And in recent times we have seen in the US, Spain etc, typically countries which have had a massive credit binge are vulnerable because when you increase your debt over a short span of time of three to five years you accumulate a lot of bad assets. And that leads to trouble for the entire banking system. So people have been very worried about the high debt to GDP ratio in China. Even I have been concerned about it and written about it. There were people sending out alerts on a China crisis. I think very few people were sending out alerts about a India crisis. Nobody did. Exactly. That’s the irony to me. Everyone was looking for a crisis in China and it ends up erupting in India, first. The Indian economic growth has fallen to around 5%. Do you see us going back to the good old Hindu rate of growth of 3.5%? No that’s not been my case. Hopefully things have changed there. There is a lot of natural buoyancy. What I do find more impressive compared to 30-40 years ago is the quality of state chief ministers. They have improved a lot in comparison to the 1970s and the 1980s. In fact even the 1990s. The moment we think of the third front we all get a bit scared because we think of the motley crew which ran the government in the mid 1990s. If you look at the state chief ministers today, they are generally better. My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can. We overshot for a while, we can undershoot for a while. That is still my base case scenario. I am not willing to give up on India and say that India is going to go down the route of 3% growth which existed till 1980. Also it is important to remember that the aspiration levels of the people here are too high now to tolerate that kind of an outcome. They will force something to happen to change that outcome. Any view on the food security bill which was recently passed by the Lok Sabha? I have no strong view on that. My concern is about the fact that you can’t keep writing cheques that which the country can’t cash. We need to understand that we can only spend that much. And if we have to spend extra then we have to show stuff that we can cut elsewhere. The big damage of the food security bill is not the bill itself but the fact that why was this not used at the very minimum by the Prime Minister as an excuse to say okay, if you want to pass this, you have to raise diesel prices by an ‘x’ amount, so that we offset some of the cost. The interview originally appeared in the Forbes India magazine edition dated September 20, 2013 (Vivek Kaul is a writer. He tweets @kaul_vivek)
Vivek Kaul The trouble with being a one trick pony is that the trick stops yielding dividends after sometime. Something similar seems to have happened to the efforts of the government of India to control the huge trade deficit. Trade deficit is the difference between imports and exports.” Trade deficit for August 2013 was at $10.9 billion. This is a major improvement in comparison to the trade deficit of $14.17 billion in August 2012. The deficit was $12.27 billion in July, 2013. This fall in trade deficit has come through the efforts of the government to bring down gold imports by increasing the import duty on it. India imported just 2.5 tonnes of gold in August and this cost $650 million. Now compare this to 47.5 tonnes imported in July, 31.5 tonnes in June, 162 tonnes in May and 142.5 tonnes in April of this year. In April 2013, the 142.5 tonne of imported gold had cost $7.5 billion and the trade deficit was at $17.8 billion. If there had been no gold imports, then the trade deficit for April would have stood at $10.3billion($17.8 billion – $7.5 billion). If the gold imports had been at $650 million (or $0.65 billion) as has been the case in August 2013, then the trade deficit would have stood at $10.95 billion ($17.8 billion – $7.5 billion + $0.65 billion). This number is very close to the trade deficit of $10.9 billion that the country saw in August 2013. So the point is that the government has been able to control the trade deficit by ensuring that the gold imports are down to almost zero. As the Indian Express reports “Gold imports stopped after July 22 due to confusion over a rule issued by the Reserve Bank of India, which required importers to re-export at least 20% of all the purchases from overseas.” The confusion has now been cleared. Also, with Diwali in early November and the marriage season starting from October, gold imports are likely to pick up in September and October. Even if it doesn’t, the imports are already close to zero. So, any more gains on the trade deficit front by limiting gold imports, is no longer possible. The Indian Express report cited earlier quotes a senior executive of the Bombay Bullion Association as saying “Imports may again rise to around 30 tonne in September, as jewellers usually start building inventory to cater to the requirement during the festival and marriage season.” At the same time, the government hasn’t been able to do much about oil, which is India’s biggest import. In August 2013, oil imports stood at $15.1 billion, up by 17.9% in comparison to the same period last year. Oil imports formed nearly 40.8% of the total imports of $37.05 billion. There isn’t much the government can do on this front, other than