How Does The SHREWDEST of FIIs thinks about India as investment destination, post Demonetisation?
December 22, 16
How Does The SHREWDEST of FIIs thinks
about India as investment destination, post Demonetisation?
Greetings from Hitesh! I always
keep my ears to the ground and listen to the sound of coming events. I keep you
well informed before the evetns take place. When I wrote my the most read post
on December 3, 16 - FIIs had not FORGIVEN MR.OBAMA,
Will they FORGIVE MR.NARENDRA MODI for NOTE BAN?, many MODI BHAKT did not
like.
Today I am presenting the VIEW of
MORGAN STANLEY Economist Mr.Ruchir Sharma. His full interview is available on
moneycontrol.com. But I have taken India relevant points and marked his opinion
in RED to save your time. Jut read.
Q: In terms of India the biggest factor to deal with this
at this point in time is the big D word demonetisation. Now you have been
fairly critical, you believe that this kind of therapy was not justified; you
also believe that if you look at the cash to gross domestic product (GDP) ratio
then it is not outrageously high at 12 percent to GDP for India. In fact you
believe it is comparable to other economies like China, Thailand etc. You have
said that revenge cannot be a development strategy and India cannot leapfrog in
that sense by using demonetisation as the route. Do you buy any of the economic arguments of the
government is presenting that yes there will be short-term pain but in the
long-term this structurally changes the India story?
A: No, I don’t see the economic argument for this. I think that the debate is now shifted that whether there
is any political benefit to this. I think that a lot of people in India have
been surprised at least outside observers by how well India has coped with
this, that this is a huge step to be done in a non crisis environment. Usually,
these kinds of measures are taken when a country is going through some major
crisis, a financial crisis, some inflation crisis. However, this step has been
taken outside of a crisis environment. I think that most people in private will tell you
whether it is the government or business people that they don’t really see any
enduring economy benefit of this. The best case that I have heard about this
that this was a lot of pain for nothing
which is that you have got a lot of pain but the enduring benefit will not
really be there from an economic standpoint. Everyone now is debating when will this economy get back to
some sort of normalcy because I have been meeting a lot of business people in
the last couple of days I have been in India and the common number I have heard
from everyone is down 30 percent. Roughly,
if you look at all the sort of evidence in terms of sales or other things or if
it is advertising, retail etc the most common number I have heard is that
things are down about 30 percent from a year ago this month. So, December is
really the pinch month for this. I think that most people agree that the
benefits of this, people spoke about a fiscal windfall and other things, I
think most people now come and conclude that none of that will be there.
However, the debate now is shifted to politics which is that is there some
political benefit to this.
Q: Or cleaning up at least political funding?
A: However, this is one of the solutions to that which I
have heard about but here is the problem with this. So, like in Mexico they
introduced that in the year 2000 because they were closed to United States that
what we should do, have state funding and free television space to all the
political parties. 16 years later today they think that corruption is way
higher in the political system than it was in when they first introduced this.
So, that to me is the point that these symptoms of a very high share of a
parallel economy, very high use of cash in the economy or things like basic
stuff like corruption these are the unfortunate plights I feel that many
developing countries suffer from. It is only as they get richer or more
prosperous that you find that these traits sort of come off that you begin to
move to a more normal environment. This is my case as far as India is concerned that we are at a very
basic level of economic development. Our per capita income is just USD 2,000 at
this level of development all we have to do is to follow the best practise of
what the other countries have done to have got in less poor and more
prosperous. We don’t have to reinvent the wheel out here that is something for
economies and technological frontier to try and do that to come up with new
thing like in United States or other economics, they have to spend a lot on
research and development to come up with new things because they have already
reached a very high level of development. At our level of development we don’t
have to do this. We just have to basically stick to the basics and get those
basic correct. I think that the real problem which I think that we face from is
that we tend to be quite insular. Like last decade I felt that one of the
biggest mistakes that policymakers made in India was to confuse the global boom
with a local boom. That all emerging markets were booming and
the rising tide lifted everybody and we thought that something special was
going on here where really it was a global boom which was lifting us. Similarly
out here these type of experiments whether it is demonetisation or other thing
are being carried out in other countries – political funding of elections all
we have to do is to basically look at what other countries are doing and what
the global trends are. The other thing which I found very fascinating is that
this decade the amount of cash being used in the global economy has in fact
gone up. So, now you think that the entire global economy is moving towards
less cash or digitisation etc. However, this decade the amount of cash being used in the global
economy has moved up significantly in many countries. In countries like Japan
in fact the cash or the share of the economy is 20 percent, so we are at 12;
they are at other extreme of 20 percent. My
point here is that why is this happening, so Japan is a classic case. When you have very low interest
rates or the real interest rates are virtually nothing or negative and there is
less faith in the banking system people tend to keep more cash and that has
what is happen in Japan as well. We have seen a such a surge in cash take
place. Now corruption I don’t find that much of a relationship with that Japan
is hardly a corrupt society at 20 percent cash or the share of the economy.
