A sub-continent is no longer an island - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
A sub-continent is no longer an island A  A  A
21 MAY 2012

India, because of its large size and immense number of people, is a sub-continent.

Geographically, India is classified as a peninsula: a mass of land surrounded by water on three sides.

Economically, we had an opportunity to be an island with a safe harbour: a place where people would seek shelter in times of a storm. Consider this:

  1. India has an economic growth rate of 7%;
  2. a savings rate of over 30% of GDP to finance internal growth;
  3. local consumption determines 70% of overall economic activity; and
  4. exports of manufactured goods is insignificant, therefore it is far less susceptible to consumption in the declining western world, a great threat to the China story.
But, instead, the Indian economy is buffeted by forces beyond our control. We look like jokers in a circus tent where the roof just got blown off. The protests and squeals of our governments (present and past) supported by the great intellect that wrests in the various opposition parties or junior coalition partiessound hollow. Even the naked emperor in the fairy tale seems to have more clothes.

Source: Bloomberg
As of May 18, 2012

Source: Bloomberg
As of May 18, 2012

The Lehman bankruptcy and the frauds committed by the global financial firms had whacked our stock markets out of shape in October 2008 and induced a shock to the Indian economy - and threatens to do so again. We could have been better prepared.

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Arrey, baba, it is not us - it is them

But, of course, we pretend we are the victims of the gale wind forces that are churning out there in the global economic world. The fault is not ours; it is solely of the world around us.

We refuse to take responsibility for our failures; for our inability to prepare ourselves as an island with a safe harbour. Rather than ensuring that the roof of the circus is made of solid concrete adhering to a strict code, we behaved in a truly Indian way: we corrupted ourselves with our greed and pretended that the leaky canvas roof would not be noticed by the crowds cheering our success. Oh, yes, and the crowds we got into our financial markets were like the ones we collect at our very Indian political rallies. We paid them to attend; few came in out of any long-term conviction.

Well, now the crowds are jeering. And they are leaving. Being a peninsula, they can leave from three sides of the Indian sub-continent by sea - and ship their capital out from anywhere.

A Business Standard article on the declining value of the Indian Rupee quotes the Finance Minister as follows:

"Finance Minister Pranab Mukherjee today said the steep fall in the rupee was a matter of great concern and the Centre was trying to resolve the situation.

"It is a matter of great concern. We are watching the situation. The Centre is not (sitting) idle. We are trying to resolve (the issue)," Mukherjee told press here.

This is due to the Eurozone crisis," he said.

Mukherjee added, "There is also currency crisis in emerging markets including Brazil."

Finance Minister Mukherjee has got a few things right:
  1. there is a Eurozone crisis,
  2. there has been a steep fall in the Indian Rupee,
  3. there is a "currency crisis" in those emerging market economies which need global capital flows to support their growth, notably Brazil, India, Mexico, South Africa, and Turkey, and
  4. the centre (his government) is not sitting idly.They have bungled and fumbled and have helped add to India's troubling present condition. Of ensuring that we are not an island with a safe harbour in a stormy world but potentially an island that can be in the danger zone of a global tsunami. Maybe sitting idly would have caused less harm?
What could India have done?

Admittedly, there is a Eurozone crisis - there is no doubt about that. The fact though, is that this Eurozone crisis has been brewing since May 2010 - when Greece first sparked fears of a default by the PIIGS economies (Portugal, Iceland, Ireland, Greece, and Spain). Every Finance Minister and central banker knew that there were only two very extreme solutions to the crisis:
  1. print money to forget the debt problem and create a new one of hyper- inflation fuelled by excessive flows of money - a path favoured by the US central bank;
  2. take the painful medicine of slower growth and austerity which would result in bankruptcies of businesses;a write-down of bank loans as bankrupt businesses or consumers could not repay debt; and a potential banking crisis lead to an overall aversion of risk - a path followed by the Euro central bank which added a twist of acting as a guarantor by injecting money into the banks.
Each of these extreme - and diametrically opposite - actions required a series of different responses.

