How bad governance and an elephant footed Judiciary is derailing the Indian economy...

How bad governance and an elephant footed Judiciary is derailing the Indian economy...

By all estimates India is poised to be the third biggest economy by 2050 sharing space with China and America. It is all set for a very high growth trajectory eclipsing China’s high growth rates anytime between 2015-2020. The basis of these estimates remains that India’s political landscape remains stable and policy framework remains strong. But as we are all set to board a high speed growth train, suddenly we have acquired travelling sickness (in terms of poor governance, policy logjam and slow justice). We are not in the best frame of mind to board the train. Rather the train is apprehensive to board us, lest we spoil their spick and span train with our sickness. It is thus giving us time to sort out our sickness before we are afforded an opportunity aboard the fastest economic growth train. This is one train we cannot afford to miss and this is one train we want to board with our best foot forward.

India is an emerging economy with a young population and strong economic fundamentals. Free judiciary (though the speed of justice remains a drag), democratically elected government, independent central bank and developed financial markets are the pillars of our economic growth and red tape, corruption and poor infrastructure remains the irritants in the growth process.

The question that we are answering here is how and why bad governance and elephant footed judiciary jeopardizes the good work and threatens to derail the economic growth engine?

India remains heavily dependent of foreign investment in order to sustain and increase our GDP growth rate. Currently we import more than we export, thus the current account deficit and we pay for our imports (which are more than our exports) by borrowing from abroad (foreign investment). FDI in any form is welcome as that is helping the country generate growth and thus this form of foreign investment is pro growth. Foreign investors when investing in a country look for the following parameters:

1.     High growth rates – India is currently in the high growth phase and thus investment by foreign investors in India is giving them high return on their investments.

2.       Current account deficit

3.       Fiscal and monetary policy

4.       Fiscal deficit

5.       GDP/Debt

6.       Liquidity

7.       Political Risk Premium

8.       Stability of currency

I ‘ll try and brief on parameters in the next blog. 

Problems with the "Indian Growth Story"

Sum evaluates chinks in the Indian Growth Story.
(Key Inputs taken from "Money Morning")

For one thing, the Indian government - which tends to run budget deficits even in the best of economic times - engaged in substantial fiscal "stimulus" in 2009, an election year. And while the central-government-budget deficit appears tolerable at 8% of gross domestic product (GDP), provincial governments also run budget deficits - in amounts equal to an additional 4%-5% of GDP.

With a consolidated budget deficit of 12%-13% of GDP, India's fiscal position is up there with such international bad actors as Greece, Britain and Ireland. And it's substantially worse than the U.S. position. India's saving grace may be the fact that its public debt level is relatively low at around 60% of GDP, and is largely domestically held, primarily in the banking system, much of which is state controlled. (Public Debt for US, UK and alike is in excess of 150 % of their GDP)

That pinpoints a problem. Since investors around the world have become worried about Greece, there's every chance that they'll one day become just as worried about India.

So if India's budget deficit gets too high it relies on foreign financing - both debt and equity - to bridge the gap. While the Indian growth rate is so high and observers generally so bullish, that is not much of a problem. But any slowdown in growth could widen the budget deficit still further and cause a crisis of confidence.

Another problem is inflation. India undertook monetary - as well as fiscal - stimulus in 2009. The Reserve Bank of India lowered its repo rate to 4.75%, which may not appear all that low except that India's inflation rate ran at 10.7% in 2009. The upshot: Real interest rates are sharply negative.

As in the United States, this has done wonders for the stock market, but it has also created a bubble-like atmosphere for investments that is rapidly widening the country's current account deficit and stimulating inflation. Since food prices are currently rising at a rate of 17% p.a. , because of the drought, the effect on India's poor is severe. The effect of rising food prices on the budget is almost equally severe because of India's wide range of subsidies on food products.

Markets sense the problems ahead. The Bombay Sensex Index has not again approached its January 2008 level of 21,000; its most recent peak - at 17,686 - was reached in December 2009. Since then, the index has dropped roughly 10%. But even at that reduced level, as I remarked earlier, India's stock market is hardly a bargain.

It appears that India is headed for the economic equivalent of a one-two punch - a simultaneous monetary crisis and fiscal crisis. Inflation will get uncomfortably high while the government struggles to fund its budget deficit and "crowds out" small- and medium-sized business borrowing while doing so. A period of government-spending austerity would alleviate both problems, but is pretty unlikely as the currently governing Congress Party has a history of heavy public spending constrained only with difficulty. Either way, there is likely to be a period of considerable retrenchment among India's business and consumers.

Given this prognostication, a heavy capital investor such as Tata Motors Ltd. should be avoided, in spite of that company's recent remarkable recovery from 2008 difficulties that stemmed from a lack of available capital. Look, instead, at such non-capital-intensive exporters (the exchange rate is likely to remain relatively weak) as the software company Infosys Technologies Ltd. or the drug company Dr. Reddy's Laboratories Ltd.

Both stocks are currently somewhat expensive: Infosys is trading at 23 times the consensus forward earnings estimate for the year that ends in March, while Dr. Reddy's is trading at 20 times the consensus earnings estimate for the current year. However, both companies should be bought for their long-term-growth potential, plus the possibility of additional profits from a manufacturing base linked to a weak rupee.

Nevertheless, at some point India is likely to run into crisis. That's when you should buy the market, because the long-term-growth prognosis is unquestionably positive.