Vijay Kumar Gaba: January 2020

Show some urgency in execution, only aspiring won't do

A common saying in markets is that investor should stop panicking once the policymakers begin to panic.

After a long spell of staying in denial, the policymakers have shown some urgency in past 6 months. However, they have so far refrained from pressing the panic button. The investors are eagerly waiting to see the finance minister pressing the red button hard today.

In my view, the current state of Indian economy is akin to a person who is single wage earner for his family; has little savings; chronically suffered from hypertension and diabetes, and recently got a heart attack.

This person cannot afford to spend couple of months in bed for recuperating. He has to immediately go for work so that he can pay the bills and feed the family.

The economy not in crisis as yet

There is enough evidence to suggest that the Indian economy is witnessing a serious slow down. It is open to debate, whether this slowdown qualifies to be a crisis as yet; because unlike the previous episodes of economic crisis in 1990-91, 2000-01, 2012-13, we are not facing any balance of payment threat, energy prices are comfortable, core inflation is under control, there is no global liquidity or credit crisis, there is no overheating in any of the sectors in the economy, the asset quality at banks is no longer worsening, and there is no political instability.

....nonetheless vicious cycle needs to be broken urgently

Nonetheless, the sharp deceleration in growth rate is a matter of concern. More so, because this time, the deceleration encompasses all sectors and sub sectors of the economy. On supply side industry, agriculture, services all three sectors have witnessed sharp contraction in growth. On demand side both consumption and investment demand growth has been at multi year low. Consequently, the economy appears slithering into the vicious cycle of low employment-low income-low consumption & saving-low investment-low growth-low employment. Breaking this vicious cycle urgently is critical due to demographic characteristics of India. The fact can no longer be denied that unemployment of youth is perhaps the most serious socio-economic challenge India faces presently; and it needs to be addressed before the things become unmanageable.

...as high risk strategy of govt does not leave any margin for error

It also needs to be fully assimilated that Prime Minister Modi led NDA government has adopted a very aggressive strategy for bringing about changes in the way business is done in the country. A spate of disruptive legislative (GST, IBC, PMLA etc.), administrative (demonetization, bank consolidation, changes in tax assessment rules, subsidy rationalization, etc.) and strategic (e,g, dramatic shift in the rules of engagement with Pakistan and China) changes when the economic growth cycle had already turned down have intensified the economic stress.

The aggressive socio-political agenda with little political consensus (e.g., legislations to reform Muslim marriage practices, J&K reorganization with abrogation of Article 370, implementation of CAA and NPR, etc.) has further deepened the economic slowdown. The opposition ruled states are mostly refusing to cooperate. BJP has suffered losses in state elections that has somewhat weakened the union government position. The global lobbies engaged to work against India's interest have also found good ammunition out of this aggression.

The key monitorable now is whether the government withstands the social, economic, political and strategic pressure being applied by both the internal and external forces and stay true the course chosen by it or yields to these pressures. Because, if the government withstands the pressure and stays committed to the course chosen by it, we have decent chances of India's socio-economic conditions improving dramatically in next five years. However, if the government wilts under pressure and retreats from its chosen position, our country will be pushed at least 20years behind on the development curve. The budget therefore needs to adequately demonstrate show the resolve of the government.

FM akin to CFO of a stressed company

I see the finance minister as CFO of a stressed company. She faces all the problems a highly stressed business could in bad times, For example—

Business of the company has witnessed considerable slow down in past few years - revenue shrinked and losses increased.
Ability to modernize and expand constricted - stressed balance sheet and poor cash flows are hindering capital expenditure.
Investors are reluctant to commit more capital - return on past tranches of investments has been poor.
Company not able to sell non-core businesses and assets to mobilize resources for sustaining capex and meeting repayment obligations.
Competitors snatched market share - competitive pricing and delivery.
Ability to retain talent hampered due to a variety of constraints.
Rating agencies have put the company on watch - possible down grade.
Top management struggling with allegations of misgovernance and failing to deliver on promises.
To make the matter worst, the new accounting system put in place a couple of years ago has still not stabilized. Many claims have been overpaid and many have been rejected erroneously.

