Lamenting that the whatever economic reforms the government has done have been incremental rather than 'big-bang', noted Morgan Stanley analyst Ruchir Sharma said the Narendra Modi government should have been quicker in its first year of government when it had more political capital.
Lamenting that the whatever economic reforms the government has done have been incremental rather than 'big-bang', noted Morgan Stanley analyst Ruchir Sharma said the Narendra Modi government should have been quicker in its first year of government when it had more political capital.
Speaking with CNBC-TV18's Shereen Bhan in New York, who is there to cover Finance Minster Arun Jaitley's US visit, Sharma picked out the lack of big initiatives towards recapitalizing state-owned banks as particular failure on the part of the government.
"All of this is reflecting in the market where expectations are being reset and the hope that there will be an economic miracle are sort of being dialled back," the emerging market head of Morgan Stanley Investment Management, and author of the best-selling Breakout Nations said.
Sharma also tore into the government's revised gross domestic product numbers, that have shown India as the world's fastest-growing large economy, and said they were 'non-sense'.
"This [the GDP growth number] is the most ridiculous thing I've seen from any country in the recent past. It is hurting our credibility," he said, maintaining that India could not be growing anymore than 6 percent.
Excerpts from the interview on CNBC-TV18.
Q: September last year is the last conversation that we had when we were here in the US tracking Prime Minister Modi's visit and then you were talking about how India was in the midst of a hope rally and historical data shows that the first year for government is when you actually see the markets go up and unless and until the government backs it up with reforms year 2 is a year of correction. Are we in the year of correction in India today?
A: It seems so, that is what the markets verdict is. There was a lot of hope built-up in the first year. We got some incremental change but not the kind of big bang reform that some people were expecting. If you look at the history that is what tends to happen. If you do not get that big bang reform in the first year it is very difficult to do that in the second year or in the third year because then the opposition tends to regroup.
Q: Let us talk about these big bang reforms, everyone talks about how the government ought to do big bang reforms, what would the market have liked to see in terms of big bang reforms?
A: The single biggest thing is the fact that something needed to be done about the public sector banks. You cannot have a system where 70 percent of the assets are controlled by public sector banks and those public sector banks have such non-performing loans which are not properly recognised for a long period of time, that is just a lot of wrought in the system.
The basic rule of growth is you need credit growth to try and fuel growth, not excessive credit growth but some credit growth and that is being choked. So, the fact that, that has not been addressed and not enough money has been spent to try and solve that problem to me has been one of the biggest missed opportunities in the first year.
Q: You think the Reserve Bank governor writing to the Finance Minister saying you need to put in more money as far as recapitalisation is concerned is the need of the hour today and if the government were not to heed to that advice we are going to be going down a sorry road?
A: I think so but even more could have been done. I agree that now it can't be done but in the first few months you can argue that some major stake sales in public sector banks, not privatisation because that is a taboo word in India.
Q: They said that they could bring it down to 52 percent.
A: Yes, or some innovative solution about doing something below 52 percent with non-voting shares, something like that needed to be done and i think that is not what we have seen and so to be that is one of the biggest constraints for growth currently.
Q: What are the other misses?
A: In terms of doing something in terms of allocating more money away from some of the subsidies to infrastructure projects that really is the modern day debate. In the old days the debate in economics used to be guns versus butter. The modern day debate really is subsides versus infrastructure.
We have to all understand there is only that much money that a government can spend and the private sector is not good at infrastructure. If you look historically it is really the public sector which plays a dominant role in infrastructure. China spends 10 percent of its GDP on infrastructure but the reason why it is able to do that is because it doesn't spend that much on subsidies.
Q: Don\\'t you think that they are making the right moves, they are sort of now trying to link everything to the DBT, they are even talking about Kerosene being linked to DBT, dont you think that at least directionally they are headed in the right way as far as subsidy rationalisation is concerned?
A: That\\'s what i said. The changes have been incremental but nothing which is big bang and that is fair in terms of the fact that may be in India we can\\'t see these big bang reforms, the political economy doesn\\'t allow for that to happen. However whatever had to happen according to me needed to happen in the first few months when the political capital was at its peak.
Now the political capital is beginning to decay and it is very difficult to get that done. What we are seeing in the market is exactly that. There is an expectations reset which is going on, which is the fact that the hope that India could be the next economic miracle is sort of being dialled back. I am not saying it is sort of being extinguished but it is being dialled back. So, what we have now is a path where the Indian economy can grow at 6-7 percent...
Q: [Interrupts] Not 8.5 percent or 9 percent or 10 percent which is the government's projection and forecast?
A: I think those government projections are completely off the mark.
Q: You don't buy the GDP numbers?
A: I think those GDP numbers are complete nonsense. I really feel that this is the most ridiculous thing that i have seen from any country in the recent past.
Q: Is it hurting India's credibility instead of boosting our confidence?
A: Of course it is. At a time when the global economy is growing at pace of little more than 2 percent and the growth rate in emerging markets has halved from a rate of 8 percent at the peak last decade to less than 4 percent just now. Ex-China it is just 2.5 percent,
To claim that the Indian economy is growing at 7.5 percent with exports slumping -- which was the big contributor to growth last decade -- is absolutely ridiculous.
