Editor’s Note: The economic mess in India has been discussed at length in the Financial Times, New York Times, Times of India, Wall Street Journal, Washington Post, just to name a few. Almost all the coverage is event-based and focuses on actions of the Indian Government. In our opinion, events are not that important for analysis about India. The analytical framework is what matters. Below we revisit and update our own analytical framework on India.
India has officially hit rock-bottom in the eyes of American investors and American media. This week, Art Cashin, a semi-ancient presence on the New York Stock Exchange, told CNBC that “India is sinking into the sea“. Jim Cramer, CNBC’s franchise player, read a recent NYT article on India, promptly described the Indian mess as “horrendous” and advised all against investing in India. This Friday, the Wall Street Journal wrote an article about Indonesia, this year’s darling market, titled “Indonesia Could Be the next India….Unfortunately“.
Media, especially financial media, have almost always been wrong at inflection points. So it would be tempting and possibly rewarding for investors to begin tipping their toes into the Indian investment ocean. Global stock markets are severely oversold and India is more oversold than others. So any snap-back rally could feature out-performance by Indian stocks. The Indian Rupee could also bounce in such a snap back rally.
Unfortunately, that might hurt India in the intermediate term. Think back to last November-December, when the Indian Rupee fell 20% in a month. India fell into a gloom. Then, Indian stocks, Indian Rupee exploded in a ferocious rally in the first quarter of 2012. India, in its typical complacent & self-congratulatory manner, decided the worst was over. And so India went on on its merry and disastrous ways. As night follows day, Indian complacency in March gave way to utter panic in May.
We are not surprised that India has fallen on its awful times. We are very surprised that the world’s media & investors were not prepared for the downfall. Because what is happening in India today was written in 2009, said in 2009 and unfortunately happened since then.
Sonia Gandhi’s Economy or Manmohan Singh’s Economy?
The seeds of today’s disaster were sown in the aftermath of the huge election victory in May 2009. Euphoria reigned among investors then. The Indian stock market exploded in a 17% rally the day after the election. Then in July 2009, the Congress Government released its budget. The Indian stock market fell by 6% the next day.
We wrote our own analysis on July 11, 2009 in our article Indian Economy – Is It Sonia Gandhi’s Or Is It Manmohan Singh’s? Is The 2009 Election 1971 Redux? Unfortunately for India and for anyone who loves India, much of what we wrote has come true. A couple of quotes below from our 2009 article:
- 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.
- 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… 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 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.
- 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.
The above have come true to the detriment of India. Global Analysts and India Experts keep lamenting about the failures of Prime Minister Singh and Finance Minister Mukherjee. They fail to grasp that Sonia Gandhi has essentially been India’s Viceroy for the past 3 years and Singh-Mukherjee & their cabinet colleagues merely serve at her pleasure.
The Credit Boom and Bust – 2009-2012
The 2009 global rally in risk assets and the flood of capital into emerging markets proved unfortunate for India. So much money was pouring into India that no one worried about the rampant, useless, social spending launched by Sonia Gandhi to buy election loyalty for her son. We call these programs as useless because they did not create jobs or the much needed infrastructure that rural India needed. These programs simply delivered cash into the hands of rural poor.
These programs worked in the short term. They created higher growth in 2009 and 2010. Indians love to spend and spending by rural Indians led to a much higher growth rate for India. This in turn resulted in more capital flooding into India to participate in the great, democratic Indian growth story.
While the short term looked rosy, the intermediate term consequences were becoming visible by 2010. Like America, the Indian economy has traditionally featured migration of labor from less developed states to states with jobs. Thanks to Sonia Gandhi’s distribution of free money, workers from poor states like Bihar refused to travel hundreds of miles to prosperous Panjab to pick agricultural produce or to industrial states like Maharashtra for construction and manufacturing jobs. Why would they? They got almost half the pay to simply sit in their villages doing nothing.
Sonia Gandhi apparently didn’t know and no one had the courage to tell her that handing out monthly cash to people is the traditional recipe for inflation, structurally high inflation. Not content with giving out cash, Mrs. Gandhi’s Government then announced a food-security program that guaranteed a minimum level of food to about 61% of Indians. Apparently, Mrs. Gandhi didn’t know or her advisers refused to tell her that such monies for food for about 600 million people guaranteed the rise of massive food inflation in India.