raising prices majorly to cut under-recoveries of oil marketing companies and limit demand for oil products at the same time. But that may not be a politically prudent thing to do. The commerce minister, Anand Sharma, warned that with the international prices of crude oil rising over the past 10 days, the oil import bill may go up in the months to come. And this may lead to a higher trade deficit. As Sonal Varma of Nomura Securities wrote in a report dated September 10, 2013, “Looking ahead, a seasonal rise in imports during the festive season and higher oil prices should result in a slightly higher trade deficit in Q4 2013(the period between Oct and Dec 2013), relative to Q3 (the period between July and Sep 2013).” But imports form just one part of the trade deficit equation. Exports are the other part. Exports for August 2013, went up by nearly 13% to $26.4 billion, in comparison to August 2012. In July, exports were at $25.83 billion. While exports may have gone up by in August due to a significantly weaker rupee, whether they will continue to go up in the months to come is a big question. As Ruchir Sharma, Head of Global Macro and Emerging Markets at Morgan Stanley, and the author of Breakout Nations, told me in a recent interview I did for Forbes India “Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist.” This something that another international fund manager reiterated when I met him recently. As he said “A part of the problem that India has is that the economic model has been based more on the service sector rather than manufacturing. The amount of manufactured products that become cheaper immediately and everyone says that I need more Indian products rather than Chinese products or Vietnamese products, is probably insufficient in number to give a sharp rebound immediately.” The other big problem with Indian exports is that they are heavily dependent on imports. As commerce minister Anand Sharma admitted to “45% of exports have imported contents. I don’t think weak rupee has any impact on positive export results.” In fact The Economic Times had quoted Anup Pujari, director general of foreign trade(DGFT) on this subject a few months back. As he said “It is a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters. India’s top five exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery — are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised. In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.” Also, the moment the rupee falls against the dollar, the foreign buyers try to renegotiate earlier deals, Pujari had said. “As most exporters give in to the pressure and split the benefits, the advantages of a weak rupee disappear.” What all these points tell us is the simple fact that the trade deficit will be higher in the months to come. And given, this the market, like is the case usually, is probably overreacting. The article originally appeared on www.firstpost.com on September 11, 2013 (Vivek Kaul is a writer. He tweets @kaul_vivek)
Vivek Kaul Every country needs foreign currency to pay for its imports. The foreign currency needed is typically the American dollar or the euro. This foreign currency is earned through exports. India is no different on this account. But what happens when the imports are greater than exports as is the case with India? This leads to a situation where the country does not have enough foreign currency to pay for its imports. How does the country then pay for its imports? What comes to the rescue are remittances of foreign currency made by the citizens of the country living abroad. These remittances can then be used to pay for imports. India is the world’s largest receiver of remittances. In 2012, it received $69 billion, as per World Bank data. But even with such large remittances being made, a country may not have enough foreign currency going around to pay for its imports. In such a situation, the country is said to be running a current account deficit (CAD). In technical terms, the CAD is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances. In 2012, India’s CAD stood at $93 billion, which was only second to the United States in absolute terms. As Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management point out in a report titled Don’t Take Your Eye of the Ball “At $93billion, India’s CAD in 2012 was second only to the US in absolute terms, and higher than the UK, Canada and France.” The following table from the report shows the list of countries with the highest CAD in absolute terms. Even if we compare CAD as a percentage of GDP, only South Africa and Turkey are ranked ahead of India. India’s high CAD is primarily because of the fact that it has to import a large portion of the oil it consumes. For the year ending March 31, 2013, the country imported $169.25 billion worth of oil. This forms nearly 34.4 percent of India’s total imports. With oil prices falling in the recent past, this has given reason for hope that India will be able to control its CAD in the time to come. The price of the Indian basket of crude oil stood at $101.58 per barrel as on May 3, 2013. On January 31, 2013, the price was $111.44 per barrel. So, clearly the oil price has fallen over the last three months and this should help India control the CAD is