Similarly Pakistan’s cash or the share of the economy is less than ours or less
than 12. I don’t think Pakistan is a less corrupt state than what India is. So,
I think that this is about sort of just learning and incorporating what other
countries are doing and following those examples. So, if you are less insular and use other templates in
terms of what is going on I think the results for us will be better. Now this
has happened, there is no point sort of going about this, it is time to move on
in terms of what are the next big issues that we need to deal with what is the
next big stuff. Here I again find that what is happening in the United States
today with the new President out there the implications of that are very
significant including for India, some huge implications to that.
Q: The evidence at this point in time on the actual impact
on the economy is largely anecdotal. You talked about 30 percent, it's what you
are hearing and that is the common refrain when you talked to businesses in
India, but what
do you think will be the implications for the GDP in the short-term and do you
believe that this is going to be more than two quarters, is this going to be a
protracted slowdown that we should brace ourselves for. What is your own sense
because there is no precedent to talk about?
A: Absolutely and so therefore it is hard to predict
because even GDP data is like a whacky data, for example someone told me that
because the number of deposits in the system has increased furiously - that in
fact will show an increase in GDP growth because the financial sector will show
that the GDP growth has picked up significantly because the number of deposits
has gone up significantly. So just looking at the GDP data - that's very
quirky. So I do not think that we are going to see the effects of that. My hope
is that India is a very resilient economy that it is able to withstand lot of
shocks. It goes back to my original point that a level of development is very
basic, so we are able to withstand these shocks and we move on. The problem though is that that
people haven't adjusted the expectations much, for example speaking to my team
here about what the earnings expectations of the market are and I find that's
staggeringly high; people have barely cut their earnings for this fiscal year,
they are still expecting 10-11 percent type of growth. The first half was 3 or
4 percent or something and for next year they expect 18 percent growth in
earnings.
Q: You believe that’s not realistic?
A: It just seems very high. We have got so much economic
disruption going on, some of it is even justified expecting GST etc to come and
it seems as if this move basically, for now at least, has killed a lot of animal spirits
in the economy because a lot of entrepreneurs, a lot of traders are sort of
feeling that they have been labelled as just being crooks in terms of this and
a lot of uncertainty about what will happen in the future. So this has killed a
lot of animal spirit in the economy but to forecast what the exact path of this
will be nobody knows. So therefore even on the market place we are seeing
complete confusion. There is complete lack of activity.
Q: As an
emerging market investor, what would the India call be today then?
A: As far as India is concerned we have pulled back
in terms of the fact that it is a very difficult time to be in many countries because there are very few countries where the prospect
looks any good and there is one statistic which captures for me - in the boom
period of 2003 to 2007 - there were about 50-60 economies in the world which
were registering growth rate of 7 percent or more every year. This year that
number is down to 5-6 percent, so economic growth is lower everywhere and in particular
across the emerging world.
Q: But
relatively we are still doing better?
A: No but this is where I think we are missing the
point - markets and investors respond to change, not to absolute levels. In the
developed world economic momentum is coming back, like in USA the dramatic
improvement in sentiment since Trump got elected on the market place is
staggering, no one would have expected that.
