Gary Dugan is the CIO – Asia and Middle East, RBS Wealth Division. In this freewheeling interview with Vivek Kaul he talks about the recent currency crash in Asia, where the rupee is headed to in the days to come and why you would be lucky, if you are able to find a three BHK apartment, anywhere in one of the major cities of the world, for less than $100,000.
What are your views on the current currency crash that is on in Asia?
People are trying to characterise it as something like what has happened in the past. I think it is very different. It is different in the sense that we know that emerging markets in general have improved. Their financial systems are more stronger. The government policy has been more prudent and their exposure to overseas investors in general has been well controlled. I don’t think we are going to see a 12 month or a two year problem here. However, countries such as India and Indonesia have been caught out and the money flows have brought their currencies under pressure. So, it’s a problem but not a crisis.
One school of thought coming out seems to suggest that we are going to see some version of the Asian financial crisis that happened in 1998, over the next 18 to 20 months…
I totally disagree with that. The rating agencies have looked at the Indonesian banks and they have said that these banks are well-abled to weather the problems. If you look at India, the banking system is well-abled to weather the problems. It is not as if that there is a whole set of banks about to announce significant write down of assets or lending. The only thing could go wrong is what is happening in Syria. If the oil price goes to $150 per barrel then the whole world has got a problem. The emerging market countries would have an inflation problem and that would only create an exaggeration of what we are seeing at the moment.
Where do you see the rupee going in the days to come?
There is still going to be downward pressure. I said right at the beginning of the year, and I was a little bit tongue in cheek when I said that in theory the rupee could fall to 72. At 72 to a dollar, in theory, clears the current account deficit. I never expected it to get anywhere near that, certainly in a short period of time. But some good comes out of the very substantial adjustments, because pressure on the current account starts to disappear. Already the data is reflecting that. Where the rupee should be in the longer term is a very difficult question to answer.
Lets say by the end of year…
(Laughs) I challenged our foreign exchange market experts on this and asked them what is the fair value for the rupee? I ran some numbers on the hotel prices in Mumbai, relative to other big cities, and not just New York and London, but places like Istanbul as well. India, is the cheapest place among these cities. Like the Economist’s McDonald Index, I did a hotel index, and on that you could argue that the rupee should be 20-30% higher. But, if you look at the price that you have got to pay to sort out your economic problems, it is probably that the currency is going to be closer to 70 than 60 for the balance of this year.
One argument that is often made, at least by the government officials is that because the rupee is falling our exports will start to go up. But that doesn’t seem to have happened…
It takes a while. I was actually talking to a client in Hong Kong last week and he said that warehouses in India have been emptied of flat screen TVs, and they have all been sent to Dubai because they are 20% cheaper now. It is a simple story of how the market reacts to a falling currency.
But it’s not as simple as that…
Of course. A part of the problem that India has is that the economic model has more been based 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. Where you may see a change, even though some of the call centre managers are a little sceptical about it, is that call centres which had lost their competitive edge because of very substantial wage growth in India, will immediately get a good kicker again. It would certainly be helpful, but I would say that it normally takes three to six months to see the maximum benefit of the currency adjustment.
What are the views on the stock market?
I am just a bit sceptical that you are going to see much performance before the elections. I always say it is a relative game rather than absolute one. If all markets are doing well, then India with its adjustment will do fine. Within the BRIC countries, India falls at the bottom of the pack, in terms of relative attractiveness, just because there is a more dynamic story for some of the other countries at the moment.
One of the major negatives for the stock market in India is the fact that the private companies in India have a huge amount of dollar debt…
It is definitely a reason to worry. It’s not something I have looked at in detail. But as you were asking the question, I was just thinking that people are dragging all sorts of bad stories out. When there were bad stories before, people were just finding their way through it. And India has a wonderful way of working its way through its problems and has been doing that for many many years. Remember that these problems come to the head only if the banks call them to account. I think there will be a re-negotiation. It is not as if a very substantial part of Indian history is about to go under because someone is going to pull the plug on them.
Most of the countries that have gone from being developing countries to becoming developed countries have gone through a manufacturing revolution, which is something that is something that has been missing in India…
It is. You look at the stories from the past five years, and the waning strength of the service sector in India, in th international markets, comes out. A good example is that of call centres that have gone back to the middle of the United States from India. A part of that came through currency adjustment. You can say that maybe the rupee was overvalued at the time when this crisis hit. But it is true, in a sense, that India has got to back-fill a stronger manufacturing industry and it has got to reinforce its competitive edge in the service sector.