a logical conclusion being made. And this has led to a lot of optimism among the lot who run this country. The finance minister on a recent visit to the United States said, “If exports rise sharply, if the oil prices soften more quickly, the current account deficit could be contained at 2.5 percent even by next year.” This is being a tad too optimistic, as Hattangadi and Kelkar put it, “even if we assume lower energy prices will result in a saving of about $20 billion in the current fiscal year”. This means the CAD will stand at over $70 billion, which is not a small amount by any stretch of imagination. What has also helped in controlling a galloping CAD to some extent has been a fall in the price of gold and various steps taken by the government to discourage buying of gold, like increasing the import duty on it. Gold imports declined by 11.8 percent to $50 billion during the period April 2012-February 2013. Falling oil and gold prices may have come as a boon but what has somewhat negated this effect is rise in the import of coal. In the first nine months of the financial year 2012-2013 (i.e. the period between April 1, 2012 and December 31, 2012), coal imports jumped 70 percent. This trend is likely to continue. “Despite having the fifth largest coal reserves in the world, India’s coal imports this year may rise to 130 million tonnes, up 50 percent from two years ago,” write Hattangadi and Kelkar. In 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013), the coal imports are expected to be around 110 million tonnes. So unless India takes concrete steps to address its energy sufficiency, its high CAD is likely to continue. As Hattangadi and Kelkar write, “India has done little to adequately address energy self-sufficiency. After declining for almost 20 years until 2005, US energy self-sufficiency has gone up from 69 percent to 80 percent. In contrast, India’s energy self sufficiency has been falling from 90 percent in 1984 to 63 percent in 2011.” With the coalgate scam currently haunting the government, it is unlikely that much will happen in the area of encouraging private production of coal in the months to come. As mentioned earlier India ran a CAD of $93 billion in 2012-2013. What this means is that the sum total of foreign exchange that came in through exports and remittances was not enough to pay for imports. So where did the remaining foreign exchange to pay for imports come from? This is where foreign investors came in. Foreign investment in the form of foreign direct investment and portfolio investment (the money that comes into the stock market and the debt market) has been in the range of $40-50 billion in the five out of last six years. Foreign investors bring money into India in the form of dollars, euros or yen, for that matter, and exchange it for rupees to invest in India. This foreign exchange accumulates with the Reserve Bank of India or any of the banks, and is bought by importers looking to pay for their imports. Hence it is safe to say that to a large extent India remains dependant on foreign investors to continue financing its CAD. And that explains why Finance Minister P Chidambaram has been on several foreign roadshows over the last few months trying to encourage foreign investors to invest more in India. But there are two problems here. As Chidambaram said in the budget speech earlier this year, “The key to restart the growth engine is to attract more investment, both from domestic investors and foreign investors. Investment is an act of faith.” And faith can turn around very quickly. When the financial crisis erupted in 2008-09, foreign investment fell to $8 billion from the $40-50 billion level. Any sense of a crisis can lead to foreign investors stopping to bring money into India. They might also start withdrawing the money they have invested in India. The other problem here is that how does the finance minister motivate foreigners to invest in India, when Indian businessmen are looking to invest abroad. As Ruchir Sharma writes in Breakout Nations, “At a time when India needs its businessmen to reinvest more aggressively at home in order for the country to hit its growth target of 8 to 9 percent, they are looking abroad. Overseas operations of Indian companies now account for more than 10% of overall corporate profitability, compared with 2 percent just five years ago.” And if all this wasn’t enough imports are not the only thing competing for foreign currency. Over the last few years more and more Indian businesses have borrowed abroad given the low interest rates that prevail internationally. This money now needs to be returned. Hattangadi and Kelkar estimate that “the total amount of debt that will likely come up for redemption or refinancing in the current year is about $165billion, which is about $20billion higher than last year.” Hence, imports and repayment of debt will be competing for foreign currency. So yes, oil prices and gold prices are falling, but there are other reasons to worry about, when it comes to the current account deficit, something the political class that runs this country, isn’t really talking about. The article originally appeared on www.firstpost.com on May 7,2013 (Vivek Kaul is a writer. He tweets @kaul_vivek)
Vivek Kaul 