Q:
Record highs for the DOW.
A: Yes and apart from that you look at all
the services, consumer confidence, business confidence, massive bump and the
rally in the US stock market today, I think I saw this data and currently this
is the best rally that the stock market enjoyed after the election of any
President in American history. So this is really sort of huge surge in animal
spirits going on in the United States. The other surprise is Europe; an economy
that people written off, even their economic momentum is accelerating. Japan
too is coming back from the brink. So in the developed world what we are seeing
is economic momentum is coming back.
Q: So that
is bad news then for emerging markets in terms of flows?
A: Yes in a way and that is what we are seeing
currently which is that the dollar is supreme and the only giant sucking sound,
we have heard so far, is of money going back to the United States and that is
something which doesn't bode well for flows to emerging markets, but there is more fundamental problem out here which is
the emerging market growth model is sort of under serious question and this is
what is going back to my earlier point about Trump presidency with two changes that they are
going to make or are very serious about making. One of them will pass for sure, the other one, I am not
sure but this has major implications for India. Take the first thing that they are going to
reduce the corporate tax rate, from 35 or something that they are talking about
to 15 or 20 percent, this is huge because here is the largest market in the
world which is reducing its corporate tax rate from 35; effective it is a bit
lower but 35 is the top rate down to 15-20 or something, that is huge because
why would anyone invest outside their domestic market and it is so large, when
the corporate tax rate is being brought down so dramatically.
Q: So that is not an issue as far as the
foreign institutional investors (FIIs) investment is concerned but even FDI
investment for countries like India?
A: As far as India is concerned - that's what
even I said two years ago - the first thing that India needs to do is to bring
down its corporate tax rate.
Q: While the growth map is 25 percent that
the finance minister laid out in his first Budget.
A: Yes but that was very incremental and now
if you do not do something dramatic on corporate tax rates.
Q: What would dramatic be for you?
A: If the United States is going to reduce
its corporate tax to 15-20 percent and if we do not bring it down to at least a
similar level, I think that is going to be a big trouble. Why would you want to
setup plant or factories here or at least a US person would want to do it, if
the corporate tax rate in the United States is going to be 15-20 percent, so
that is a major change which is taking place.
Q: You think that the government ought to
bite this bullet even in this Budget?
A: Absolutely and this is where you have the
long-term consequences of demonetisation because what is happening today is
that the focus is now shifting to what sops to offer to try and make up for
whatever hardship that the poor have gone through and the sentiment has been a
bit more anti-rich.
Q: In that context to do a significant
corporate tax rate you believe will be in question?
A: I think so but for me this is the economic
necessity, this is the need of the hour that you need to match those corporate
tax rate because the US used to have highest corporate tax rate in the world
and now from 35 they are going to go to 15-20 percent - that is like a dramatic
shift and if you do not match that that is going to have a serious implications
- that's one. So the corporate tax rate cut of 15-20 percent is a very high
probability that's going to happen in the US. The second is much more
controversial but with even greater implications for India which is that they
are discussing something called destination tax. The destination tax
implication is that exports are going to be tax-free and imports are going to
be taxed - that's a very crude way of putting it but that is what they are
talking about. If that were to go through - that would mean the entire
outsourcing model to emerging markets or even exporting your way to prosperity
model which is how many emerging markets have grown rapidly, Korea, Taiwan,
China - that model is going to be seriously impaired.
Q: What else?
A: I think that our entire model of exporting
our way to prosperity is something under serious threat because we are in the
world of deglobalisation and in this to rely on external capital much to fund
our growth that is something that the government spoke about, we just have to
be mindful that yes, that is how it used to work but that model today is
seriously impaired.
Q: So encourage domestic investments which
haven’t picked up?
