Just when one thought things could only get better, they have got worse. An all-pervading sense of gloom seems to be descending on India and its capital markets. Having recently spent a week in the West, I can report first-hand the alarming lack of interest in India. Investors have a deep sense of disappointment. They also feel that trying to track and interpret all the noise swirling around the country is no longer worth the trouble .
We have clearly lost the battle trying to make the case for India as a separate asset class (a status China and Brazil currently enjoy). Most investors no longer feel India deserves a separate allocation; they are happy being exposed to the country through regional allocations. They don’t want to take the career risk of trying to allocate separately to a country whose economics and policy-making they no longer understand. Not one investor felt India had any chance of regaining a nine per cent growth trajectory, and everyone had heard of the Vodafone tax case and the infamous retrospective amendment. There was genuine unease about the perceived randomness of economic and regulatory decision-making in the country. In meeting after meeting, investors would show us articles from the Financial Times, The Wall Street Journal, The Economist or The New York Times and ask us to counter the criticism. Was the Western media too harsh? Was it biased? How could India shoot itself in the foot yet again?
There was a small minority who, seeing all the negativity, was trying to figure out whether there was a contrarian case to invest in India, but they came up against perceived expensive relative valuation (India’s price-earnings multiple is still at a large premium to the emerging-market average and its own history). No one seemed to care about the vastly different sectoral composition of the Indian indices vis-à-vis Brazil or China (making it look fundamentally more expensive).
Amid all this gloom, I saw a short piece by HSBC economist Frederic Neumann in HSBC’s economic research report dated March 8, 2012, which was refreshing in its simplicity and balance. He makes the case that India can still ultimately match China in economic vitality and that much of the current slowdown is cyclical, not structural. He feels investors have given up too easily and too soon on the India story.
He tracks China and India on various parameters since the beginning of their respective reform programmes (China began reforming in 1978 and India in 1991). Looking at data from the perspective that China had a 13-year headstart, he finds that India and China had a very similar growth trajectory across indicators in the first 20 years after reform. If you look at investment as a percentage of GDP, both countries were at 32-33 per cent of GDP 20 years after reform (India in 2011, China in 1998). India has not lagged China, adjusted for years into reform, despite perceptions to the contrary. Even if one looks at the size of the respective economies or growth in exports 20 years after reform, the numbers are very similar. Nominal GDP in dollars of both the economies grew about 6x in their first 20 years of reform. Exports, an area where China has been a world champion and India has been perceived to be a laggard, also shows a similarity, with both countries showing exports rising by 16-17x in the first 20 years of reform.
The problem with this analysis is that China starts growing exponentially at just about this time (20 years into reform). So by 2011 (33 years into reform), China has an investment rate of 45 to 46 per cent, exports have grown 200 times and the economy has grown 40 times. Most investors have absolute conviction that India will not repeat this growth-and-investment acceleration and will, in fact, decelerate from here. Neumann concludes his note by pointing out that while India may not hit 10 per cent growth like China has done, it is not going back to five per cent growth either — the country does not seem to get full credit for what it has achieved, and it still has an exciting growth outlook.
This got me thinking as to why we were all so bullish on India in the first place.
The first reason was demographics. India was going to have this demographic dividend, as its dependency ratio declined and it would have the largest absolute increase in working-age population in the world over the coming two decades. The falling dependency ratio would boost savings, lead to higher productivity and urbanisation, underwrite eight per cent GDP growth and ensure subdued labour costs. No matter how weak our educational, social and vocational attainment, the mass of new workers would be of better quality and boost the country’s output and competitiveness. The changing income distribution and rising share of the middle class as we go through this demographic transition would underpin consumption.
The second pillar of the bulls was the drive, flexibility and highly dynamic nature of Indian entrepreneurship. India was a stock picker’s market, where you could find companies that were able to scale, build innovative business models, deliver high returns on capital and handle economic uncertainty. India was a market where strong economic growth translated into corporate earnings.
The third pillar of the bull story was the belief that much of the supply-side and policy rigidities, whether in labour, land, infrastructure or capital, would be gradually addressed. India would become an easier place to do business, with less rent-seeking opportunities in areas of distribution, natural resources and government regulatory structures. There was tremendous scope to unlock productivity as the economy opened up and we made small policy improvements in multiple product markets.
Most of the bull arguments around India build on these three pillars, all of which are secular and long-run themes.
It is a testament to how much damage the country and its image have taken that investors across the world have either forgotten or given up on these secular growth drivers, besieged as they are with short-term negative noise. Rattled by the current on-the-ground reality, investors are not willing to look at India from a longer-term perspective or give it the benefit of doubt. Unless our political masters are able to communicate and inspire more confidence in their economic vision of India, you will continue to see more and more long-term pools of capital give up on the country and vote with their feet.
The author is fund manager and CEO of Amansa Capital.