India’s mammoth election in May 2009 resulted in an unexpected and lopsided victory for the Congress Party and its UPA alliance. Global Investors have a great deal of respect for Manmohan Singh, the Indian Prime Minister. They interpreted the victory as a signal that the Singh Government would liberate the economy, attract foreign capital and divest government’s stakes in state-run enterprises to raise money.
These hopes fueled market euphoria and the Indian stock market exploded in a 17% rally the day after the election. Then, last week, the Indian Government released its much-awaited fiscal 2010 budget. This was an “inclusive” budget that increased social spending to reduce the strain on the rural poor and raised India’s consolidated fiscal deficit to 10.4% of GDP in the fiscal year 2010.
Market euphoria in May gave way to market gloom in July. The Indian stock market fell almost 6% the day after the budget and now has fallen by over 8%.
The reaction from ratings agencies and analysts has been negative. For example, James McCormack, head of Asia-Pacific sovereign ratings at Fitch Ratings, said: “It is not a budget that in any way alleviates pressures on India’s sovereign credit ratings”. The new budget provided “nothing specific at all” for foreign investors, said Sanjay Nayar, chief executive of Kohlberg Kravis Roberts in India and a former head of Citibank’s Indian operation.
Frankly, we were not surprised at this turn by the Indian Government. Our views about the Indian election were more balanced than the consensus and were expressed in our May 23 article India’s Election – The Stories Underneath The Story.
In this article, we discuss our thoughts about India’s budget and the direction of India’s economy.
Is It Sonia Gandhi’s Economy or Is It Manmohan Singh’s Economy?
The budget answered the question. The Indian Economy belongs to Sonia Gandhi. That was the real lesson of the May election. Actually, as Sonia Gandhi signaled herself, the post-election economy is, in spirit, Indira Gandhi’s economy.
This was made clear after the election when Sonia Gandhi made Pranab Mukherjee the Finance Minister of India. In the pre-election Government, Mr. Mukherjee was the Foreign Minister and the Harvard-educated Chidambaram was the Finance Minister.
In the 1960s-1970s, the then young Pranab Mukherjee was a favorite of Indira Gandhi and in return, he became a Gandhi family loyalist. He has remained so for the past 40 odd years. By making him the Finance Minister of India, Sonia Gandhi sent the clearest signal that India’s economy is hers and that she would return it to the Indira Gandhi philosophy.
If global investors missed this signal, they should blame their own myopia. They should have realized that in a democracy, the power belongs to the person that wins the election.
As we wrote in our May 23 article, Sonia Gandhi won the May 2009 election. She is today the best political strategist in India, an amazing statement given her Italian birth and upbringing as well as lack of knowledge of Indian languages or culture.
To win the election, Sonia Gandhi went back to the lessons learned from her mentor and mother-in-law Indira Gandhi. One of her master moves was to embrace Indira Gandhi’s nationalization of India’s banks. She said to India’s voters ““It was my Mother-in-law Indira Gandhi who nationalised India’s Banks. That is what protected India from the global economic crisis”.”
As we wrote in May, this statement was reassuring to the vast majority of Indians who were shell-shocked from what they saw as the banking mess in America. We wrote then “Now that the election has been won, this master stroke of Sonia Gandhi might come to be seen as roadblock to reforming India’s finance sector. It is not clear to us that increased foreign ownership of India’s Finance sector would be acceptable in the short to medium term.”
If you doubt us, read what Pranab Mukherjee, the Finance Minister said in his budget speech to Indian Parliament “Never before has Indira Gandhi’s bold decision to nationalise our banking system exactly 40 years ago – on 14th of July 1969 – appeared as wise and visionary as it has over the past few months. Her approach continues to be our inspiration even as we introduce competition and new technology in this sector.”
So it has been written, so it has been said and, unfortunately, so it will be done.
The 2009 election reminds us of the 1971 election. Two years after Indira Gandhi nationalized Indian Banks, a populist and a popular move, Indira Gandhi called for national elections. She ran that campaign on the “Garibi Hatao” or “Eliminate Poverty” platform. This was a brilliant move and it made her a revered figure in India. The election was a landslide victory for Indira Gandhi and her party. After that election, she amassed semi-dictatorial powers.
Sonia Gandhi adopted the Indira Gandhi strategy with her “aam aadmi” or “common man” approach and won big. Her mandate to her Government is to work for the poor rural Indian to better their lot. She is also a matriarch whose overriding goal is to get her son Rahul Gandhi elected as India’s Prime Minister and continue the Gandhi family’s rule over India. She has realized that the best and perhaps only way to do so is to improve the economic conditions of the rural poor in India.
So the fact that the recent budget favors social spending and favors the rural poor over the urban English-speaking class should not surprise anyone, least of all Global Investors who are supposed to do research and analyze India.
We have always believed that the true India lives in India’s rural villages and true Indian prosperity can only come from increase in incomes of the rural poor. The much-ballyhooed India’s middle class is fine and true but the leverage in the Indian economy comes from India’s rural poor. If India can bring about a sustainable increase in rural income, India will be the Greatest Growth Story in the world, bar none.
So we should be thrilled at the direction of India’s budget. If we are not, it is because we remember what happened to India’s economy in the 1970s and 1980s. In 1970, India’s per capita income and GDP were on par with South Korea’s. By 1990, South Korea and the Asean Tiger economies had left India in the dust. Soon after the 1971 rapprochement with Nixon’s America, China began its “let a thousand flowers bloom” economic policy under Deng Xiaoping. What China set in motion in the 1970s can be seen in China’s massive economic strength today.
