The other side of midnight - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
The other side of midnight A  A  A
20 JUNE 2012

India, it seems, is no longer shining.
In fact, with all the gloom around us, we must be in some pretty dark midnight.

And much of the "evidence" supports this.
The politicians remain politicians and - worst of all - the IPL seems to have lost its magical charm.

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The "problem" that has obsessed the local and the foreign media has been the shocking decline in India's quarterly GDP numbers. For the fiscal year ended March 31, 2012, India's GDP reportedly grew by 6.5% dragged down by the 5.3% rate of growth reported for the quarter ended March 31, 2012 - the lowest quarterly rate of growth in 7 years (see Chart 1).

Chart 1: India reports lowest GDP growth in 7 years
Source: Government data

Well, we all really want India shining again, and everyone is telling us how to do it.

As expected, most of the recommendations to get out of the "problem" tend to be "fixes" put forth by the lobbyists and the corrupt that, in the first place, have infested the system.

For all the depressing news around us, let's put this recent darkness into context.

The external reasons for the rate of growth in GDP are:
  1. The uncertainty in the US and Eurozone and its dampening effect on capital inflows which have hurt many emerging economies including India (see Table 1),

  2. Higher oil and commodity prices which resulted in higher inflation and higher interest rates in India,
The purely Made-in-India, shoot-ourselves-in-the-head reasons for the decline in growth are:
  1. The inability of India's politicians to replace their long-perfected "how much is my cut?" art of policy making (exposed by various scandals since August 2010) with solid nation-building rules;

  2. A disrespect for a Supreme Court judgement in the Vodafone tax dispute demonstrated by the Indian government's desire to change the tax laws with retrospective effect - these amendments have frightened multinationals;

  3. The constant bullying to change the DTAA with Mauritius and the ill-conceived amendments to taxation rules that have scared even genuine long term investors.
Table 1: India is not the only stock market or currency that has been beaten down!
The asset class or equity % change from August 5,
2011 to May 31, 2012 (in USD)
US 10 Year Treasury Bond +10.50%
S&P 500, USA +11.30%
FTSE 100, UK -1.10%
DAX, Germany -12.80%
MSCI World -0.50%
MSCI Emerging Markets -11.10%
IBOV, Brazil -18.90%
SHCOMP, China -8.20%
BSE-30, India -24.90%
RTSI$, Russia -28.90%
Oil, WTI (USD/barrel) -0.40%
Gold (USD/ounce) -6.20%
Silver (USD/ounce) -27.80%
USD Currency Index +11.30%
BrazilĀ  Real / USD * -22.10%
Mexico Peso / USD * -16.60%
Turkey / USD * -6.50%
South Africa Rand / USD * -18.80%
Indian Rupee / USD * -20.30%
Source: Bloomberg, * emerging economies with current a/c deficit, data till May 31, 2012

Yes, let's change back to the old system
As one can see, most of the "made-in-India" reasons for the decline are part of our "Indian-ness". If we really want to change into some shining star mode, we need to change the way we think, plan, and govern.
But no one has time for that - certainly not the business lobbies and their political friends who will both lose out if we shone a torch into their deal-making abilities.

It is probably easy for the business lobbies to use the hysterical "lower rate of growth" screams around us, to slip in some of their solutions. The solutions offered, to remind ourselves once more, are part of the historical problem.

Here are a few examples of the quick fixes that aim to get India shining again - and the money flowing back into the wrong hands.

A leading newspaper, known to confuse its editorial space available for money with advertorial space available for money, suggested that Indian mutual funds should renew the age-old practice of paying opaque distribution commissions to gather more assets. What this newspaper forgets was that it was precisely this fraudulent practice adopted by the local and multinational players in the Indian mutual fund industry that has discouraged local Indians from investing a significant portion of their USD 450 billion of annual savings into the stock markets. Moving back to the opaque distribution systems may "generate" more activity and - by definition - more GDP. But it would generate GDP of theft. And encourage the annihilation of hard earned savings by a class of intermediaries that only seem to care about their own well-being. Oh, yes, and they do have the power to buy advertisements which the retail investors don't have.

Or the other recommendation: open the doors wider for the synthetic P-Notes to invest in India's capital markets. The P-notes were used either by rich local Indians to funnel their Swiss bank money back into India or by hedge finds looking to flip on every global twitch. Neither of these pools of suspect money should be welcome by an economy trying to build for the long term. P-Notes are unknown pools of money with unknown intentions. If a local investor needs a KYC on an investment in the local mutual funds, why should a P-Note router be exempt? Again, the recommendation is more about "generating" economic activity rather than generating "reputable" GDP.

Chart 2: Opaque P-Notes are not welcome
Source: SEBI

And, of course, there is that constant sermon to limit subsidies. India's pink business journalists rarely measure the subsidy given to the rich for all the resources they take, grab, or steal from the nation.

