Summary: As inflation soars to 13%, and with the manufacturing and infrastructure sectors now in the midst of a decisive slowdown, international and Indian investors need to revisit the fundamentals which triggered the India growth story nearly three years ago. Was India Rising merely a slogan adopted on the back of the exponential growth in disposable incomes within upper middle class Indians? And, were government issued statistics, and related forecasts, entirely misleading since they failed to encompass the future impact of growth, not in the gross domestic product, but in the poor-rich divide?
Over 250 million Indians continue to live on less than one dollar a day; roughly 600 million more live on less than two dollars. But, a dollar or two apart, if national poverty statistics are calculated on the bases of a basket of essentials, India is mired in poverty. Despite hundreds, probably thousands, of anti-poverty initiatives adopted since Indian independence in 1947, the wealth distribution matrix continues to shift, year after year, in favour of industrialists, landlords, money lenders, criminal syndicates and, of late, the 75-million strong upper middle class.
Blaming rising energy and commodity prices, New Delhi has just announced a downward revision in the 2007 growth estimate to 7.7%, from 9%. But already, a broad range of economists are emphasizing that 5% is a more realistic target for 2008. “Then, of course, we have to see the impact of the monsoons on the harvest,” a senior cabinet minister said yesterday on condition of anonymity. “Mother Nature remains the biggest single component of national performance data, regardless of the marked expansion in manufacturing and services.”
International asset managers have failed to understand the most fundamental of truisms: that India Rising is a meaningless slogan without significant, material and sustainable changes in the vast agrarian hinterland, where 75% of Indians live. While it is quite possible for an investor to extract short and medium term profits from a stock market driven by massive infrastructure spending, consumer demand and the outsourcing window, it is not prudent for portfolio strategists to assume that the factors which justify short and medium term trading lay the foundations for longer term rewards.
In other words, India-related valuations currently employed by equity and debt investors need to be dramatically revised downwards. The price of oil and food is now placing tremendous pressures on middle class families who have been surviving or thriving, thus far, on ill-advised credit; the poor are already enveloped by a sense of desperation and hopelessness. With domestic interest rates trending higher, default ratios for mortgages and credit card loans are due for a sharp rise towards the end of this year. More importantly, while rural poverty and marginalization is sparking unrest in at least two dozen pockets of conflict, the working poor in India’s cities are rapidly embracing the agendas of radical religious and social groups.
Quite obviously, the level of impoverishment has not kept pace with the growth of political consciousness, as many Indian progressive and leftist intellectuals would have liked; as such, nobody should expect anything remotely similar to a mass revolution. But impoverishment does impose severe constraints on consumer surpluses and purchasing power, and on debt servicing abilities on usurious loans. The question is: at what point will the collective degradation in family balance sheets, in the villages and in the townships, cause a genuine reversal of the real growth cycle?
Bear in mind that, as opposed to the commonly-recognized GDP, real growth in India needs to be measured by benchmarks which fully incorporate all the intermediate stages of production, starting with the agricultural sector, and which identify core trends governing the process of capital formation and capital spending.
The GDP framework is not structured to incorporate one other salient fact: that the Indian economy is, to a considerable extent, driven by the vast pool of underground capital, acquired through organized criminal activity, illegal logging, loan sharking, smuggling, widespread corruption and, of course, plain old-fashioned tax avoidance. Estimates of the size of underground capital vary; but conservative figures range from 25% of the official economy in places like Delhi and Punjab, to 50%-plus in Mumbai, and in certain cities in the states of Uttar Pradesh and Bihar.
Hardly any Indian economist has credibly explained the impact, negative or otherwise, of black money on national growth. Government statistics do not venture to engage the issue, and for good reason. Since more than 70% of India’s politicians survive on, or are the beneficiary of, handouts from the perpetrators of such money. But underground surpluses will, at the first signs of economic or political uncertainly, begin moving away from cash-generating activities to find homes either in non-dynamic items like gold or in offshore deposits which clearly offer a play on potential declines in the worth of the Indian Rupee over the next decade; at least three Dubai hawala outlets confirm a steady flow of transfers from India and Pakistan in recent weeks.
The inherent problems pertaining to the wealth gap between rich and poor, the inability to substantially upgrade the agricultural infrastructure over many decades, the vagaries of the monsoon rainfall, the looming prospects of loan defaults and the forthcoming capital allocation adjustments in the underground economy, all create unprecedented risks for international investors today. Are the rating agencies capable of defining those risks? That is the question which mutual fund managers should be asking prior to selling India Rising to their retail participants at this juncture.
