I’ll get back to more thoughtful blogging in late October. Meanwhile, in a lame excuse to keep up with blogging, here are some weekend Indian musings.
Ex-necessities (not including food), purchasing power has improved but remains highly uncompetitive vs. the developed world. While growth in Indian domestic manufacturing (indigenous and assembling) has significantly improved the number of available consumption alternatives, the bang for buck remains significantly less. One can buy a BMW 3-Series in the US for as much as one would buy a Honda Accord in India (Buying on loan or leasing compounds the situation). A 330 ml soda can retails for about as much as it does in the US – All this in a country whose per-capita, even after adjusting for purchasing power, is about 1/13th of the US. That said, this pricing discrepancy in discretionary spends will gradually whittle away as volumes improve and aid absorption of significantly high fixed costs (Infrastructure bottlenecks ensure that typical cost structures are more fixed-cost saddled than what one sees in the US e.g. higher fixed power costs associated with captive generation, higher inventory levels due to longer lead-times etc.), infrastructure related challenges wind down, and import duties fall - Total duties (actual collection rates, which include CVD and additional special tariffs) on non-fuel imports still average in the low teens, about where they were 5 years back. Notional duties on about a tenth of products actually average more than 50%, steep by any measure.
Service quality is better or worse, depending on who delivers it. You step into a private hospital for a routine check-up, board just about any domestic flight or check into any half-decent hotel in India and you’ll appreciate what kind of shoddy service one gets in the US. I am being generous here in calling that “service”. The situation quickly changes when you compare anything that falls within state’s purview – Be it power supply interruptions, hap-hazard municipal cleaning routines in smaller cities or travel inspections by police on roads, which are nothing but facades for wringing money (I estimate that at least 80% of traffic violations are settled by money exchanging hands vs. actual citations being written), the sad situation of anything delivered by the state is apparently palpable. That said, quite a bit of what is generally provided by the state can, and is, often supplanted by private alternatives - In Gurgaon, for instance, many apartment buildings now come with electric supply back-ups, short-circuiting the underlying power-load bottlenecks.
Traffic citation……what citation ?. If you insist on a citation, traffic cops will list a laundry list of violations, forcing you to cough up cash and settle. However, quite a few of India’s underlying inefficiencies are curable – For instance, why not lower fines and put caps on citation’s value. Then share part of the receipts with cops responsible for writing citations and pocket the rest. Let’s examine the facts first – Cops are significantly underpaid in India (A police constable with 20 years under his belt takes home a salary, which is about half that of an Indian urban household ); Almost all violators who prefer getting a citation do so only if the payout is not much above what it will take to settle in cash; Violators don’t want to go through the red-tape of getting back their Driver License or Registration, one of which is usually retained by the cops when they write the citation. What regulators need to do is 1. Ensure that cops’ compensation doesn’t go down (Their settlement income needs to be substituted somehow); 2. Lower fines and institute caps on citations; 3. Incentivize cops to write citations; and 4. Do away with requirements such as retaining License/Registration at the time of writing a citation. Let’s say that currently out of every 100 violations, 80 get settled by INR 100 ($2) changing hands, with the other 20 violations getting an average citation of INR 250 ($5).That translates into INR 13,000 in cash receipts, with just under 2/3rd of that being pocketed by the cops. Realize that a major constraint to finding a solution here is ensuring that cops keep getting their INR 100 share per settlement. If one lowers the citation cap by 20% (INR 250 to INR 200) and shares half of citation’s value with cops, payout for cops remains unchanged. Even if one assumes that about 20% of violators somehow convince the cops to settle for INR 75 vs. writing an INR 200 citation (of which cops pocket INR 100), government receipts still go up 75% and even the cops see close to 10% increase. This is obviously over-simplified and I can think of plenty of challenges here. However, I can’t think of any that is insurmountable, especially given the potential of significantly improving cash flows. Such solutions are executable but amazingly these inefficiencies have lingered on for years. All this in a country, where non-tax revenues have been handily outpaced by tax revenue growth.
The case of parallel Indias – Chauffeurs and sahibs. Income growth across India has been wildly asymmetric. While real compensation growth for white-collar Indians has been significant, unorganized blue-collar workers have barely seen any material real growth. The massive rural-urban and cross-border migration patterns are driving this differential. That however doesn’t mean that bottom quartile households haven’t seen growth. Given income and savings potential differentials between rural and urban households, migration patterns tend to be significantly accretive. House maids and chauffeurs grind for hours each day, to earn enough to survive while their well to do patrons enjoy massively improved consumption choices and investments, whose returns by any measure are as sweet as the Indian sweets – I met someone in Delhi who had recently invested in a commercial property in Kolkata in Eastern India that yields after-tax returns of 12% (It’s actually pre-tax but I haven’t come across an Indian that discloses rental income on tax returns. However, I am sure some do).