What is holding back the Indian service sector?
A number of structural things. I talked to some service sector companies at the beginning of the year. And one of things I was told was that I have got all my workers sitting here in this call centre, but now they cannot afford to live within two hours of commuting distance. Why did that happen? That is not about service sector. It is about the broad infrastructure and putting people at home, close to where they work. There are lot of problems to be solved.
There has been talk about the Federal Reserve going slow on money printing(or tapering as it is called) in the days to come. How do you see that going?
Everyone has got to understand that the principle of quantitative easing is to generate growth. So, if there is enough growth around they will keep tapering, even if they get it wrong by starting to taper too early. They will stop tapering if growth is slow. Secondly, number of Federal Reserve governors are worried about imprudent actions of consumers and industrialists, in terms of taking cheap money and spending it on things that they typically do not need to spend on. A good example is speculation in the housing market, something which created the problem in the first place. So they want to choke such bad behaviours. They will probably start tapering in September in a small way. The only thing that may stop it from happening is if the middle Eastern situation blows up. The US didn’t think it was going to get involved a few weeks ago. Now it is.
Isn’t this kind of ironical, that the solution to the problem of propping up the property market again, is something that caused the problem in the first place…
That’s been very typical of the United States for the last 100 years. Evertime there is a problem you ask people to use their credit cards. Or use some form of credit. And when there is an economic slowdown because of the problems of non performing loans, then you get the credit card out again. So, yeah unfortunately that is the way it is.
Why is there this tendency to go back to the same thing that causes the problem, over and over again?
It is the quickest fix. And you hope that you are going to bring about structural changes during the course of a better economic cycle. So people don’t bring the heavyweight policies in place until they have got the economy going again and sadly the only way you can get the economy going again is to just to make credit cheap and encourage people to borrow.
Inflation targeting by central banks has come in for criticism lately. The point is that because a central bank works with a certain inflation target in mind, it ends up encouraging bubbles by keeping interest rates too low for too long. What is your view on that?
These concepts were brought in when central banks thought they could control inflation. If you look at one country that dominates the world at the moment in terms of product prices and in terms of the inflation rate, it is China. Your monetary policy isn’t going to change the behaviours of China. And some of the flairs up in inflation have been as a consequence of China and therefore monetary policies have no impact. Secondly, the idea of controlling inflation, the concept worked for the 20 years of the bull market. Then we got inflation which was too low. So we have changed it all around to actually try to create inflation rather than to dampen inflation. I don’t think they know what tools they should be using. The central banks are using the same tools they used to dampen inflation, in a reverse way, in order to create it.
And that’s where the problem lies…
For nearly two to three hundred years, the world had no inflation, yet the world was kind of an alright place. We had an industrial revolution and we still had negative price increases, but that did not stop people from getting wealthy.
Many people have been shouting from the rooftops that because of all the money that has been printed and is being printed, the world is going to see a huge amount of inflation, so please go and buy gold. But that scenario hasn’t played out…
Chapter one of the economic text book is that if you create a lot of money, you have got a problem. Chapter two is that there is actually another dimension to this and that is the velocity of money. If you have lots of money and if it happens to go around the world very very slowly it doesn’t have any impact. And that has been the point. The amount of money has gone up considerably but the velocity of money has come down. To date, again in the western world, there is little sign of the velocity improving. We are seeing this in the lending numbers. Even if banks have the appetite for lending money, nobody wants to borrow. Someone’s aged 55, and the job prospects are no wage growth, and the pension is tiny, I am not sure that even if you have gave him ten credit cards, he’ll go and use any of one of them. And that is the kind of thing that is happening in Europe and to some extent in the United States.
Yes that’s true…
The only money going into housing at the moment is the money coming from the institutional market, as they speculate. If you look at students coming out of college in the United States, they have come out way down with debt. There is again no way that they are going to go and take more loans from the bank because they have already done that in order to fund their education. So I do not seeturnover of money in the Western world.