A: Exactly but to expect much more FDI or
foreign investment to flow into India, I am not very hopeful of that because we
are in a deglobalising world which means that the trade flows are going to
remain weak for a long period of time across the world and also capital flows
are going to remain weak across the world. In that environment, you have to
focus much more on the domestic economy and exporting way to prosperity that
model has been seriously impaired. The developing ladder from just being like
this has basically gone vertical. So it is going to be much harder to grow.
Even in terms of bringing back black money and doing these kind of things, I
think that once again I wish we had sort of learned from our own experience of
the past and what other countries are doing like Indonesia -- Indonesia wanted
to bring back black money so they decided to have a penalty rate of just 4 percent
and they got USD 300 million including the former President Suharto -- one of
the biggest crony capitalist leaders, his son brought in USD 30 billion. So it
depends what we want to achieve. We are a capital starved economy, if we need
more capital, it is getting more and more difficult in the global market place.
How do you attract capital flows in this? It is best if you attract your own money back,
which is in terms of overseas money but today in terms of the message is -- if
you speak to businessmen, they are still figuring out how to keep a lot of
their wealth overseas rather than bringing it back. Indonesia did the opposite,
in fact, they have been criticised a lot, it is the other extreme, 4 percent
penalty rate and you can bring back whatever money you want. They did that
under the scheme and they got USD 300 billion dollars so that is like an
abundance of riches but see how the mechanism works because they got that much
capital in, now they are being able to cut interest rates, the currency has stabilised
even though they have a much larger current account deficit as a share of gross
domestic product (GDP) than India does.
Q: That is the argument the government is
presenting even as far as this particular scheme is concerned, there is now an
income declarations scheme Part II?
A: At 50 percent of those kind of rates, these
things don't work globally. That is a global experience. Maybe in India, it
will function but globally at those rates, you don’t get much traction. So,
Indonesia does it at 4 percent, you get massive money in but then that has
political problems and all that. So I think that this is what we need to do. So for me, that is the important part that these
experiments going on across the world, we don't have to reinvent the wheel, all
they have to do is to basically borrow. As far as Prime Minister Modi was
concerned, when he first came into power in May 2014, I remember I wrote in
Wall Street Journal back then in the US that this is India's Regan Walker
moment and my optimism was that -- he was speaking a lot about minimum
government, maximum governance and he had someone like Raghuram Rajan along
with him that this combination could be really great for India in terms of
potentially what it could be. I had some reservations about it but potentially
what it could be so I think that is what we were hoping and then even then
after that we kept wondering that which global leader will Modi be like, the
things like demonetisation are not from the global leaders' playbook. That is
my point.
Q: He is writing his own playbook, that is
what he said?
A: That is fine but I want to say that as far
as I am concerned, I think that my basic difference is the fact that we don’t need to
write our own playbook out here, these global experiments are going on, we are
at a basic level of economic development. We have to follow the best practices
of what other countries are doing and then we can move on. There are some
places where you can argue that things are out of whack in India and we need to
do something. So the other thing which I have been speaking about the last
couple of years is the scope of privatisation -- I
really thought that something bigger would happen as far as privatisation is
concerned because this is still an economy where the state is very large and
very dysfunctional in many parts, the harassment that ordinary people face has
a lot to do with the fact that the state is dysfunctional in India in the way
that they interact with it. Take the case of banks, there is no other country
in the world that I know where the share of assets held by the public sector is
as large as India that in India the share of assets in the banking system held
by the public sectors is close to 70 percent. There is no democratic nation in
the world which does that. The average for emerging market is more like 30-33
percent. So why are we bringing that down in terms of what needs to be done? So
I think in terms of what India can do -- for me the path is quite straight
forward but politically I don’t know what is going on anymore because I don’t
know -- if you change the narrative now because if the average person is
reacting well to this -- I have no idea what exactly is going on currently --
if the average person is saying like he is getting this sort of real thrill that
the rich person is being socked and stuff like that, there will be good
politics but from an economics standpoint, I don’t think that is going to be
great for the nation. For the nation, what we need currently if we have to become globally
competitive and to grow at the rates of 7 percent which is so difficult to do
in today's environment on a sustained basis at the time when the global economy
is growing at 3 percent, is that we need to basically react to the
international environment, we have to cut our corporate tax rates very sharply,
we need to privatise our bloated public sector and also if you want to bring
money back in, how to incentivise people to come back into the country and that
needs to be done with more carrot than sticks like more incentives rather than
disincentives.
