Modi's economic policies should help India deal with the problem of inflation, but the new structure will take time to become fully operational
08-May-2015 •Saurabh Mukherjea
"So what about corruption and crony capitalism - which along with the economic slowdown have destroyed his [Manmohan Singh's] primeministership? Singh slipped up because he views issues from the perspective of policy instrumentality rather than from the viewpoint of curbing wrongdoing by others - about which he is surprisingly non-judgmental for someone so fastidious about personal integrity. As he sees it, businessmen's animal spirits should be nurtured; if they get up to tricks... then, as he told a Cabinet colleague, we can't wait to get ideal men from Mars. He has argued publicly that corruption grows along with economic development. In short, better learn to live with corruption - precisely the view that gave a booster shot to the Aam Aadmi Party and made many people turn to non-corrupt Narendra Modi." - T N Ninan, Editor of Business Standard, writing on Manmohan Singh, May 03, 2014.
My discussions with the policy ecosystem in Delhi as well as my colleagues' understanding of the key policy measures announced by the NDA government suggest that the prime minister is seeking to engineer three structural resets: (1) shift India's savings landscape away from gold and land, and towards the formal financial system by enacting legislation which specifically cracks down on black money, (2) disrupt the Indian model of crony capitalism by tightening law enforcement in the seedy borderland where commerce and politics intersect in India, and (3) redefine India's subsidy system through the direct benefit transfer mechanism.
These resets should help India deal with a problem that has bedeviled it over the past five years - inflation. Inflation in India was low and stable until the UPA's ten-year rule. Then, under UPA-II inflation roared away towards double digits. Modi's resets - by attacking subsidies, by attacking black money, and by pushing labour and capital towards the organised economy - should help bring inflation down on a structural basis.
However, the new structure will take some time to become fully operational. Hence, the three resets look likely to adversely impact the GDP growth in FY16. My reading of the economy and my colleagues' macroeconomic modelling suggests that FY16 GDP growth will be around 7.5 per cent, similar to FY15 economic growth. The short-term pain in GDP growth will be driven by: (1) alterations in the subsidy regime, which will adversely affect rural/semi-urban consumption and construction activity; (2) crony capitalists' refusal to begin capex activity, as they see reduced scope for supernormal profits under Modi; and (3) Modi's attack on black money, leading to a crack in land and real estate prices, which will adversely impact lenders' balance sheets.
History suggests that the initiation of powerful resets renders redundant the traditional constructs used by investors. This in turn spawns a new generation of winners and losers in the Indian stock market. For instance, 1992-2002 saw the era of the 'licence raj' coming to an end and also saw the Sensex's churn ratio rise to 60 per cent (i.e., 18 of the 30 companies in the Sensex in 1992 were out of the Sensex by 2002).
Whilst in the short term Modi's resets will adversely impact crony capitalists and rural-demand-reliant companies in the cement, auto, electricals, paints, banking and NBFC sectors, the more interesting development will be the emergence of a new generation of structural winners. My belief is that these winners will emerge from the following:
Financial services sector: At present two-thirds of India's annual household savings of around $450 billion goes into gold and real estate. As a result banks and the stock market struggle to attract funding and that keeps the cost of capital high for these institutions. If the PM's attack on black money is even partially successful, the cost of funding will fall for banks (thus making mid-cap banks with currently modest CASA franchises particularly attractive) and more money will flow into the stock market (thus making well-run listed stockbrokers particularly attractive).
Agro-chemical sector: As the PM throttles back on the rapid hikes in the minimum support prices of food grains seen under UPA-II, we are likely to see more farmers shift towards fruit and vegetables, items which are in short supply. This in turn should increase demand for agro-chemicals. India has several well-run small- and mid-cap companies in this sector which should benefit mightily from this shift.
Export-centric manufacturing sector: The 80 per cent depreciation of the rupee against the RMB over the past five years has made light industrial manufacturing sector competitive vis-à-vis its Chinese counterpart. Now, as the cost of land, labour and capital stabilise in India, my reckoning is that these companies - which manufacture bikes, cars, various auto ancillary items, air compressors, gensets, etc. - will go on to build large global franchises.
Saurabh Mukherjea is CEO of institutional equities at Ambit Capital. The views expressed here are personal.
This column appeared in the May 2015 Issue of Wealth Insight.