The Comptroller Auditor General of India (CAG) seems to have some time to do this. The CAG has, in various reports, uncovered the granting of such favours in the allocation of land, spectrum, oil, gas, and coal. The figure is an astonishing 20% of GDP. Spread that over 5 years and it is a cool 4% of GDP every year. About 2x the annual subsidy bill for 350 million poor people.
Look at that data again.
The pay out of subsidies to the poor (maybe 350 million) is 2.2% of GDP.
The pay out to a few favoured families and their cronies is possibly 4% of GDP.
Has the press "uncovered" any of this?

Well, they have covered it in a different way by: writing glorious editorials on these top families.
While there are many obstacles in doing business in India, the truth is that many families have made it to the lists of billionaires not by any brilliant business skill set but by the brazen acts of corruption and favour-mongering. To kick-start the economy, India's "hand in the cookie jar" industrialists are back to asking for "quick action" on coal, spectrum, and a host of "reforms". SEZs, discredited for being land-grabbing machinations, have found a little snippet in the newspapers that the government is considering a relook at the "tax exemptions". The well connected want more!

The urge to allow big box retail is also back in vogue, but there is still no clear cut answer on whether that will hurt - or benefit - India's ability to create employment. And you don't necessarily need a Wal-Mart to bring prices down. Inflation could also be reduced by removing restrictions on inter-state movement of goods, by introducing a universal sales tax, and locking up a few politicians with known control over agricultural supplies in jail. But this requires some kind of nation-building and statesmanship, a trait that is in short supply - globally.

In an online discussion on the economy Mr. Rajeev Chadrasekhar, a Member of Parliament of the Rajya Sabha (the Upper House) and a former telecom entrepreneur, was spot-on when he said, "For many years industry and bodies like CII and FICCI have been bland cheerleaders to government policy making instead of doing a bit of brave critiquing in addition to the cheerleading. So the chickens have come home to roost."

The Economic Times carried a response from Mr. Adi Godrej, a flag bearer of corporate governance in India, and the President of the CII, "Mr. Rajeev Chandrasekhar is a politician. And politicians believe in critiques and criticism (while) businessmen believe in continuous improvements".

It is to be seen whether Mr. Godrej's colleagues in corporate India improve by refusing to play (and pay) the system or focus their "continuous improvements" on how to better milk the system to make it in time for their meetings at Davos and other billionaires' clubs. But Mr. Chandrasekhar's point is clear: business associations are just as much to blame for the policy freeze or bad policy as the government is.

How to kick-start India's GDP
My view remains that a 6.5% to 7% solid rate of growth in GDP with an even and fair distribution is far better than a 9% skewed, plunder-the-nation rate of growth in GDP. The focus on a pure number is ridiculous. The quality of the GDP is what counts. And India (light blue in Chart 3 below) has achieved a sustainable rate of growth in GDP over the past 32 years - despite the changing rates of growth in the global economy (grey in Chart 3 below).

Chart 3: GDP real growth rate across 9 governments has been 6.3% p.a. over the past 32 years - 6.5% is a good assumption for the next decade
Note: 9 governments of which 6 were coalition government
Source: World Bank;* Dec '11 data for World GDP sourced from aggregates provided by Bloomberg since World Bank data was not available

So, here are a few suggestions on how to kick-start GDP and - most importantly - to make sure it is more evenly spread.
  1. India's real estate developers are sitting on over 500 million sq feet of unsold inventory in the six major metropolitan regions. Assuming that, on average, each apartment is about 1,000 square feet, that translates to some 500,000 apartments. If 20% of this stock or 100,000 units could be bought by the middle class it would trigger a boom. But developers only wish to sell at prices which generate super-normal profits. And the developers can wait it out since their friendly neighbourhood, politician partner can call the friendly and obliging government-controlled bank to roll over the loans to the developers in perpetuity. Reports suggest there are more than 80,000 people in this country waiting to buy a first home - at the right price. Even at an average selling price of USD 90,000 per unit that would add some USD 9 billion to economic activity - a solid 0.6% of GDP. Furthermore, having cleared their inventory and paid down their loans, developers will again start borrowing to build new stock - adding to future GDP.

  2. India has a shortfall of about 1 million drivers and chauffeurs every year; setting up a school that charges Rs 30,000 a year to teach driving lessons will not only generate employment but also add about USD 2.6 billion to GDP every year, that is another 0.2% for the growth camp; with fewer accidents on the road, traffic will move more smoothly and add to productivity - and some sort of immeasurable peace of mind;

  3. While creating employment is critical, limiting the subsidies to the rich and the well-connected is equally crucial in a country known for its leaks. With about 7,000 lawmakers at various state and national governments controlling India's destiny, a team of 5 people monitoring the work of every legislator will go a long way in supervising how India's resources are being utilised. Not only will this estimated USD 763 million in annual expenses for such a network of teams add 0.5% to annual GDP, these "costs" can be recovered through lower leakages. And if this experiment works, the next task will be to monitor the works of the 3,255 urban local bodies (Census, 1991) that rule India's bustling cities and towns. Many of the well-connected industrialists screaming their lungs out for lowering subsidy handouts for the poor, may finally be conclusively exposed as the biggest beneficiaries of government largesse. And here is one way to fund it: we have had the education cess, the telecom cess, let's have a "monitoring cess" on the tax bill of corporate India.
Clearly the macro India news hitting the headlines is worrying people. And the global risk-off trade as we approach the summer months is reminiscent of the troubled second half of CY 2011.

