Ajit Ranade answers 4 timely questions

Nov 26, 2018

Ajit Ranade, Group Executive President and Chief Economist with the Aditya Birla Group, is an economist and an acute political observer.

Here are some of the views he presented at the Morningstar Investment Conference in Mumbai on October 23, 2018.

What macro headwinds do you see?

There are 4 adverse macro headwinds over the next 12 months:

  1. Higher Inflation
  2. Higher Interest Rates
  3. High Current Account Deficit
  4. Higher Fiscal Deficit

I say that they are a matter of worry because we cannot afford our GDP growth rate to go down to, say, 4%. Though they are all essentially temporary and none are alarmingly high, they are higher compared to last year.

  • Widening Current Account Deficit (CAD) and negative Balance of Payments (BOP)

The current account, the difference between imports and exports, including services, is offset by capital inflows. So, when capital dollars come into the country in terms of foreign loans, or FDI or stock market inflows, they offset the dollar shortage in the country, Now, we always have more dollars coming in than going out. So, that's called the BOP - balance of payments.

For the first time in six years, the BOP will be negative, and it will be negative by about $30 billion or $40 billion. Where are these dollars going to come from? That's why the current account is a concern because we need to finance that shortage which we never had for the last six years.

The short-term debt, which is the debt which is maturing by March 2019, is $222 billion. Usually, this is refinanced or rolled over. What if the rollover conditions are not strong? That's what I mean by how precarious the BOP situation can become. Of course, we are nowhere near 1991 or 2013. We have about $390-$400 billion of foreign exchange reserves. But imagine, if there is some kind of panic or some kind of self-fulfilling panic, then you need to have those dollars ready. Already, the Reserve Bank of India has been trying to protect the currency. A lot of intervention has gone in by selling dollars, so dollar depletion is already happening.

By the way, this $222 billion is a short-term debt that does not include the money that foreign investors have put into India's debt market, which is about $60 billion. If you include corporate bonds and government bonds, about $70 billion.

Now, if I am a foreign investor, I put dollars into the bond market. I am seeing that the rupee is depreciating, and I am seeing that the bond yields are moving higher, so which means that bond values are going down. And I am seeing that the U.S. bond yields are going up. So, the arbitrage opportunity is lessening. So, I might just decide to quickly sell the bonds. And once some people start selling Indian bonds, it can be self-fulfilling, that is, the bond prices may fall further. So, the $222 billion does not include that phenomenon. All $70 billion might not go. But what if another $20 billion go? This is just a potential headwind.

This year, the CAD might actually breach 3%. In 1991, the crisis year of modern Indian economy, the current account deficit was 3% or 3.1%. In terms of percentage of GDP, it was higher in 2013, but today's deficit is actually (in dollar terms) higher. This is a worrying sign.

It seems to be correlated with oil prices. So, when oil prices are $80 a barrel, it's 2.7%. While oil is a big factor, so is coal. India has been importing 200 million tonnes of coal for the last four years, and this is a country which has the third largest repository of coal in the world. Electronics is the second largest import item on the goods side. Fertilizers.

  • Consistently low GST collection

The indirect tax collections ultimately impinge on India's fiscal situation.

If GDP is growing at 8.2%, which was the first quarter data, then GST collection should reflect GDP. Broadly speaking, indirect tax growth should be somewhat aligned to GDP growth as it covers Manufacturing and Services. So, if GDP itself is growing at 8%, GST collection should be going up. It's a puzzle as to why it is consistently short by around 6-7%. It's supposed to be Rs 1 trillion every month but comes at around Rs 93,000 crores.

  • Interest Rates

To some extent, we have to be aligned with the global cycle and can't be going in the opposite direction. The U.S. is expecting three more hikes during 2019. So, if interest rates are steadily going to go up in the U.S., there's no way our interest rates are going to go down. So, I believe that we are also on an upward path, though it may not be very steep. While a lot depends on sentiment, the bond market and capital flows, I do believe that interest rates on average will be higher next year as compared to this year.

Can India be a $10 trillion economy by 2030?

I think $10 trillion may be a bit of a stretch. We can safely assume, as a thumb rule, that we'll grow at 7-7.5%, which means doubling every 8-9 years. So, do the math.

The Indian growth outlook is strong. Last quarter data was 8.2%; there is a first quarter of this fiscal year and this next quarter may be about 7%. So this year we'll grow at around 7-7.2%. China will grow at less than 6.5%, which means that India is basically the fastest-growing large economy in the world.

It is okay to be ambitious and aim for 9-10% GDP growth, but there is something called overheating. If you have an engine, which is not supposed to run at 200 kmph and you try to run it at 200 or 300 kmph, you are going to run into trouble.

The Indian economy is a complex engine. It is supposed to run well-efficiently, well-tuned at a particular optimum speed. If you want to grow at a higher speed, you need the increase the horsepower; education and skills and human capital. India does not rank well on the Human Development Index. HDI is very simple index and a combination of three indicators – per capita income, life expectancy and literacy. The Human Capital Index captures the value of education, skills, knowledge, innovation. India ranks 115, below the rank of Nepal, Bangladesh and Myanmar.

If the economy is growing, why is the stock market declining?

I am not a market expert, I am an economist, but here are my thoughts.

Midcaps in India is down 21% this year; smallcaps around 27%. NIFTY grew 11% every year for four years - April 1, 2014 to April 1, 2018. The rupee was fairly stable during this period. This year the NIFTY has grown only 4%.

If you look at last 2 years, starting from January 2017, only five stocks out of 50 have contributed 95% of the stock market growth. This kind of dichotomy is evident in the U.S. as well over the same 24-month period. The Dow gained around 20% in the last 2 years, but FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) they have gained something like 80-90%. The top 5 stocks in the S&P 500 have market wealth equal to the bottom 282 stocks. This kind of divergence in valuation is not something we have seen before and needs to be kept in mind.

So, is it the foreign investors panicking and leaving, stress in banking, stress in fiscal, the elections next year?

I think the current situation is basically affected by foreign investment outflows. I hope it's temporary because even though $11 billion has left India in the last 10 months, what's happening is that India is still the costliest among the Emerging Market peers - the P/E ratio is still among the highest at 21.6%. Brazil, Russia, China, Mexico, South Korea and Taiwan are all lower.

What is the impact of the 2019 General Elections on the market and economy?

Why are elections on the minds of investors? Because of fiscal situation. There are a lot of unbudgeted promises. For example, the Universal Health Insurance, a great initiative that will benefit Indians. But in the short-term, it's not fully funded. Where is this money going to come from? Or, the promise to farmers that they will get a price for your farm produce which is at least the minimum support price, or MSP, but it's not fully provided for. Or, the various loan waivers that state governments have announced.

When you get closer to elections, no harsh decision will be taken by diluting some of these promises. These are promises which become very relevant as you get closer to elections and yet they are unbudgeted. As you get closer to elections, there's no tightening. The purse-strings are loosened and there are many unbudgeted promises.

So, the worry is that the fiscal situation may get worse and that is something that the bond markets don't like, that international investors don't like.

So, if it the elections are on, say, May 15, 2019, what will happen the next day? I don't know.

Just to remind you, Chidambaram was the Finance Minister when he presented the so-called Dream Budget which made dividends tax free. That was under the United Front government with Deve Gowda as PM. A minority coalition government. India's big economic reforms happened in 1991 with a minority government.

Elections are important in the minds of the investors, but in terms of the long-term structural features of the economy, they actually are impervious to electoral cycles.

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