Stalled Growth

Dayal is not too concerned about the fiscal or trade deficit. While he cites the biggest concern of global investors being the pace of reforms, he is of the opinion that corruption and lack of transparency in the system are the biggest impediments to India's growth story.

In your interactions with global investors, what’s their view on India?
There are two kinds of investors. One class of investors are those that bought into the India growth story on the assumption that India will grow at 8, 9 or 10 per cent per annum. They are a disappointed lot. Take Jim O’Neill, Chairman, Goldman Sachs Asset Management, for instance. He coined the term BRIC to jointly describe the four biggest developing economies -- Brazil, Russia, India and China. He recently was quoted in the press as saying that of the four countries, India is the most disappointing. I counter that by saying probably their assumptions were wrong which is why they are disappointed. So those who came to India with expectations of such high GDP growth are very disappointed.
Those who believe that India can still grow at around 6-6.5 per cent per annum are very excited because now the stock market is giving them an entry point to allocate money in the long run for long-term investors at great valuations.
We at Quantum are talking to those who look at long-term investing and seek value over the long term. Amongst those international investors, there is a lot of interest and excitement to invest in India. I am not talking of short term money but referring to long term, patient capital.

What is their biggest concern about India at this point in time?
I think one of the most important concerns global investors have about India is concerning the pace of reforms. How long will the slowdown in reforms go on? Will reforms get stuck? Or, worst case scenario, will it go into reverse gear? So that is a concern. Policy making has slowed down. But they also recognise that they are not buying a macro story here. Infosys or Wipro were not created by the Government of India’s mandate. They were created by the private sector and thrived and prospered and grew despite the governmental issues. So the crux is to keep looking for smart managements that do not live by government handouts. Therefore, the Infrastructure space is we are underinvested. Infrastructure is, by and large, government handouts. Oil and gas, roadways, toll ways, airports, airline licenses, spectrum etc are all areas where government policy decisions can be slow or opaque.

What do you feel is the biggest cause of inflation in India?
Food prices and oil prices. Food inflation is a global phenomena. People have become wealthier in India, China and other countries and this will first result in a change in dietary requirements. So you graduate up the food chain and eat more fruits and more protein. The demand for food is more than the immediate supply.
Having said that, food prices will always move in very sharp cycles. A year ago, onion prices in Mumbai were Rs 80/kg. Today it has dropped sharply, it is around Rs 5/kg in the wholesale market. This is because the farmer reacts to price signals. So when a farmer sees food prices go up, he tends to plant more of that product so the next season will see more of that crop. This pattern is followed in wheat, rice, onion, fruits and vegetables. And it is a global pattern. So now that the price of onions has dropped, the farmer will not grow this next season resulting in a possible rise in prices of onions in November 2012. But the price of another commodity will drop because the farmer will have moved supply to that product - whose price is high today. Around 8-10 months ago, farmers in India planted 30 per cent more acreage of wheat than they did in the last cycle. So when supply increases, prices will fall.
So I do not see a secular rise in food prices but I see sharp cyclical movements amongst crops with price swings. And the consumer too will react to such price changes by changing demand patterns.

Is there no way out?
There is. The supply chain needs to get much more efficient. Or we have genetically created fruits and vegetables that will last longer, which can be stored for longer periods and will not be purely seasonal.
Food inflation is a big issue in India and around the world and will not be going away anytime soon.
One of the biggest crimes in my view is allowing Futures and Options in agricultural products and oil. Financial firms are speculating on the prices. In the last quarter of 2010, the price of onions in the US escalated, for reasons very different from those in India. And when the farmers came out with more product, the prices collapsed. The Wall Street Journal, the bastion of capitalism, had a line which stated that the reason why the price dropped was because there was no Futures and derivative trading in that commodity. The price of crude oil would be much lower if there was no speculative trading on that commodity. Such financial transactions in agricultural products are a disservice to consumers across the world.