The Reserve Bank of India, fearing inflation from excessive printing, decided to raise interest rates two years ago. The RBI wanted to slow down the demand for goods and services with its monetary tools. It was discouraging consumption.

Increasing the supply of goods and services - another way to reduce prices - was the task of the government. For example, the fact that we have poor food grain storage silos is not a recent problem. It is something that we have known for decades. The fact that we need more railway wagons - and revenues from higher railway tickets to fund them - is not a revelation. Or, the fact that we needed to link petrol and diesel prices to global prices and not let subsidies distort consumption is also an old story, not "news".

A tougher stance towards the internal costs of the government - including salaries and pensions - would have helped reduce budget deficits and given India the room to navigate the looming crisis by announcing government-supported programmes in the event of a slowing global economy. Charging the correct price of crucial raw materials like coal, gas, iron ore, and spectrum to India's pampered industrialists would have also added to revenues for the government - and reduced our annual deficits. But possible side deals and corruption ended that possibility. Any "policy" moves on these fronts would have altered the supply and/or demand pattern of goods based on market signals.

Giving a clear signal to providers of foreign capital

We should have encouraged multinationals to think of India as a stable regime under which they can operate. In addition to the issue of corruption and local politics that many MNCs have to deal with, we continue to have this "we are India, they will come" attitude. As if there is something magical about our "welcome to the land of the gods" tourism slogan. By the way, tiny Singapore with its plastic soul gets more tourists than India!

Our obsession to show that we are right on the Vodafone tax case despite a contrary ruling by the Supreme Court, has led us on a path of confrontation. In explaining the logic of imposing a retrospective law, members of the Ministry of Finance said, "even China does it". This supreme arrogance in a globally uncertain environment where companies are being extra careful on where to invest is proof that the government "not sitting idly".

We may as well start shooting people on the streets and say, "even the Taliban does it".

One option for the government to build an "island India" is to recognise that our near term rate of growth of GDP cannot be 8% plus given these uncertain times. But, with our internal savings, it can be 7%. Solid and safe.

Of course, this honest admission will mean fewer invitations to attend meetings in Davos and fewer photo-ops with President Obama at G-20 meetings. No one in power wants to miss out on that.So, we continue to propagate an 8% rate of growth.

Note that an 8% rate of growthis possible but it requires the certainty of external capital - whether from the multinationals or from portfolio flows. While we have decided to kill the multinational flows with our retrospective tax laws, we are still not sure whether foreign portfolio flows are welcome or not.

India should court long-term capital from pension funds and foundations. Yet, we continue to bungle along not knowing the difference between the source of capital and the financial intermediaries that live off capital flows. The advisory committees set up by successive governments and regulators continue to represent the brokers and investment bankers - the government and the regulators remain clueless about what long term capital seeks or wishes to avoid. The procedures for attracting long term capital remain cumbersome and unimaginative with requirements of photographs and IDs - again reflecting that arrogance that foreign investors are queuing up to invest in India.

Furthermore, as per one interpretation of the proposed changes in the taxation law, any foreign investor buying or selling a mutual fund outside India (which invests in India and, therefore, is an owner of underlying Indian assets) may have to pay a capital gain tax to the government of India in case there is a profit on the investment. No one in their right mind would want to deal with a tax department of another country. This uncertainty in policy is causing investors to sell out of India - no matter whether their fund is domiciled in Mauritius or elsewhere.

To find the hidden loot of local Indians (a great cause), they are hounding Mauritius to change the Indo-Mauritius tax treaty. It seems easier to bully Mauritius than to ask the Swiss government or the Singapore government to hand over documents linked to Indian accounts, just as the US has done.

Or to demand that banks like Citibank and HSBC (to name a few) with operations in India hand over the account details of Indian-origin money housed in their banks globally. The US government has reportedly forced UBS and HSBC to hand over documents about off-shored accounts of US persons. But, hey, why fight the big boys? Let's train our guns on the weaklings in Mauritius, which happens to be an island with a safe harbour!

India is a micro story

Do not expect governments to sit by idly. Unfortunately, they will take actions. So expect governments - present, past, and future - to mess up India's potential.