There may be no inflation in everyday life but if you look at asset inflation, it has been huge.. That’s right. People just find stores of value. Gold went up as much as it did, in its last wave. If you look at Sotheby’s and Christie’s, in the art market, they are doing extremely well. The same is true about the property market. Places which are in the middle of a jungle in Africa, there prices have gone up to $100,000 an acre. Why? There is no communication. No power lines. It is just because people have money and are seeking out assets to save that money. Also, there has been cash.If you go to Dubai, 80% of the house purchases there, are in cash. So you don’t need the banks.
Can you tell us a little more on the Africa point you just made?
I did laugh when Rwanda came to Singapore to raise money for its first ever bond issue and people were just discovering these new bond markets to invest purely because they did not know what to do with their money. So someone said that I am building, you know in a Rwanda or a Nigeria, and people just ran with their cash, buying properties and buying up land wherever the policies of the government allowed. Sri Lanka again just closed the door on foreign investors because you start to get social problems as the local community cannot afford properties to live in. It was amazing how commercial many of these property markets became, even though in the past they were totally undiscovered. And as we have seen with many of them, you take considerable risk with the legal system. The world has got repriced. I always say that if you can find a three bedroom house below a $100,000-$150,000 in a major city, you are doing well anywhere in the world today.
In Mumbai you won’t find it even for that price..
Yes, though five years ago it was true. It is impossible now.
(The interview appeared in the Forbes India magazine edition dated Oct 4, 2013)
Raghuram Govind Rajan, the governor of the Reserve Bank of India, has refused to join the party.
The financial markets were expecting the Rajan led RBI to cut the repo rate in its Mid Quarter Monetary Policy Review. But that has not happened. Instead the repo rate has been raised by 25 basis points(one basis point is equal to one hundredth of a percentage) to 7.5%. Repo rate is the interest rate at which RBI lends to banks. Hence, the BSE Sensex has fallen by more than 500 points after the policy review was announced. As I write this it is down by around 350 points. The rupee is now quoting at 62 to a dollar, having touched 62.6 to a dollar earlier.
So now Rajan is suddenly looking like a villain after having been turned into a hero by the media over the last few weeks. As a Facebook friend quipped Phatta Poster Nikla Zero.
What Rajan has done needs to be analysed in line with the economic philosophy he believes in. A major reason for increasing the interest rate is high inflation. As the Monetary Policy Review points out “What is equally worrisome is that inflation at the retail level, measured by the CPI (consumer price inflation), has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence. Although better prospects of a robust kharifharvest will lead to some moderation in CPI inflation, there is no room for complacency.”
This statement is totally in line with Rajan’s thinking on the issue. In fact, Rajan has clearly pointed out in his earlier writings that RBI should simply concentrate on managing inflation instead of trying to do mulitple things at once.
As Rajan wrote in a 2008 article (along with Eswar Prasad) “The RBI already has a medium-term inflation objective of 5 per cent…But the central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
And given this the RBI ends up being neither here nor there. As Rajan put it “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should ‘just’focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation and intervening in currency markets only to limit excessive volatility…an exchange rate that reflects fundamentals tends not to move sharply, and serves the cause of stability.”
Currently, the RBI is trying to control inflation, accelerate economic growth and stabilise the value of the rupee, all at the same time. Something which is not possible. Rajan understands this well enough. “The RBI’s objective could be restated as low inflation, and growth consistent with the economy’s potential. They amount to essentially the same thing! But it would let the RBI off the hook for targeting the exchange rate. And that is the key point,” Rajan wrote in the 2008 article cited earlier. Given this focus on inflation, it isn’t surprising that Rajan has chosen to go against market expectations and raise the repo rate. His belief is that if inflation is brought under control, other things will sort themselves out.
Rajan is also trying to address the high current account deficit by raising the repo rate. Lets try and understand how. As the monetary policy review of the RBI points out “However, inflation is high and household financial saving is lower than desirable.” Lower savings have an impact on the current account deficit. As Atish Ghosh and Uma Ramakrishnan point out in an article on the IMF website “The current account can also be expressed as the difference between national (both public and private) savings and investment. A current account deficit may therefore reflect a low level of national savings relative to investment.”
If India does not save enough, it means it will have to borrow capital from abroad. And when these foreign borrowings need to be repaid, dollars will need to be bought. This will put pressure on the rupee and lead to its depreciation against the dollar.