Q: The
case that you presented, what does it mean in terms of capital allocation,
where would India stack up then for instance as far as your emerging market
fund is concerned as we look ahead?
A: As far as we are concerned, we are pulled
back because I don’t know how the next 12-18 months this country is going to
pull out.
Q: Not
even the top 5?
A: There
are other places where the recovery stories are a bit better like Eastern
Europe for example where we find a lot of opportunity because Europe is doing
better. In southeast Asia, I am quite impressed with the reforms that Indonesia
is doing, Philippines despite everything that the President says in public and
politics on the economic front, they are doing relatively good job and then in
Latin America there is opportunity. In Mexico the currency has never been this
cheap in its history. It is super comparative as far as Mexico is concerned. So
you are finding these kind of stuff but in general, this is a difficult environment
for emerging markets because US has decided to totally change the game and I
think that the implications of that are being felt. So that is the reasons,
over the last five-six weeks, why we have had such a strong rally in United
States and it has not been matched by what is happening in emerging markets.
Emerging markets have done nothing over this period even as United States has
rallied very strongly and I think that the threat of protectionism is very real
but there are different ways it is not going to come. It is not going to come
in the classic way of more tariffs and stuff but these non-trade tariff
barriers is how it is going to come and changes in the tax regime are possibly
going to be a very big deal now.
Q: You were talking about whether this will in fact reap
dividends for the BJP politically or not and outside of economics you also
spend a lot of time on the election yatra, you cover state elections as well.
UP is coming up. Do you believe that this narrative is going to work for them
politically, a lot of people are comparing this to the days of Indira Gandhi
and Garibi Hatao and whether Modi is actually positioning himself in that sort
of avatar. Do you believe that this is going to pay dividends politically for
them?
A: I have no idea as yet. Because I think we haven't really
heard much from what is happening on the ground in UP apart from some people
who have been there and they all think that there is economic distress but at
the same time they also come back with reports.
Q: The BJP holds up the municipal election results as sort
of a vote of approval for demonetisation so on and so forth.
A: Yes, but in the past though having looked at Indian
elections those election results have been very poor forecasters of what
happens in the main election by the way. So, I wouldn't read too much into it.
But having said that the anecdotal evidence is that a lot of people are quite
tolerant of this pain that they are saying that yes because they think that
this is a bold step they think that this is something which is right because it
is sort of very emotive thing that you are basically soaking this corrupt rich
people. So, that is good like in a way. That is what happened in 1970s also
back here in India. However, in terms of what is going to work today I don't
know but here is what we know about UP that my own feeling is that it is very
much going to be an election dominated by the traditional factors of cast but
we in the media and everybody is going to portray that election as a referendum
on demonetisation.
Q: Which is missing the woods for the trees.
A: Yes, but I am not sure that is going to be a big factor
in the election because cast is so important and in terms of what is going to
happen out there. So, this is going to be a fascinating thing that even though
the election will be won and lost in UP based on the cast arithmetic in terms
of it where everyone is debating where would the Muslim vote go this time, if
it goes to Mayawati she is home, if it doesn't go to her then the BJP has a
chance if they are able to split the vote between the Congress-SP kind of
combined. So, elections would be fascinating, I am going to come back to India
at the end of February to basically travel to UP. In fact I think it will be
our 25th election trip that we have done over the last 20 years and seven of
them I have done to UP because there is no state like UP for politics. You can
sort of stop at any Dhaba in UP and get people very activated about politics.
But it is very much still about cast arithmetic in that state. So, I am not
sure demonetisation will be such a big issue on the ground there. But we in the
media are going to portray that as a referendum on demonetisation. But what is
happening regarding cast arithmetic I don't know as yet. I want to go with an
open mind. When we do go in February to travel across UP.
