Thanks to political changes, India is in the midst of a long-term growth path that will mirror China.
I think India will be a very exciting investment destination over the coming five years. The reason for my confidence is simple: We are likely to experience high and sustained economic growth (in a low-growth world) which will drive corporate earnings and equity market performance. My sense is that India is in the midst of a growth acceleration, which will last years and surprise the world much like what China has delivered over the past ten years.
If one looks at India as China with a 10/12-year lag, you can see great similarities. China began its reform in 1979, compared to 1991 for India, and this lag seems to hold good even today. The growth acceleration India began to see in 2004 corresponds reasonably well to China’s own growth path and should be just the beginning of an extended and accelerating growth trajectory.
The similarities with China are reinforced by the fruits of the demographic dividend, which will be realised over the coming years as well as rising savings and investment ratios which are now over 35 per cent compared to 23-24 per cent when liberalisation began.
However, the most important change to my mind is that the Indian politician has now finally a vested interest in economic growth. This may seem an obvious statement, but the reality remains that till recently politicians would openly question the premise that economic growth or good economic governance brought with it electoral votes.
This election seems to have changed all that, as the clear takeaway has been that success in transferring significant resources into rural India has delivered votes. Spend large chunks of money on social schemes targeted at rural India, ensure reasonable delivery of these schemes and you will get votes. Every political party has understood this message, and this trend of increased resource transfer towards the poor through enhanced social security schemes is here to stay. For example, the NREGA outlay has already moved up to Rs 39,000 crore, this will only increase further as the scheme gets extended to urban areas and wages are maintained in real terms. There is now the imminent launch of the Food Security Act, and we will see more such schemes given our poor development indicators.
The desire and intent to spend money is clear. While the government will be able to improve the delivery and targeting of these schemes through IT and smart cards etc, any savings realised will be re-invested. The needs are so great that we are still only scratching the surface.
The question then comes to how will we fund all these schemes and social expenditure, and this is where the political imperative to ensure high economic growth kicks in. For the simple truth is that unless we get back to an 8 per cent-type GDP growth, we will be unable to simultaneously get the fiscal deficit under control and fund the required social sector outlays. Economic growth is the only tonic which can provide the revenues needed to fund our ever-growing social sector commitments. Politicians, I think, now understand this. They need to transfer large amounts of money in an effective way into rural India to get elected. The only way for that to happen is if the economy is robust and growing strongly. Thus everyone is aligned in ensuring the end outcome of high GDP growth (probably for the first time).
For, what alternative does the political class have? Electoral compulsions will ensure that there will be no going back on social sector outlays. Thus the critical question revolves around how will we fund our social sector commitments. If we don’t get revenue buoyancy from strong GDP growth then there are two alternative scenarios.
n We could simply print money and risk the consequences. I doubt this will happen, as the RBI has enough independence to prevent monetisation on a continued basis. One year maybe, because of the economic crisis, but highly unlikely on a multi-year basis. If the markets even get a hint that we are going down this path, you will see domestic capital flight, reduced access to international capital and growth and revenues will crumble. I am confident India has enough checks and balances in its political system to stop us going down this road. If we don’t print money and instead force the banks to fund double-digit fiscal deficits, then the crowding out of the private sector and a reduced credit rating profile will ensure slower economic growth and an eventual domestic debt spiral as growth and revenues slow. The fiscal deficit has to come under control, no country can continue indefinitely with double-digit deficits.
n We may decide to turn the clock back 35 years and introduce punitive taxation on the wealthy. Why not take corporate taxes back upto 50 per cent, income tax peak rates to 70 per cent, put excise of 50 per cent on cars etc? This is unlikely to work as high rates encourage evasion and discourage entrepreneurship. The economy would slow massively. The government has shown no inclination to move down this road as even in the latest Budget, peak rates of income tax were reduced and the role of the private sector in driving the economy forward unchallenged.
Rapid economic growth is the only way this equation solves. You cannot fund schemes of the scope of NREGA and the proposed Food Security Act unless you get back to at least 8 per cent GDP growth; you simply will not have the money. You have no fiscal flexibility left. Over the last two years the entire incremental expenditure of Rs 300,000 crore has been funded by incremental borrowing, this game is over. Higher expenditure now requires higher revenues.
This is why the GST is so critical and will get implemented, along with other reforms in education, FDI, fertiliser and fuel pricing and infrastructure, as without structural steps of this kind we are not getting back to sustained and high growth. This is also why disinvestment will happen, we simply need the money.
Everyone knows what India needs to do to unshackle its economy and get back to the growth rates of 2004-08. Just read the Economic Survey, what has been lacking is political will. As politicians understand the link between economic reform, growth and their ability to spend money and win votes, the willingness to overcome vested interests will increase.
Most of the reforms investors want to see — be it disinvestment, FDI limit hikes, education reform, tax rationalisation etc — will happen over the coming years. Maybe not in the next six months as investors want, but it will happen. We only reform with our backs to the wall, and the fiscal situation leaves us with little choice. Without serious structural reform we will not get the growth we need to fund our social commitments.
In China the political leadership obsesses over maintaining 8 per cent GDP growth to ensure its own legitimacy. A parallel with India is our political leadership needing to maintain 8 per cent growth to have the resources to spend on social schemes to ensure re-election. Both the imperatives ensure that high growth is top-most on the agenda. This has been true for some time in China and just beginning in India.
The markets may consolidate and be range-bound for some time as they have had a huge move. We are also seeing valuation and equity issuance challenges at these levels. That may hold true for the next few months, but India is going to be a very exciting investment destination over the coming five years.
The stars are beginning to align.