Given these circumstances, you imagine the plight to the CFO (here minister), given that -

Most debtors are unable to discharge their obligations and are seeking debt waiver or substantial concessions.
Employees are threatening strike if salaries are not hiked and non-core assets are sold.
Raising prices of goods and services is mostly out of question due to already precarious competitive positioning.
Shareholders are seeking higher dividend.
Creditors want equity to be diluted materially and debts be discharged to deleverage the balance sheet. Any increase in leverage ratios is strictly no-go zone.
The media has already declared that the CFO is going to lose her job in a month. They have also declared a retired banker as her successor. The management has neither confirmed nor denied these viral media posts.

Under these circumstances, as an investor I am totally befuddled. I do not know what to wish from the finance minister today.

I cannot wish for-

Fiscal profligacy (large tax concessions or subsidies), because I know it will be politically extremely challenging to unwind the stimulus in near term.
Meaningful tax hikes, since it could be counterproductive at this juncture.
Substantial easing in foreign investment norms, since it could jeopardize the nascent recovery in the financial system as more domestic businesses may become potential defaulter.
Any disruptive reform, as the system has still not assimilated the disruptions caused by demonetization, GST, IBC, bank consolidation, etc.

This essentially means that I am not praying with the large majority of market participants for tax concessions, cash subsidies, etc. So the chances of my being disappointed with the budget are far lower.

Nonetheless, I would expect that the finance minister-

Avoids jingoism.
Doesn't try to please all, because she cannot.
Is not incremetalist in her approach and does some zero based thinking.
Understands that we need ship loads of foreign capital and technology to survive and grow, and respects them for what they have.
Focuses on India's strengths not weaknesses.
Gives euthanasia to the people who have been already declared brain dead, instead of keeping them on ventilators with false hopes.

Economic Survey 2019-20

The government presented the annual economic survey for the financial year 2019-20 on Monday. The 941 page document divided in two volumes and several appendices is mostly directed at the criticism of the government policies and its failures. In that sense its mostly apologetic and defensive. It tries hard to justify the government policies and statistics that have been questioned by many experts and some global agencies.

If one has to find a development theme in the Survey, it is the "stong emphasis on private enterprise". The best part is that for the first time a government paper is speaking so forcefully about Laissez Faire - Free market, free economy based on trust and transparency.

Make money

“Make money – there is no weapon sharper than it to sever the pride of your foes.” – Thirukural, Chapter 76, verse 759.

The Survey shows that contemporary evidence following the liberalization of the Indian economy support the economic model advocated in our traditional thinking, i.e., reliance on the invisible hand of the market for wealth creation with the support of the hand of trust.

It is highlighted that India’s aspiration to become the third largest economy in the world by 2025 depends critically on strengthening the invisible hand of markets together with the hand of trust that can support markets.

The invisible hand needs to be strengthened by promoting pro-business policies to—

(i) Provide equal opportunities for new entrants, enable fair competition and ease doing business;

(ii) Eliminate policies that undermine markets through government intervention even where it is not necessary;

(iii) Enable trade for job creation, and

(iv) Efficiently scale up the banking sector to be proportionate to the size of the Indian economy.

Most importantly, it is emphasized that the socialist policies followed post independence were hindrance in achieving the scared goal of wealth creation. The policies path was set right in 1991 and that has led to exponential wealth creation in subsequent 3 decades. Rise in market capitalization of Indian equities is acknowledged as a major source of wealth creation.

Private enterprise key to wealth creation

“The one who utilizes all resources and opportunities at hand is an efficient (entrepreneur) and nothing is impossible for him to achieve.” – Thirukural, Chapter 76, verse 753.

The Survey emphasize the importance of entrepreneurship as an engine of economic growth and change in India. It seeks to dismiss the popular view that entrepreneurial activity in India is largely necessity driven and typically borne from a lack of alternative employment options.

The Survey finds that entrepreneurship at the bottom of the administrative pyramid – a district – has a significant impact on wealth creation at the grassroot level. This impact of entrepreneurial activity on GDDP is maximal for the manufacturing and services sectors.

It suggests:

1. Policies that enable ease of doing business and flexible labour regulation enable new firm creation, especially in the manufacturing sector. As the manufacturing sector has the greatest potential to create jobs for our youth, enhancing ease of doing business and implementing flexible labour laws can create the maximum jobs in districts and thereby in the states.

2. Literacy, education and physical infrastructure are the other policy levers that district and state administrations must focus on foster entrepreneurship.