Your faith should remain in managements that aim to build long term businesses and can navigate uncertain times.

Stock markets are at risk from global events and global flows. The Indian currency was first at risk due to rising oil prices in a hyper-inflationary world caused by the US central bank printing too much money. Now oil prices are declining due to global uncertainty in case Greece goes bust andthe INR has a new risk factor: falling foreign flows.

Much as I may wish India were an island with a safe harbour, the fact is that India is a peninsula with a circus show that brings tears to my eyes - and not from laughter!

There is little one can do to weather this storm but stay invested in a mix of assets - from gold to bank deposits to equities. Your ability to invest in good companies with good businesses at good valuations is your best defence. A price of a good stock may decline, but its value will not. And that is your island with a safe harbour.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

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5 Responses to "A sub-continent is no longer an island"


May 21, 2012

Hi, Its good article but feel some of the points and arguments are not in the context.
1. The argument has flaw as it suggest that Don't do A by pointing at B. In this case you are asking not to work with most abused Mauritious tax treaty by pointing at some other absurd idea of getting account details from HSBC or Swiss Bank.Besides I don;t see any point going after HSBC to get account details as India doesn't tax global income of the citizen as in USA.
2. I don't see how allowing somebody to cheat a tax will create fair system. I think property comes with fair and just treatment to all creating level playing field.The others has paid taxes in similar cases but Vodaphone despite prior notice help evading of taxes ( which obviously it got indirectly through price reduction). Finance minister gave example of "Britain" mecca of capitalsm ( just as author cited other countries such america going after HSBC , justifying action)
3. Its illogical to ask indian to pay taxes whereas foreign based company to not pay same taxes. This unlevel field will create incentive for Indians to cheat by anyhow reaching favorable side of the deal. You can have double taxation avoidation treaty to be fair as both should pay same taxes not more or less.

Like (1)


May 21, 2012

Current predicament and frustration very well brought out. How about the farce of austerity measures like restriction in foreign tours of officials, not more than one car per department etc being worked out!

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May 21, 2012

Dear Mr.Dayal,
I have been an admirer of your views for a long time but I think you are now being blinded by your love for our country.
I would not ask anyone to invest in India much less in Indian equities. Why? Simple -
1. MNCs are slowly delisting. Liaison offices of foreign companies are pondering leaving - post the horrendous new Form 49C that the Income-tax department wants annually. The information being sought is meaningless. Apart from the ramifications of Vodafone. How long before the better managed Indian companiees follow suit? After all, today HDFC is 100% FII limit - how will it be treated in another year or two?

2. Apple shifted manufacturing to China. Infosys, TCS, et al want to recruit locally in US. Why would Arcelor Mittal or Tatas or others want to continue operations here if conditions are more congenial elsewhere? An option that could become even more attractive post a worldwide economic crash and India retreating to full currency controls. Haven't we already taken the first step in that direction by insisting 50% of FC accounts be converted immediately and compulsorily into Rupees?

3. What are the companies which are going to be left in operation here in ten years' time? The Ambanis, the Poddars, the Singhanias? - I'm sure you know how their managements work. Or the PSUs with 1 minister (or 10) feeding off each company?

I can remember gambling on the BSE in the 80s - and it was gambling with no information available to you. Even financial reports were hard to come by. It seems we will return to that.

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Prem Khamesra

May 21, 2012

Hats off, Ajit! Fantastic mix of insight and sarcasm. Am sure you will get picked up as the advisor to the Government of India one day.

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May 21, 2012


Doyou think the govt. cares for the opinions of people like you and me?You have been crying hoarse about the evils of P-Note route for years and what happened?When they were forced to act (for reasons other than your protests) they only succeeeded in messing up thoroughly regarding GAAR.

They only listen to the likes of Montek Singh Ahluwalia whose ideas are as phoney as his accent.

and by the way,didn't they try practicing austerity sometime back to save our economy?
Soniaji travelled economy class ONCE to Mumbai and Rahulji travelled to Pathankot ONCE by train.Oh!it's so tiring you know for our worthies.

So,blame it all on RIO or rather Europe.

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