This is something that Rajan said in an interview to the India Brand Equity Foundation. As he said “Current account deficit (CAD) essentially reflects the fact that you are spending more than you are saving. That’s technically the definition of the CAD, which means that you need to borrow from abroad to finance your investment. Ideally, the way you would reduce your current account deficit is by saving more, which means consuming less, buying fewer goods from abroad and importing less. Or, the other way is by investing less, because that would allow you to bridge the CAD. Now we don’t want to invest less. We have enormous investment needs. So ideally, what we want to do is save more.”
And to achieve this “the first way is for the government to cut its under-saving or its deficit.” “The second way is when the public decides to save more rather than spend. We need to encourage financial saving,” Rajan said in the interview.
The fact of the matter is that India has not been saving enough over the last few years. As the recent RBI financial stability report released in June 2013 points out “Financial savings of households…have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.”
Financial savings are essentially in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore. This has largely been on account of high inflation. Savings have been diverted into real estate and gold in the hope of earnings returns higher than the prevailing inflation.
Also people have been saving lesser as their expenditure has gone up due to high inflation. And the financial savings will only go up, if inflation comes down, pushing up the real returns on various kinds of deposits.
“Households also need stronger incentives to increase financial savings. New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability,” wrote Rajan in a column in April 2013.
Rajan has increased the repo rate hoping that bank’s and other financial institutions increase the interest rates on their deposits. This will encourage people to save more. Also, by trying to control inflation Rajan hopes that the real return on deposits (nominal return minus inflation) will go up. Once this happens, people are likely to stay away from investing in gold. If people stay away from investing in gold, it helps bring down our imports and hence, also the current account deficit. This puts lesser pressure on the rupee. The current account deficit(CAD) can also be expressed as the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
Also, as India saves more the need to borrow from abroad will come down. India’s external debt as on March 31, 2013, stood at at $ 390 billion. Of this nearly 79% debt is non government debt. External commercial borrowings(ECBs) made by corporates form nearly 31% of the external debt.
The trouble is that a lot of this external debt needs to be repaid before March 31, 2014. NRI deposits worth nearly $49 billion mature on or before March 31, 2014. Nearly $21 billion of ECBs raised by companies need to be repaid before March 31, 2014.This will mean a demand for dollars and thus further pressure on the rupee. If India’s borrowing from abroad comes down in the coming years that will mean lesser pressure on the rupee, as the demand for dollars to repay these loans will go down. But for that to happen financial savings need to go up. And that can only happen if inflation is brought under control and real returns on fixed income instruments (like deposits, bonds etc) go up.
Of course, raising the repo rate just once by 25 basis points is not enough for all this to be achieved. Hence, chances are Rajan will keep raising the repo rate in the days to come.
The article originally appeared on www.firstpost.com on September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
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 Policy magazine 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.”
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 Times you 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.
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)
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)
Our politicians think our problems come from being connected with the world, but the reality is we are too little connected to the world, says Pankaj Ghemawat.
The United Progressive Alliance government is fond of telling us that India’s weakening macroeconomic indicators – a falling rupee, a declining stock market, rising bond yields – are the result of being tied to a weak global economy and factors external to India. But if you were to ask Pankaj Ghemawat, Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Barcelona, Spain, India is not exactly as globally connected as we think it is.
Ghemawat has constructed a broad index of international integration, the DHL Global Connectedness Index, which was first released in November 2011. The 2012 version of this index was released last year and it shows India closer to the bottom. “This index extends beyond trade to incorporate capital, information and people flows as well, and covers 140 countries that account for 95% of the world’s population and 99% of its GDP,” says Ghemawat.
India ranks 119 out of 140 countries on the depth of its global connectedness. “When it comes to trade intensity, India still ranks in the bottom 25% in the sample. As far as capital connectedness is concerned, it is closer to the median,” says Ghemawat.
Capital connectedness is calculated from measures of foreign direct investment (FDI) and foreign portfolio equity investment into the stock market of the concerned country. India’s decent performance on capital connectedness is primarily on account of the huge money that has come into the Indian stock market from abroad in the last decade and big outward FDI flows in the form of overseas acquisitions by Indian corporates.