Policies to focus on business, encourage creative destruction

The events post 1991 liberalization provide strong evidence that India's economic growth depends critically on promoting “pro-business” policy that unleashes the power of competitive markets to generate wealth, on the one hand, and weaning away from “pro-crony” policy that may favour specific private interests, especially powerful incumbents, on the other hand.

While pro-business policies increase competition, correct market failures, or enforce business accountability, pro-crony policies hurt markets. Such policies may promote narrow business interests and may hurt social welfare because what crony businesses may want may be at odds with the same.

The liberalization of the Indian economy in 1991 unleashed competitive markets. It enabled the forces of creative destruction, generating benefits that we still witness today. The forces of creative destruction following liberalization in the Indian economy have led to the rise of new sectors such as financials and information technology.

Creative destruction brings new innovations into the market that serve people better than the old technologies they displace. It brings new firms into the markets, which compete with existing firms and lower prices for consumers. It brings dynamism to the marketplace that keeps firms on their toes, always on the lookout for the next big way to serve consumers. It has only one pre-requisite – a pro-business policy stance that fosters competitive, unfettered markets.

When creative destruction is fostered, sectors as a whole will always outperform individual companies within the sector in creating wealth and maximizing welfare. Therein lies the motivation for India to pursue pro-business, rather than pro-crony, growth.

The following chart shows the creative destruction in post liberalization period in terms of changes in the Sensex constituents over various time periods.

Laissez faire - the preferred policy

The Survey admits that Government intervention, sometimes though well intended, often ends up undermining the ability of the markets to support wealth creation and leads to outcomes opposite to those intended.

For example—

Frequent and unpredictable imposition of blanket stock limits on commodities under Essential Commodities Act (ECA) neither brings down prices nor reduces price volatility. However, such intervention does enable opportunities for rent-seeking and harassment.
Regulation of prices of drugs through the DPCO 2013, has led to increase in the price of a regulated pharmaceutical drug vis-à-vis that of a similar drug whose price is not regulated.
Government policies in the food grain markets has led to the emergence of Government as the largest procurer and hoarder of foodgrains – adversely affecting competition in these markets.
Debt waivers given by States/Centre shows that full waiver beneficiaries consume less, save less, invest less and are less productive after the waiver when compared to the partial beneficiaries.

It is suggested that each department and ministry in the Government must systematically examine areas where the Government needlessly intervenes and undermines markets. Note that the chapter does not argue that there should be no Government intervention. Instead, interventions that were apt in a different economic setting may have lost their relevance in a transformed economy. Eliminating such instances will enable competitive markets and thereby spur investments and economic growth.

Make for the world

The Survey identifies that the current environment for international trade presents India an unprecedented opportunity to chart a China-like, labour-intensive, export trajectory and thereby create unparalleled job opportunities for our burgeoning youth.

By integrating “Assemble in India for the world” into Make in India, India can create 4 crore well-paid jobs by 2025 and 8 crore by 2030. Exports of network products, which is expected to equal $7 trillion worldwide in 2025, can contribute a quarter of the increase in value-added for the $5 trillion economy by 2025.

China’s remarkable export performance vis-à-vis India is driven primarily by deliberate specialization at large scale in labour-intensive sectors, especially “network products”, where production occurs across Global Value Chains (GVCs) operated by multi-national corporations. China used this specialised strategy to export primarily to markets in rich countries.

By harboring misplaced insecurity on the trade front we are unlikely to grab this opportunity, our trade policy must be an enabler.

...enforce ease of doing business

Ease of doing business is key to entrepreneurship, innovation and wealth creation.

Enforcing a contract in India takes on average 1,445 days in India compared to just 216 days in New Zealand, and 496 days in China. Paying taxes takes up more than 250 hours in India compared to 140 hours in New Zealand, 138 in China and 191 in Indonesia. These parameters provide a measure of the scope for improvement

Setting up and operating a services or manufacturing business in India faces a maze of laws, rules and regulations. Many of these are local requirements, such as burdensome documentation for police clearance to open a restaurant. This must be cleaned up and rationalized

Logistics is inordinately inefficient in Indian sea-ports. The process flow for imports, ironically, is more efficient than that for exports. Although one needs to be careful to directly generalize from specific case studies, it is clear that customs clearance, ground handling and loading in sea ports take days for what can be done in hours. A case study of electronics exports and imports through Bengaluru airport illustrates how Indian logistical processes can be world class.