Investors need to throw away those rose-coloured glasses that portrayed India as a super-power. That 8%, 9%, and 10% rate of growth in GDP is a fiction that will only be achieved in spurts. It can only be achieved on a sustainable basis only when some of the above suggestions - and others that aim to clean the system - are taken seriously.

Subsidies are here to stay - you cannot wish away the responsibility of looking after 350 million poor people for the next few decades. With a solid domestic savings rate of over 30%, India has the capital to achieve a 6% plus rate of growth in GDP even in a troubled global environment.

Yes, it would be good if India could grow at 8%, 9% and 10% - but we had that growth with lopsided benefits. The opportunists are using the media to lobby for a return of the old ways of cheap coal, gas, land, oil, and spectrum. What we need is more transparency, not less. What we need is more equitable growth, not just a "higher growth".

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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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8 Responses to "The other side of midnight"


Jun 27, 2012

Well written MR.Ajit. As suggested we urgently need reforms in the real estate space. I don't think that our politicians will go for reforms in this sector. We can see that these politicians push for reforms in sectors where their survival will not be in jeopardy. If they push for political,real estates, administrative and judicial reforms they will be out of business. Who will dig his own grave? If the above reforms are not carried out in the near future India will never become a super power. I am sure that it is not going to happen in our life time.



Jun 23, 2012

Many of your articles are excellant and impressive.
It is unfortunate that almost all the educated /intellectuals get satisfied with their contribution of giving suggestions and witing in media.
If we want to see the " happenings" in our country,the educated ones have to particaipate in the "power" and drive all the current politicians and specifically uneducated and corrupt politicains out of the system.
India needs "system cleansing". There may be a few less- educated clean persons; for example,we had in the past, clean person like Kamraj.But today they can not be found.
Ajit, jump into political race and fight for a new nation building!

Like (1)


Jun 23, 2012

Well written factual article but with a big if. Three things which need to be done are-1. Clear rules framed based on the experiences gained during last 65 years of independence 2.removal of discretionary powers vested to individuals which breeds corruption 3.time bound actions on any matters connected with the common man with accountability clause.
In contrast what happens today, the cases lingers on for decades and nothing happens to the person who caused the root cause of litigation as he was not bribed in the initial phase.

Like (1)

shabbir dossa, Canada

Jun 21, 2012

Ajit Bhai, its easier said then done. I have been reading your artciles for a long time and few others like you. I think the major problem in india is that the educated people like you do not want to run for elections nor want to challenge the goverment in the highest court of law. Actions are poewrful then words. Its time for revolution in India also as it happened in Tunisia, libya, egypt and syria. The illeterate politicians have to away now and the MP's we need are lawyers, enegineers,go doctors. Its easy to sit on your desk and critizie then do something for the country. Somebody has to gather the momementum with the young generation of our country. I would really like to see the same thing what happened in Middle east to India also so that all these family owned parties go away for good.

Like (1)


Jun 21, 2012

Dear Ajit,
You are an excellent person to bring all these facts on our nation`s present scenario But few favored families are(political & industrial ) holding the very nature of our economy, so it would need another freedom fight to break the shekels of slavery & suppressing rule of our poverty ridden nation. Thank you for your courageous expression

Like (1)


Jun 21, 2012

A brilliant and focussed,understandable article by Ajit.
Such articles give some hope to the otherwise disgusting scene in indian political and corporate world.

Like (1)

manmohan khetan

Jun 20, 2012

Thanks a ton, Ajit for sharing these eye opening facts. I will appreciate if you reveal name of business newspaper so that media also is alerted that they are also under people's watchful eyes.

These facts point out one fact very clearly that we, Indians are responsible for oour own miseries by looking only into the selfish interests at the cost of fellow citizens and the country as a whole. Earlier invaders took advantages of our this mentality now our own political and business leaders are taking advantages at the cost of fellow citizens & country as a whole. When will be learn ??

Like (1)

Prof. N K Jain

Jun 20, 2012

The points made above are good. I feel the biggest reform government can make is in the area of education to poor people. Let them make it compulsory for every child to study upto 10 + 2. Provide them with free uniform, books and meals. Provide them with vocational training to enable to use their skills and local resources to develop income generating projects. This kind of subsidy will build a solid foundation for development of our country. Industries can monitor and nurture this program for their own long term benefits.

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