If one looks at just inward FDI, the performance is dismal. As Ghemawat puts it, “In terms of inward FDI stock (i.e. foreign companies having built or bought businesses in India) expressed as a percentage of GDP, India comes in the bottom 10%.”
FDI flows into India have also fallen in three out of the last four years. For 2012-13, FDI fell by 21% to $36.9 billion, government data show. The United Nations Conference on Trade and Development (UNCTAD), in a recent release, said that FDI inflows to India declined by 29% to $26 billion in 2012.
The government has, faced with an unsustainable current account deficit (CAD), has been trying to encourage FDI into the country to firm up the rupee against the dollar. Last year in September, the government opened up FDI in multi-brand retailing with the rider that each state can decide whether it wants companies like Wal-Mart to set up shop within its borders.
But since then not a single dollar has come into the sector. “One reason for foreign money not coming in is that investors are not sure whether the policy will continue as and when a new government comes in. Also, letting states set their own rules on such an international economic policy matter is basically unheard of elsewhere,” said Ghemawat. Towards the middle of July 2013, the government relaxed FDI norms in 12 sectors, including telecom, insurance, asset reconstruction, petroleum refining, stock exchanges and so on.
Ghemawat feels that there is a lot that India can learn from China on this front. China started opening up its retail sector to FDI in 1992, initially with various restrictions, but ultimately allowing 100% FDI in 2004. This benefited them with foreign players bringing in new management practices along with supporting technology and investment capital. And we shouldn’t forget the complementarity for foreign retailers between sourcing from China (contributing to China’s export boom) and selling there.
Ghemawat argues that much of the fear about FDI in retail is exaggerated, because even with full liberalisation, foreign retailers would hardly come to dominate the Indian market. “Retail is a very local business, where an intimate understanding of customers, real estate markets, and so on, is essential to success.” He cites a recent estimate that 40 foreign players account for only about 20% of organised retail in China, to suggest that foreign and domestic retail could thrive side-by-side in India.
“Foreign retailers don’t always win out against domestic rivals,” he adds. “Electronics retailers Best Buy from the US and Media Markt from Germany both shut down their stores in China in the last few years. They just couldn’t compete with local rivals Gome and Suning, which had greater domestic scale and business models more attuned to the Chinese market. Home Depot also exited China in 2012. But Chinese consumers gained anyway – competition against foreign retailers spurred locals to improve customer service, one of their weak points.”
Coming back to data from the Indian market, Ghemawat notes an interesting factoid from the 2013 Economist Corporate Network Asia. The nominal GDP of India grew by 12.6% in 2012. In comparison, the sales of MNCs (mainly Western) in India grew by only 6.3%, only half as fast as the GDP. “While this could be viewed as positive regarding Indian firms, a difference of such a big magnitude is probably reflective of a lack of openness,” said Ghemawat.
There are multiple reasons for India’s poor showing on these indicators India regularly figures in the bottom tier of countries in terms of the extent to which its policies promote trade. In the World Economic Forum’s 2012 Global Enabling Trade Index, India figures in the bottom tier. On the market access parameters, in particular, it figures third from last in a list of 132 countries. Ghemawat also cites the OECD’s FDI restrictiveness index which he has inverted into the FDI Friendliness Index. “India again figures in the bottom 10% of 50 countries in terms of the extent to which it encourages FDI.” No amount of ministerial cajoling of potential foreign investors is likely to outweigh the impact of such protectionist policies.
These indicators, of course, translate into low productivity and lack of infrastructure required to carry out a profitable business. “The Global Competitiveness Report tells us all we need to know about India’s poor infrastructure and low productivity,” says Ghemawat. “India currently ranks 59th on the list (out of 144 countries). It has fallen 10 places since peaking at the 49th spot in 2009. Once ahead of Brazil and South Korea it is now 10 places behind them. China is 30 places ahead of India,” he adds.
When it comes to the supply of transport, energy and ICT (information, communications technology) infrastructure, India is 84th on the list. This lack of infrastructure is the single biggest hindrance to doing business in India, feels Ghemawat. And this has kept foreign investors away from the country. Also given India’s weak health and basic education infrastructure (where it is 101st on the list), India remains low on productivity, which is an important factor for any foreign investor looking to make an investment. And as if all this was not enough it is worth remembering that it is not easy to start any business in India. Every year the World Bank puts out a ranking which measures the Ease of Doing Business across countries. In the 2013 ranking, India came in at rank 132 on the list – the same as in 2012. When it comes to starting a new business In
dia is 173rd on the list. Hence, foreign investors have an option of starting their business in a much easier way in many other countries. Given this, why should they be hurrying to India?
