India: one of the most intriguing and exciting stories in markets today
Derry Pickford, Macro Analyst at Ashburton Investments.
Eyes are being cast upwards. From executives at project finance companies to economists at government think tanks, the weather is dominating conversations. Unseasonal rain, together with hailstorms, back in March has been devastating farmers’ crops. But this is just a precursor to the big weather question: the amount of rainfall India will get in the 2015 monsoon season.
The monsoon should blow-in from June to September and generally speaking, the more rain, the better the Autumn Kharin harvest will be, with beneficial consequences for both inflation and GDP growth. Economists' reputation for economic forecasting isn't great, so it might seem strange that they should spread their attention to the weather rather than leaving it to the experts. However, their musings are perhaps no worse than the India Meterological Department's (IMD) initial estimates.
Meteorological and economic forecasts have a lot in common - both systems are vastly complex and highly non-linear. This makes predictions about both the economy and the weather notoriously difficult, particularly if what we care about is rates of change or deviations from averages. The IMD thinks that rainfall is likely to be only 93% of the long-term average and claim they have a model error of +/-5 % suggesting a range between 88% and 98%. The IMD's past April forecasts have had less precision though: the forecast error in the last 16 years has only been under 5% on just 4 occasions. Indeed the sign of the forecast has been wrong on nine occasions. It is therefore far too early to panic.
The huge amount of uncertainty about factors such as the weather should remind us how crucial luck is to outcomes. So far Raghu Rajan, the RBI central governor has been a lucky governor. The fall in the oil price in the last third of 2014 has been incredibly helpful for achieving a reduction in inflation which has enabled two interest rate cuts this year. However, it would be churlish not to give credit to good policy as well, it just happens that the good policy may have come from the Finance Ministry rather than the RBI. Or so thinks Surjit Bhalla who runs a local hedge fund as well as being an economist with the Observatory Group.
He claims that most of the fall in the CPI can be explained by the slowing in the rate at which the government has increased minimum support price (MSP) for agricultural prices. Under the previous Congress administration, MSPs were hiked at a rate often above 20%, in an attempt to boost rural incomes. By raising prices above clearing prices, the policy is very similar to how the Common Agricultural Policy (CAP) in the EU used to operate. Like the CAP, there was a big build-up of food inventories, particularly in grains. But Surjit argues that as well as a direct impact on prices, it increased inflationary expectations too. The new BJP administration cut down the rate of increase of the MSP to 5% for the FY ending March 2014 and to 3% for the current fiscal year in their first full budget. Even if there is a poor harvest, the more pro-urban BJP could release some of those food stocks to keep inflation under control.
Of course what is good for urban India isn't necessarily good for agricultural incomes. The big land owners are a formidable lobby group and emotive adverts about the conditions of the farmer dominate road-side hoardings. Farmer suicides usually galvanise support for measures to help distressed farmers. All the political parties claim to be the friend of the farmer. Of course the majority of the benefits from agricultural support policies are not enjoyed by impoverished farmers, who usually own less than a couple of acres, but accrue to the large landowners with good access to government buyers.
This is where the second area of excitement amongst commentators comes in: the huge potential from biometric UIDs (unique identification numbers). The UID combined with a massive increase in financial coverage (99% of households now have access to bank accounts) will enable efficient direct payments to farmers. Ashok Gulati, a Professor at the Indian Council for Research in International Economic Relations, argues that if you combine this with satellite technology then crop insurance with quick direct payments to alleviate farmer distress, when a crop gets wiped out by extreme weather becomes feasible. Together with giving support to the individual farmer rather than subsidising production through free electricity, cheap fertilisers and above market prices, will enable a big reduction in wasteful fiscal transfers, freeing up funds for productive uses such as improving India's infrastructure stock. UIDs could also help improve the delivery of some of the old Congress party policies such as the National Rural Employment Guarantee scheme which provides work to rural workers but has been beset with problems with fraud.
Biometric ID is transforming the delivery of services too. Biometric clock-in devices are becoming common-place. IndusInd Bank makes all of its employees clock-in and out with a swipe of a fingerprint and this is increasingly becoming compulsory for civil servants and teachers too. It might not improve the quality of the teaching but having a teacher turn-up for the class is an important first step. Another area of excitement is the potential for finally implementing GST – an indirect goods and services tax – which will operate like a value added tax. This will replace various turnover taxes, including many on intermediate goods. Under the existing system there is no credit for taxes paid on inputs, creating what economists call a “tax cascade.” This can be highly distortive and where taxes are paid on the inputs for exports, make them potentially uncompetitive. Inevitably, there has been a watering down of the proposals and the introduction may adversely impact both the inflation rate and consumption but in the longer-term it will be an important step towards encouraging trade between India's 36 States and territories. It will also mean that India will get the most out of new Free Trade Agreements (FTAs) that it is currently negotiating, including potential ones with the African FTAs.
Surprisingly, the subject where expert opinion most differed was the impact of the possible new Land Acquisition Bill. If passed, the new law will make it far easier for developers to acquire land. Consequently, it is creating opposition from the farming lobby, who argue that farmers could end up being forced to sell their land. Although the price will be four times appraisal values, the policy is not popular. Horrifically, one farmer committed suicide at a protest rally in Delhi. Many of the large conglomerates we met were unconcerned about opposition to the bill. They have built up large land banks already. As for providing land for new greenfield FDI projects, most analysts point out that demand is currently low and where foreigners do wish to enter they will usually work with a local partner in a joint-venture with the local partner usually responsible for land provision.
Despite the breather taken by Indian equity markets recently, optimism is high. The IMF forecast India to be the fastest growing major economy in the world. Monetary policy is on an easing course although economists inevitably disagree about the speed with which rates will be brought down. Just like the Fed in the US, the RBI's actions will be data dependent. Inflation in India will inevitably rise after August when the inflation rate is likely to bottom out as base effects work through. However, later in the second half of this year, the base effects will reverse. If it looks like that, the acceleration in inflation will not be too rapid with the government keeping MSPs and the fiscal deficit low, there could be room for another 0.5 to 0.75% of cuts before the financial year-end next March. India could, therefore, enjoy both lower rates and stronger growth. This makes India one of the most intriguing and exciting stories in markets today.