In contrast, the Indian economy under Indira Gandhi withered and fell into a growth less stupor. This continued in the 1980s under her son Rajeev Gandhi. Finally by 1990, India was virtually bankrupt and pathetically poor. It was in 1991 that Manmohan Singh, as India’s Finance Minister, launched financial reforms in India.
The facts are undeniable. The economic policies of Indira Gandhi proved to be an unmitigated disaster for India and its economy in the 1970s and 1980s. When you look at Pranab Mukherjee’s 2009 fealty to the Indira Gandhi approach from this historical context, you understand why Global Investors have become so jittery about India.
We sincerely hope that the 2009 election is not 1971 redux and the economic a
ftermath of the 2009 election will be very different than the economic aftermath of the 1971 election.
What Makes Us Worried?
The curse of India has always been Indian Family Values or more precisely, the greater loyalty to the family over the country. Frankly, this is not unique to India. You can say that about every country and society. But, unfortunately, in India, the establishment fabric has been built around family prerogatives.
This is why you see that in India, the children almost invariably follow the professions or businesses of their parents. This social custom has been established in the most lucrative business in India, the political business. It was Jawaharlal Nehru, the first Indian Prime Minister who created this modern custom by making no secret of his desire to have his daughter Indira Gandhi succeed him. Indira Gandhi made absolutely sure that her son would succeed her as India’s Prime Minister. Sonia Gandhi is now obsessed with making her son Rahul Gandhi the next Prime Minister of India.
The lesson of India’s first and most powerful family has been adopted by each and every politician in India. You find today that the sons and daughters of prominent politicians become politicians when they grow up. This keeps the personal, political and business connections of the parent politician in the family. This has had a corrosive effect on India’s governance and created deep seated problems for the Indian economy.
What worries us most is Sonia Gandhi’s single-minded focus to make her son the next Prime Minister. This focus may cause her to spend India’s meager resources to distribute largess among her party’s most loyal voters even if it damages India’s economy and its long-term interests.
We had great respect for Indira Gandhi as a politician and as a leader with steely determination. She was responsible for modern India’s greatest strategic and military victory. She was the toughest Prime Minister of modern India. But, we had no respect whatsoever for her economic understanding or her economic policies. Today, we have great respect for Sonia Gandhi as a politician but we have no respect for her economic understanding or policies.
What worries us most is the possibility that Sonia Gandhi is setting the economic policy for India and Manmohan Singh is merely a caretaker Prime Minister at best or an increasingly irrelevant, lame duck Prime Minister at worst.
What Makes Us Optimistic?
Ironically, it is China that makes us optimistic about India. We believe that every Indian leader, every Indian politician and every aware Indian is deeply embarrassed or ashamed by China’s progress. Even if they choose to ignore China, the world does not let them ignore China’s gleaming success.
China is putting massive pressure on India on all fronts. On economic front, China’s lead over India is at best flat and at worst accelerating. Militarily, China is trying to put pressure on India by increasing its defense spending at a breath neck speed and trying to encircle India by building bases in Pakistan, Bangladesh and Sri Lanka.
It is this in your face competition from China that prevents, or so we hope, India from lapsing into its greatest vice, a complacency of minimal expectations. An old Marathi proverb advises “Thevile Anante Taise Chi Rahave” or “Be content with the condition in which God placed you”. In other words, accept your fate and do not try to change it. Well, China refuses to do so and it is dragging India with it.
If China’s problem is that too much foreign capital came in for infrastructure projects, India’s problem is that too little money came in for infrastructure projects. China’s problem is a bloated economy beset with overcapacity. India’s problem is an economy hungry for capital with tremendous unmet demand.
If foreign capital were readily available, then we would take India’s problems over China’s in a heartbeat. But, today, foreign capital is scarce and we believe it will get scarcer in the next couple of years.
India’s leaders understand this. But they also understand that, if they retrench their stimulus today, they will reduce the long term attractiveness of India. They have seen that India’s economy is too dependent on the fate of global economies and they see the need to minimize this dependency.
In this context, the new Indian budget is a bold and much needed move. With its increased fiscal spending, India is trying to reduce the strains on the rural poor and to put more money in the pockets of the rural poor. The budget also cuts direct personal taxes by about 3%, by eliminating the surcharge on personal income tax. The hope is that this increase in incomes will translate into increased consumer spending and the multiplier effect will result in higher growth in India.
Higher growth is the most powerful magnate for global investors and Indian Government is betting that India’ growth will attract that much needed foreign capital. The combination of increased capital flows and sustainable higher growth will eventually reduce the deficit the right way.
Frankly, we like this bet. Remember India’s economy is much more like America’s economy than China’s. It is primarily driven by domestic consumer spending. Further, unlike today’s American consumer, the rural Indian consumer is neither leveraged nor burdened by falling assets. Above all, the rural Indian consumer is ready to spend and this consumer demand is a rare commodity in today’s world, a world in which the American consumer, the prior King of consumer spending. is retrenching and the Japanese consumer is deflating again. If this bet works, India will become the best long term growth story in the world.
So we are optimistic about India and we love the current decline in India’s stock market. We expect to get better and better values in the Indian stock market in the next couple of months. This is a fire sale devoutly to be wished for and one that should be seized in full in the fall.
Editor’s Note: We wish that the Obama Administration would learn from this Indian budget. In our opinion, the Obama Administration needs to cut payroll taxes as India did and increase fiscal spending that will put money in the pockets of the American consumer. Unfortunately for America, the Obama Administration seems determined to dump additional cost burdens on the American consumer and the American corporation by increased tax burdens and by idealistic programs like Cap & Trade.
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