The spate of recent scams also has not helped the way India is viewed abroad. There is significant evidence to show that corruption hampers trade. Says Ghemawat: “According to one study, an increase in corruption levels from that of Singapore to that of Mexico has the same negative effect on inward foreign investment as raising the tax rate by over 50 percentage points.” India stood at 94th position in Transparency International’s 2012 Corruption Perception Index. “Given this, tackling corruption has to be a priority,” adds Ghemawat.
The moral of the story is that although India is much more open than it used to be 20 years ago, there is a lot that still needs to be done. And this is important because there is a clear connect between the global connectedness of a country and measures of prosperity. As Ghemawat puts it, “There is a strong positive correlation across countries between the depth of a country’s global connectedness and measures of its prosperity, such as its GDP per capita and its ranking on the UN’s Human Development Index. To be sure, correlation is not the same as causation, but statistical analysis indicates that after controlling for initial income levels, countries with deeper global connectedness have tended to grow faster than less-connected countries.”
The point is further buttressed by one look at the list of countries that are on the top of 2012 DHL Global Connectedness Index created by Ghemawat. These countries are the Netherlands, Singapore, Luxembourg, Ireland, Switzerland, the United Kingdom, Belgium, Sweden, Denmark, and Germany. In the recent past some of these countries have been caught up in the aftermath of the financial crisis, but it’s important not to let recent growth rates overshadow measures of current prosperity, on which all of these countries far surpass India.
Ghemawat gives the example of the Indian information technology sector. “Ask this simple question to yourself: Would Indian IT companies have been as globally competitive if we had protected them from international competition?” The answer of course is no. But that is the case with the business services sector. There is a huge protective moat around it. This, despite the fact that the sector has a huge potential to create jobs.”
And he backs his argument with numbers. “Although some services (like haircuts) will always be delivered locally, liberalizing trade in services alone could boost global GDP by at least 1.5%.” In India’s case, opening up business services is even more important given that we don’t trade much with our neighbours due to various reasons. “For example, Indian trade with Pakistan, according to one study, is only 2 to 4% of what it might be under friendlier circumstances. The rest of India’s neighbours are relatively small and poor, presenting limited opportunities compared with, for example, the benefits China realised by tying into Japanese and Korean production networks. It is neither exaggerated nor xenophobic to say that one of India’s key structural problems is that it is located in a difficult neighbourhood,” says Ghemawat.
Countries tend to trade the most with their neighbours. Ghemawat explains, “all else being equal, if you cut the distance between a pair of countries in half, their trade volume will go up almost 200%. Add a common border, and trade rises another 60%. That’s why more trade happens within world regions than across them, and the US’s top export destinations are Canada and Mexico.”
In India’s case, at least over the short-to-medium term, trading primarily with neighbours won’t be workable (though Ghemawat does urge India to take the lead on regional integration in South Asia). Hence, he feels that some business services can be outsourced over greater distances than many categories of merchandise are traded, since physical shipment of products is not required.
One exception he notes is how, recently, China became India’s biggest trading partner, overtaking the United States. But Ghemawat feels that caution is in order. “India runs a huge trade deficit with China and exports mainly primary products there: Cotton, copper and iron ore account for nearly one-half of the total. Given the limited progress the US has made in rebalancing its trade with China, it’s hard to see what India might accomplish within any reasonable timeframe,” he says. Trade deficit is the difference between imports and exports.
Ghemawat also feels that India has a lot to gain by encouraging trade within states. “I have been trying unsuccessfully for years to get hold of data on trade between Indian states,” he says. “India has a lot to gain by encouraging and increasing trade between states. As the former Chairman of Suzuki once put it to me, what India needs is not external trade liberalisation but internal trade liberalisation. And I heard Ratan Tata say something similar about the need for more integration and fewer barriers within India. For a large country, the potential gains from internal trade are typically much larger than those from international trade,” Ghemawat concludes.
The interview originally appeared in the Forbes India magazine in the edition dated Sep 20, 2013