Even as the obituaries regarding the UPA government pile-up, it is worth noting that the UPA’s central macro failure has not been around economic growth but around the major upsurge in inflation. Even as India’s GDP growth mirrored the trends of other large Emerging Markets, the country’s CPI inflation rate zoomed from 4 per cent to 11 per cent over the past decade. As a result, India’s inflation rate went into an entirely different orbit compared to other Asian Emerging Markets. So why did happen? Who were the beneficiaries of this surge in inflation? And will this construct unwind now the UPA is history?
Alan Beattie, the International Economy Editor at the Financial Times, draws a distinction between the two very different models of corruption:
Model 1: Corruption as a tax or as a necessary cost of doing business. Examples of this include the need to pay an extra 10 per cent to the local civil servant even in places like the US, to receive building permissions and the like. As Beattie puts it, “If corruption is stable and predictable enough, it essentially becomes a tax. And as the performance of western European social democracies shows, having substantial rates of taxation, as long as they are collected efficiently and predictably, is no block to getting rich.” Beattie calls this the “cream-skimming kind of corruption.”
Model 2: Corruption as the capture of large sectors by cliques of politicians. An example of this is the “capture” of Air India over the last decade and the grounding of a large number of its aircraft which coincided with the private sector operators on those routes hiking their fares. This model of corruption becomes very damaging for the economy if different political groups manage to capture different sectors of the economy. Then, if there is no co-ordination between these political groups, each group behaves like a monopolist and tries to maximise its gains by driving-up prices as much as it can and as a result the economy as a whole is worse off.
Until the 1990s, the pre-dominant model of corruption in India was the ‘cream-skimming kind of corruption’ whereby private companies were required to pay an extra 5-10 per cent of their project outlay to the local powers that be. Over the last decade, however, India’s core model of corruption appears to have shifted to a different level whereby various political-business cliques capture a large sector in the economy and then suppress competition in the sector in a bid to maximise their gains. The good news is that this new model of corruption could be on the retreat due to four reasons:
(1) The NDA has made it clear that the Land Acquisition Act looks likely to be amended and this could make it easier and cheaper to buy land for industrial use.
(2) The NDA seems likely to address the distortions in India’s food regulations (arising from the Minimum Support Prices for staples, from the hoarding of grains by the Food Corporation of India and from the state-level APMC Act) and thus reduce food inflation.
(3) The RBI Governor is keen on preventing PSU banks from being gamed by unscrupulous promoters. If he’s successful, this could lower the cost of capital in India because the gaming of PSU banks by unscrupulous promoters is a key reason for India’s elevated cost of capital. Furthermore, for the first time in its history, the RBI has announced an explicit inflation target.
(4) The rise of ‘check & balance’ institutions in India (such as the RTI, CAG, Lok Pal and social media) is making it harder for the cliques to “capture” specific sector and then push through price hikes.
The unwind of the “Corruption, Competition, Inflation” triangle is likely to lead to three major shifts in profitability (and hence market cap) over the next five years:
Shift 1: From the top private sector banks to the PSU banks. Over the last five years, politically connected companies have systematically borrowed money from PSU banks and gone into arrears even as they stay abreast of their commitments to the top private sector banks. The RBI’s determination to stop this arbitrage bodes well for the SBI, BoB and PNB and should raise concerns vis-a-vis ICICI, Axis and Yes.
Shift 2: From intermediaries in the food supply chain to farmers, consumers and agrotech companies. Due to various regulatory distortions, politically connected middlemen cream away 70 per cent of the retail price of foodstuffs. As these distortions are reduced, not only will consumers get a better deal but farmers’ incomes should rise and they will, in all likelihood, buy better quality seeds, pesticides, fertilisers, etc. Bayer Cropsciences, Rallis and Kaveri Seeds are interesting names in this context.
Shift 3 (a): From domestic monopolists in B2C sectors to light industrial exporters. A closed and corrupt economy with high inflation is an ideal home for an established consumer brand as it is able to protect its margins and generate super-normal ROCEs. However, as corruption and inflation abates, these “champion” franchises could come under pressure. Simultaneously, as the economy becomes more efficient, light industrial exporters should find themselves in a better position to win market share abroad. Bajaj Auto, Balkrishna Industries, TVS Motors and AIA Engineering are our favourite plays on this dynamic.
Shift 3 (b): From domestic monopolists in B2C sectors to MNCs in the capital goods sector. The local teams of most multinationals simply do not have the financial means or management authority to grease the numerous palms that seek lubrication in New Delhi and in the state capitals. In a less corrupt economy, several of these firms which have installed capacity and credible technology in India, could blossom. Interesting firms in this context are ABB, Siemens, Wabco, Ingersoll Rand, 3M and Grindwell Norton.
Saurabh Mukherjea is CEO of Institutional Equities at Ambit Capital. The views expressed here are personal.
This column appeared in the June 2014 issue of Wealth Insight.