Banks need to scale up

A large economy needs an efficient banking sector to support its growth. Historically, in the last 50 years, the top-five economies have always been ably supported by their banks.

The Indian banking system is currently sub-scale compared to the size of the economy.

As PSBs account for 70 per cent of the market share in Indian banking, the onus of supporting the Indian economy and fostering its economic development falls on them. Yet, on every performance parameter, PSBs are inefficient compared to their peer groups.

It is suggested to use FinTech (Financial Technology) across all banking functions and employee stock ownership across all levels to enhance efficiencies in PSBs. These will make PSBs more efficient so that they are able to support the nation in its march towards being a $5trn economy.

All these recommendations need to be seriously considered and a definite, time-bound plan of action drawn up. With the cleaning up of the banking system and the necessary legal framework such as the IBC, the banking system must focus on scaling up efficiently to support the economy.

Government needs to get out of business

A comparative analysis of the before-after performance of 11 CPSEs that had undergone strategic disinvestment from 1999-2000 to 2003-04 reveals that net worth, net profit, return on assets (ROA), return on equity (ROE), gross revenue, net profit margin, sales growth and gross profit per employee of the privatized CPSEs, on an average, have improved significantly in the post privatization period compared to the peer firms.

The analysis clearly affirms that disinvestment (through the strategic sale) of CPSEs unlocks their potential of these enterprises to create wealth evinced by the improved performance after privatization.

Therefore, aggressive disinvestment should be undertaken to bring in higher profitability, promote efficiency, increase competitiveness and to promote professionalism in management in the selected CPSEs for which the Cabinet has given in-principle approval.

Economic overview and outlook

Overview

The year 2019 was a difficult year for the global economy with world output growth estimated to grow at its slowest pace of 2.9 per cent since the global financial crisis of 2009, declining from a subdued 3.6 per cent in 2018 and 3.8 per cent in 2017. Uncertainties, although declining, are still elevated due to protectionist tendencies of China and USA and rising USA-Iran geo-political tensions.

The Indian economy slowed down with GDP growth moderating to 4.8 per cent in H1 of 2019-20. A sharp decline in real fixed investment induced by a sluggish growth of real consumption has weighed down GDP growth from H2 of 2018-19 to H1 of 2019-20. Real consumption growth, however, has recovered in Q2 of 2019-20, cushioned by a significant growth in government final consumption.

India’s external sector gained further stability in H1 of 2019-20, with a narrowing of Current Account Deficit (CAD) as percentage of GDP from 2.1 in 2018-19 to 1.5 in H1 of 2019-20, impressive Foreign Direct Investment (FDI), rebounding of portfolio flows and accretion of foreign exchange reserves.

Imports have contracted more sharply than exports in H1 of 2019-20, with easing of crude prices, which has mainly driven the narrowing of CAD.

In an attempt to boost demand, 2019-20 has witnessed significant easing of monetary policy with the repo rate having been cut by RBI by 110 basis points.

Having duly recognized the financial stresses built up in the economy, the government has taken significant steps this year towards speeding up the insolvency resolution process under Insolvency and Bankruptcy Code (IBC) and easing of credit, particularly for the stressed real estate and Non-Banking Financial Companies (NBFCs) sectors.

At the same time, impact of critical measures taken to boost investment, particularly under the National Infrastructure Pipeline, present green shoots for growth in H2 of 2019-20 and 2020-21.

Outlook

Based on CSO’s first Advance Estimates of India’s GDP growth for 2019-20 at 5 per cent, an uptick in GDP growth is expected in H2 of 2019-20. On a net assessment of both the downside/upside risks, India’s GDP growth is expected to grow in the range of 6.0 to 6.5 per cent in 2020-21.

Key Risks

Continued global trade tensions and Escalation in US-Iran tension

Hike in short-term interest rates by global central banks may result in capital flight.

Slow progress in IBC implementation

Expansion of fiscal deficit due to higher public spending

Worsening of CAD due to non recovery in domestic savings

Indian economy in nine charts

Investment decline to the lowest in a decade

The merchandise imports have shown a structural down turn, indicating success of import substitution strategies. Though Make in India program does not seem to have yielded desired results as imports are almost constant since FY16