The combination of the credit bubble, unpreced
ented distribution of cash to hundreds of millions of people created serious structural inflation in India by late 2010. Nothing is more deadly to India’s politicians than food inflation and resultant populist anger. So the Reserve Bank of India went into action in late 2010 to control inflation by raising interest rates.
This was like doing a heart bypass surgery to cure a kidney malfunction. The RBI’s aggressive rate hikes slowed down India’s manufacturing sector and infrastructure investments. But the RBI or the Indian Government had no power to stop the massive injections of cash into the hands of India’s poor. So food inflation kept going up and the Government kept putting on the brakes on manufacturing and infrastructure. The result is today’s stagflationary bust in India.
If this sounds nuts or mondo bizzaro, it is. Investors and analysts around the world wondered and still wonder how experienced, smart ministers like Manmohan Singh and Pranab Mukherjee can engage in such self-defeating and utterly contradictory behavior. Their basic mistake is that they got taken in by the facade.
India – Not a Democracy but a Viceroy-cum-Electocracy
Those who think India is a democracy are doomed to fail in their analysis. Today’s Indian Cabinet and the visible trappings of a Parliamentary democracy are merely a facade. The Indian people know this and feel this every day. That is why this Government is described often as being run by “remote control”.
This transformation of India took place the day after the victory of Sonia Gandhi in 2004. The ruling BJP party which ran on an India Shining campaign was blown out unexpectedly by Sonia Gandhi and her Congress Party. Sonia Gandhi reportedly wanted to become India’s Prime Minister but middle class India reacted with outrage at the prospect of an Italian-born woman becoming India’s Prime Minister.
So in a brilliant political move, Sonia Gandhi renounced all claim to power and chose the widely respected Manmohan Singh as the Prime Minister. Nothing works in India as renunciation. Instantly Sonia Gandhi became a sort of a selfless saint dedicated to serving her party and the Indian people. The 2004-2009 Government was a coalition government and her freedom of movement was restricted.
The massive election victory in 2009 made Sonia Gandhi the Viceroy of India. She had absolute power in India without even a shred of accountability. Her cabinet, despite the presence of heavyweights like Manmohan Singh, Pranab Mukherjee, was dedicated to Sonia Gandhi’s wishes.
This is unheard of in any real democracy. The concept of democracy is based on the political winner becoming the chief executive. That is the only way to create accountability. India has not been such a democracy since 2009. Actually, today’s India resembles British colonial rule when a Viceroy was surrounded by Indian cabinet members and advisers. The Viceroy was absolute and infallible while blame always fell on the Indian advisers.
This brings us to the other concept of Electrocracy. Democracy is based on Government of the people, by the people and for the people. India is as far away from this as you can get. India works on a vast election system, a system that elects Members of Parliament (MP) and Members of State Level Legislative Assemblies (MLA) via popular elections. In India, you tend to meet or see your MP or MLA during an election campaign. But once the election is over, the MP or MLA is hardly ever seen again. After all, they have to make sure they get a return on their massive election investment.
The Indian Electrocracy runs on money and local power. Each local party head is like a warlord who battles other such warlords in elections. The goal is simple. Collect large sums of money to spend on elections and then spend your tenure as MP or MLA to generate adequate return on your election investment and to build a kitty for the next election. The people who elected you just don’t matter.
This Viceroy-cum-Electocracy system is ideally suited for massive collection of monies from the Indian economy. This is called Corruption by some. It is not all that different from the warlords in today’s Afghanistan or feudal India where the principal goal of the warlord is to stay in power and amass riches. The only difference is that those warlords became powerful with physical force while today’s Indian political lords became powerful by winning elections.
This system exploded in size and power after the 2009 election. Thanks to the credit bubble & the massive inflows of foreign capital, corruption rose to unprecedented levels in India.
To understand this phenomenon, just compare Vladimir Putin and Sonia Gandhi. Witness the rise of protests against Mr. Putin. In contrast, despite the utter mess in India, there has not been a single protest directed against Mrs. Sonia Gandhi. How can you hold her accountable when she has no official responsibility?