Unless you plan to live in India, you are better advised not investing in the Indian residential realty market. Nowhere is the likelihood of bubbles more visible than in the Indian residential realty market; a market where yield chasers have driven down rental yields to low single digits, well below risk-free returns in India. Still, resident and non-resident Indians continue to flock to the realty market. The situation is particularly bubble-like in pockets such as satellite towns in the National Capital Region (Gurgaon and NOIDA), where the concentration of renters is well ahead of Indian averages – These towns have attracted quite a few realty investors, who have bought their second home in these markets. However, for any bubble to burst, demand-supply mismatch has to become sufficiently evident and will have to manifest through an incremental spike in vacancy rates [Note that there is no credible available information on residential vacancy rates. One way to look at the underlying issue is to analyze growth in a relevant industry that is expected to follow real-estate sales (with or without a lag) - Last week, I was having a chat with CFO of an Indian publicly listed appliances company and he mentioned how his industry continues to trail growth within real-estate. Note that Indian apartments come without appliances and even though appliances' sales are expected to follow real-estate sales, they are obviously getting outpaced, suggesting that quite a bit of sold apartments remain off-market and aren't being furnished]. It’s alarming to see that property prices have run up so much even as the market has been largely unable to keep up by raising asking rents, creating a situation where buying a second home as an investment property has become a highly unattractive proposition. Think twice before you act on what is now commonplace advice from your family and friends to buy an apartment in an upcoming building, which won’t be ready for another couple of years. You’ll be better off investing in Indian equities through some systematic investment plan.
Can India fail itself ?- A meaningless near-term question. Economic growth in India is more sustainable than most, given 1. High savings rates (I estimate that complete re-investment of India’s corporate earnings, and household consumption from income from invested savings, despite highly sub-optimal allocation, can contribute 100+ bps to underlying economic growth), 2. Lifestyle changes (selected savings monetization within the top quintile), 3. Massive rural -> urban migration pattern, which is generally consumption accretive (About two-thirds of Indians are rural residents, while rural India’s per-capita NDP, which is generally a good proxy for wage differentials, is about 1/3rd of urban India. The fact that investment in agriculture has trailed investment just about anywhere else has further compounded the situation. As a result, about 45 million rural residents are migrating towards urban India annually. Assuming such patterns are even $75/capita accretive to annual consumption, that alone contributes about 3% to GDP growth), and 4. Continued investment inflows, even as FDI inflow has dropped this year, in-line with the rest of the world.
India’s primary “derailment” risk stems from infrastructure related challenges. Nowhere does infrastructure fall short of minimal requirements than in power generation, driven by inadequate and inconsistent coal supply (the only space where state monopoly still exists). India is planning to increase its spending on infrastructure from the current 4%-5% of GDP to 9% of GDP by 2014E, with about a third of required investment coming from private sources. That translates into about $60 bil in incremental state investment, or more than 5% of GDP. If India’s recent fiscal progress is any indication, there is reason to suggest that the above target might be a little aggressive – Over the last 5 years, India’s consolidated fiscal deficit (centre + state) went down from 7.5% of GDP to under 5%, principally due to strong tax collections (more payees and simplified structure). Still, India will have to significantly improve on that performance if it is to achieve its infrastructure investment goal. That said, even with no help from FDI inflows, associated job creation and infrastructure related investment, India can still sustain a mid single-digit normalized growth (These aren't "normalized" times though) for the next several years (see Exhibit 1). India, at least among liquid markets, is what I call the “easiest growth” story, which unfortunately keeps poor fiscal discipline and inflexible economic policies away from limelight, at least for now.
Exhibit 1 – India’s normalized base-case growth est. (ex-FDI, new capital deployment and investment in infrastructure)
Source: Internal Analysis & Estimates; Misc. sources
Perma-bears and the broken clock syndrome. One can argue that the sorriest performers this year have been Emerging Markets’ dedicated hedge funds, which while returning a nonetheless impressive 20% return this year have underperformed MSCI Emerging markets by close to 40 pps. The situation is fascinating to observe – Those that have missed the boat are viewing current valuations as “relatively stretched”, ensuring that these investors will likely not keep pace with further upside but will be quick to point out that they came out unscathed in a potential sell-off, which will inevitably take place at some point. I have an opinion but I am not sure what’s coming next and rest assured that no one does, except for the ones that will be proven right in subsequent hindsight. What I do know is that India is by no measure a "relatively" expensive market, trading in the mid-teens (Liquid Sensex constituents trade much higher), and at a discount to MSCI World. With the exception of US aligned markets (ex-Japan) i.e. markets where earnings recovery is closely aligned to recovery in the US (Mexico, China, Chile, Taiwan etc.), most emerging markets are trading at a discount to MSCI World, and to India. With the exception of MENA and Baltics, most trade within 15% discount to India. Any b-school kid will tell you that 6% growth (India’s 2010E growth est.) is about 15% more expensive than 3% growth (Ex-China and India 2010E growth est. for emerging markets), everything else being the same. In fact, if anything, India’s situation is not particularly similar to emerging market peers – India, for instance, is a poorer country with very liquid markets and one that respects investment interests.
India may not be a relatively attractive pick anymore for some, given 65%+ returns YTD, within the broader emerging equity asset class (up 55%+ YTD) but to call it’s valuation “relatively stretched” is likely the work of those that have missed the boat, and that means most hedge funds. Even a chimp can keep on shorting and eventually be proven right, just like a broken clock. I am not saying that Sensex wouldn’t face a relative sell-off but to attribute such an event to “stretched” valuations is comical.
DISCLAIMER: The information, opinions, estimates and projections contained in this post were prepared by me and constitute my current judgment. The information contained herein is believed to be reliable and has been obtained from sources believed to be reliable, but I make no representation or warranty, either expressed or implied, as to the accuracy, completeness or reliability of such information. I do not undertake, and have no duty, to advise you as to any information that comes to my attention after the date of this post or any changes in my opinion, estimates or projections. No part of this post can be reproduced without permission, unless reproduced with due credit provided for the source. Investment research is provided for information purposes only and does not constitute investment advice or an offer or solicitation to buy or sell any designated investments discussed herein. Please discuss with your investment advisor before investing.
.JPG)
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