You only talk of food prices will regards to inflation. Between 2005 and 2007 there was capex driving growth which led to capacity creation and the supply prevented inflation from going through the roof. In 2008, price of crude shot up. The government was reluctant to pass on the price of crude so demand did not drop. Then came the government stimulus - reduced taxes, increased spending in rural areas and employment guarantee. Supply just did not keep pace with demand and the result today is inflation.
The size of the fiscal stimulus was about 1.8 per cent of GDP. Contrast this with China where the figure was around 10.5 per cent of its GDP. So I do not think it was a factor which contributed to inflation. But, yes, a larger supply of goods will reduce prices. There is sufficient capacity in steel, cement, automobiles, textiles and consumer durables today. Even if there was no capex for the next 18 months in most industries, the selling prices will still be subdued due to existing excess capacity and competition.
Oil prices are a more complex issue and can add to inflation across the economy since it will add to the cost of production and distribution. In July 2008, the price of crude was $150/barrel of oil. By October it had collapsed to $35/barrel. It gained ground in CY09 and now stands at $100/barrel largely due to speculation and due to the political and social turmoil in the Middle East. There is also the expectation that Israel or the US could strike Iran’s nuclear facilities. So, would higher petrol prices have curbed demand? Possibly. But maybe we need to have a stronger emphasis on improving bus and train services -a more efficient and comfortable public transportation system will go a long way in curbing demand for oil.

Was the RBI was justified in its rate hikes?
I think the RBI was forced to increase interest rates because the government was doing absolutely nothing about it. The government must work on getting supply side obstacles out of the way. Unfortunately, the responsibility fell on the RBI whose job really is not to get food inflation under control. The job of the central bank is to get credit inflation under control. If we as consumers demand more credit and are borrowing more, that is where the RBI steps in to make the cost of money or the cost of borrowing more expensive. But here they were pushing with a string, not even a rope, because the RBI was the only one wanting to do something about inflation. What choice was there? Did the government raid horders? Did the government curtail the power of the food supply lobby?

Supply side bottlenecks are a big hurdle to the ‘India growth story’.
It is a very big concern. I recently co-chaired a talk with a representative of a multilateral agency. He gave me an interesting statistic. He said that in emerging markets such as India, 30 per cent of food gets lost in the farm. So before it reaches the plate of the end consumer, we have lost a third of our supply. In the US, a third of the food gets wasted at the final stage - at the table. They throw out a lot of food, after having spent time and energy on transporting it and cooking it. So whether you look at the start or end of the food chain, a third of the food in the world gets wasted. But this problem can be resolved. Supply side issues can be tackled if there is a will.
For me, the bigger issue is oil. We in India have no control over oil prices. According to a retired CEO of a global multinational oil firm, the price of oil should be $60/barrel, not the current $100. Geo-political concerns are jacking up the price.

How worrisome is the fiscal deficit?
I am not worried about the fiscal deficit. India is a country with 300 million people who live below the poverty line. We will have deficits for the next few decades till the people at the bottom of the ladder start moving up the economic ladder. The only way to do that is to spend more than you earn, as a government. Or by transferring more taxes from the wealthy to those who need help.
These are fundamental issues which will not go away. That is what we tell potential long term international investors. If they are uncomfortable with fiscal deficits then they should not invest in India.
The NREGA is a great policy but there are leakages because all the money does not reach the poor household. But that does not mean the policy or scheme is bad, just its implementation. NREGA has set the minimum price of labour across the country. So it is good, it’s just that the leakage must be plugged.
Fiscal deficits - with lower levels of leakages - are good for India’s long term stability as a society and an important mechanism for assisting the poor.

Is the trade deficit more of a concern?
No. We are not a manufacturing country. So we will have trade deficits. Even when we take out exports of software into account, we do have a trade deficit. But then we are a growing economy and we will be importing more as we grow and exporting less.
As we build up our infrastructure -power plants and ports , then multinationals will come to India and build factories and exports will increase. And we will have a trade balance. But that is decades away.