This is the state of affairs that led Gandhian activist Anna Hazare to launch a nationwide protest against corruption in 2011. We think this movement and its nationwide impact tarred the Congress Party to a great extent and might have played a major role in the big loss in March 2012 elections.
Recent Crazy Actions of the Indian Government – Parallels to 1971?
The pivotal moment of 2012 was the defeat of Rahul Gandhi and the Congress Party in the state elections in March. This was the election that was supposed to crown Rahul Gandhi, the son of Sonia Gandhi, as India’s next leader and Prime Minister. Rahul Gandhi lost and lost big. This was the election that led the Congress Electocracy to begin questioning the power of the “Gandhi” lineage.
Just as President Obama cannot backtrack from his 2009 stimulus program and his populist rhetoric, Mrs. Sonia Gandhi cannot backtrack from her platform of delivering monies to rural poor. But 2012 is not 2009. Today India faces a credit bust, the Rupee is on a down escalator and inflation refuses to come down. Clearly, Sonia Gandhi and her advisers cannot be blamed. They had such laudable social goals. So it must be the foreign investors and multinational corporations that are fickle and successors of the East India Company.
Go back and look at the actions of Indira Gandhi in the mid-70s when she started losing ground despite her populist largesse. When her plans went awry and the succession of her son Sanjay Gandhi became questionable, Indira Gandhi reacted with fury against Indian businesses and foreign companies.
Today’s rage of Indian Government against foreign entities seems similar. The Indian Government needs revenue to keep up the income distribution schemes that are absolutely necessary until the 2014 elections. So the Indian Government is trying all possible ways to generate revenues from foreign investors regardless of long term consequences. The only thing that matters is the 2014 election. The foreign investors you hit today can be given lucrative deals after winning the 2014 elections. So no one should wonder whether the Indian Ministers have lost their mind. It is just that the immediate goals of the Congress Electocracy are different.
The 2014 election is absolutely the last chance for Sonia Gandhi to make her son, Rahul Gandhi, the Prime Minister of India. She needs reasonably good governance from her cabinet until then and she needs the recently elected opposition governments in key states to fail. She still has two years to do all this. She may prove lucky again. India could bottom sometime in 2013 and begin an upward trajectory by 2014 just as elections come around.
Could India Get Lucky?
Frankly, the steep fall in the Indian Rupee has been somewhat of a blessing for India. Its system is as bad as that of any European country but it has the flexibility of a free currency. There is no question that India is much more attractive at 56 Rs. per Dollar than the 44 Rs. level of August 2011.
A global slowdown might als
o prove beneficial for India. The two sources of Indian inflation are Oil and Food. If commodities keep falling through mid-2013, Indian inflation could come down despite the fall of the Rupee. India is mainly a domestic consumption story. India is not reliant on exports the way China & Brazil are. So a global slowdown may be less damaging to India.
Any one who travels in India comes away very bullish on the Indian micro story. The Indian people are NOT leveraged in any way; India has real secular demand for just about any product, a rarity in an over-leveraged world of low demand. So at the right price and at the right time, India again will become a very attractive investment opportunity.
A Catalyst for India’s Turnaround?
What is the right time or the right price? No one knows but it is useful to think of catalysts. We have one in mind.
- The Indian situation keeps getting bad and the Rupee keeps falling slowly until the Indian Electocracy realizes it is time. Then they tap the rich Indian Diaspora for FX deposits into India by offering high rates PLUS a guarantee against FX losses.
This proved to be the magic potion in 1991 and it will do its magic again. Would you not invest in a Bank Certificate of Deposit in India at say 9% interest rate if you have protected against FX losses. Such a move resulted in massive flow of funds into India in 1991.
This time the flow could be far greater. Why? The Indian Electocracy, of course. You have no doubt heard of massive amounts of monies (some say, half a trillion dollars worth) held outside India by the Indian Electocracy. These monies could flood back into India under a FX guarantee and high interest rates. Indian Electocracy is the smartest money in India. When they bring their overseas money back into India under a safe scheme, perhaps simple folk should consider doing so too.
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