Q: What would be the key inflections points, what would be
the key risks that you would watch out for in 2017?
A: As I said what is happening like the United States has
major global implications particularly for India. How are we going to respond
to that, are we sort of even paying any attention to that and how we are going
to respond to the dramatic cut in corporate tax rates by following up. If they
have a destination tax what we are going to do and then of course that how bad
the hit is – is this to animal spirit because at the end of the day it is the
money that makes the world go around, it’s the entrepreneurs, it’s the business
people who create wealth in an economy. Will that process come back to normal
and how quickly will it come back. Those are the two key things to watch and
then lurking in the background is China – the dead bomb is ticking in China and
if the Fed keeps increasing interest rates 2 or 3 times will that dead bomb
finally sort of explode -- that what we have to keep a lookout for. As far as
India is concerned the next 12-18 months to me looks very challenging, because
the reason you invested in India was for high economic growth -- that's what
this market always traded at, that the premium like it traded at.
Q: The government believes that
we will continue to be the fastest growing economy in the world?
A: That’s fine. In terms of
that may still be the case, but I think that for now at least that is not the
case. In terms of the hit that we have taken and how soon the economy comes
back to normalise path is what we are all trying to sort of look at. However,
the big game changer in the agenda from an economic standpoint is going to be
set by the United States in terms of what it is going to do with all these
changes that the new administration is making, because this is something
dramatic we are looking at. This is not status quo and we have to respond to
that. So what I would like to see from our side – the Indian side is an equally
aggressive response of the world’s biggest market is making these changes – how
we are going to respond to it that for me has to be the big focus of discussion
out here.
Q: So outside of the US the bright spot that you would
watch out for?
A: Well, I say that Europe for me looking much more
resilient – that because people are very pessimistic on Europe and in fact last
year or rather this year at this closing it is going to be the first time that
the European economy would have grown at a slightly faster pace than the United
States since the recession ended. So the slow comeback of Europe is important
and thee is lot of opportunity there because valuations there are really
distressed – so you can get some very cheap valuations out there and some
markets like Poland etc are trading at 20 years low, so you have real value out
there at a time when a slight comeback is on its way across the continent. And
within Asia I would say the Indonesia, Vietnam, Philippines – Southeast Asia to
me looks okay and in Latin America something very interesting is going on that
just as across the world we talk of the rise of populism, populists are rising
– Latin America is going the other way which is that they are going back to
economic orthodoxy, so all the Wall Street crowd etc they are back in terms of
running economic policy as far as Latin America is concerned. From Brazil,
Argentina to Peru if you look at it it's basically returning to economic
orthodoxy. So, their populism has been discredited with the populist who were
in power over the last 10-15 years. So, that also makes Latin America for the
first time in a very long time a pretty interesting place because they are
doing the kind of economic orthodox stuff that we crave for out here. At least
as investors. So, to me these are the bright spots that I would look out for in
2017.
Q: And India is not one of them?
A: So far no as I said. There are two operating rules about
India that I have always kept in mind.
Q: You can disappoint the pessimist and the optimist.
A: Exactly. So, it is no point getting too optimistic or
pessimistic about India. This is a very resilient economy like they will carry
on. But the next 12-18 months it is very hard for me to see as to how we get
back to being like a really fast growing economy given the disruptions that we
are dealing with. But still it is very hard to ever disengage from here, there
is enough opportunity out here and diversity but that is still like a big
concern, so that is one. The second thing which to closer the loop on what we
said or how we started it that the capacity of this country to follow this whole
mantra that if it ain't broke you fix it until it is quite incredible. So, just
when we had some momentum going that is what has happened so far but the
politics now all the attention is going to turn to the politics. In terms of
what happens in UP and after that if the government loses or wins then after
what does it do, how does it interpret that message and then what we do. But I
am really looking to see that is there any way I am going to respond to what is
happening in the USA because if they keep sort of just giving sops and won't do
anything about changing our tax structures and don't bring our corporate tax
rates down dramatically we are going to lose out in this pivot that is
happening to the US.
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