Where are the signs of this domestic boom? There is something called as measured economy and something called as experienced economy. Who is experiencing the 7.5 percent economic growth in India, i want to know who these people are?
I think this has been the single biggest falling of this government which is not to have put an end to this controversy much earlier and to have used this data to falsely claim that we are growing faster than China.
China's economy is slowing down but to compare with China is anyway misleading but to sort of go ahead with this data to me has been the single biggest pitfall of this government.
Q: I want to address the China issue because i remember you wrote that China's slowing down shouldn't be seen as a victory for Narendra Modi's government and you are absolutely right, it is misleading to do this India China comparison because you have written about how China\\'s economic miracle has already happened and we are still aspiring to create an economic miracle for ourselves. How do you see now the India China context? There is a lot of talk about Modi's visit to China and how expectations on the India China front have been reset, do you really believe that?
A: I really feel that these groupings are just great marketing exercises with absolutely no fundamental value. So, comparing India and China is cool because these are two large economies based in Asia but there is nothing in common between them even in terms of size.
The Chinese economy is multiple size India\\'s economy. India today is where China was about 20 years ago. So, these comparisons are completely misleading according to me. Having said that we can aspire to be like China and try and grow as fast as China did but then we have to sort of understand what exactly China did.
They took some pretty big risks with economic reforms. Every few years they took some very big risks and those risks paid off. If you are not willing to take those risks we should not aspire to be that. The attitude in India often tends to be where else will the money go? It has got to come to India, this is the best story in the world and you here these clichés and these banana statements.
Q: It is no longer the best story in the world? Even the folks are Morgan Stanley back in India say that India is the only game in town but you don't buy that?
A: No, I think that is a very dangerous analysis according to me because that leads to complacency. That sort of makes you believe that where else will the money go, it has got to come here, this is the only place where it will go. These dynamics shift very quickly.
We are also in an environment where the overall environment for emerging markets is not that conducive. The overall flows to emerging markets haven't been that strong and this is not what the case was last decade. Once again we tend to have i think a very insular analysis of what is happening just in India and not realising that we are operating in a global world out here. The last decades boom was a lot to do with the global emerging market boom.
Even if you look at the stock market, around half the earnings of the stock market really come from external sources. We try and sort of project how much the stock market earnings will be or growth will be based on what the domestic economy is doing but there is also like an external economy.
That external economy affects both our growth rate and also half the year earnings of the stock market and i think that is something which is forgotten in this entire analysis which is very insular only about India.
Q: Let us talk about the risk to capital flow especially into countries like India and the emerging market basket if we are not the only game in town what do you anticipate in terms of capital flows and especially if we do see the Fed move in September or December -- I don't know what is your take on that -- given what we have heard from Janet Yellen?
A: Yes, as I said so even in September when we last did this interview that my basic analysis is that the flows in general will not be very strong because a lot of moneys which has gone into emerging markets over the last decade is sort of tired money and even in the case of India you have many stale bulls in the international investment community. So to expect too much capital flows into India is going to be a bit of a stretch.
Also globally we really have to be mindful of one thing that we have been in the super easy liquidity environment in the last few years and that liquidity environment is only going to get less favourable in the coming couple of years. What their exact pace is - is still up for debate but it is going to be less favourable and so, it is going to be much tougher to compete for money in that environment. So, I do not expect flows to be anywhere as storing as they were last decade and it is going to be lot more difficult and even internationally as I have written I really feel that asset prices are very high everywhere. In every single places asset prices have been inflated by super easy liquidity conditions and as the Fed does some sort of normalisation you should expect asset prices to do that well.
In the case of the US you look at the point here, we have gone through now one of the longest spells in US stock market history without even a 10 percent correction and that is because many people believe that good news is good news that the Fed sort of doesn\\'t raise interest rates even that is good news. So, bad news is also good news because it won\\'t raise interest rates because you believe that the Fed is sort of concerned about the economy and if the economy does well that is good news any way.
That sort of analysis has lead to a lot of complacency amongst stock market investors and investors worldwide and it is natural to expect that you are going to see some sort of correction take place out there which is also going to affect India over the next 6 to 12 months. I mean how long is the US stock market going to go on without even a 10 percent correction, that is just very unrealistic.
Q: So, speaking of corrections now and you talk about a 12 percent correction, that is what historical suggests. In year two of the government, we have already seen that in India. How much more of a downside, do you expect then given the fact that you are not seeing the kind of big-bang reforms that you would expect and the government seems to be moving on incremental reforms? And you do not believe the growth numbers that the government is putting out and we actually have not seen things turn around for the economy?
A: I think we have seen some sequential improvements. I mean, you take away the headline numbers. I was there in India recently and what I think that I do see is that I see some sequential improvement in terms of some of the consumption indication do suggest that in the months of April. May... (Interrupted)
Q: Well, we have had a good Index of Industrial Production (IIP) number come up.
A: That is the one month number, but in general I think you are seeing some sequential improvement. So, maybe the economy is not growing at seven and half percent as projected, maybe it is growing at five and a half, six percent. But that is possibly better than maybe five percent, which was there at this time a year ago. So, I really feel that we have seen an improvement as far as the Indian economy is concerned. It is just that the improvement is not as strong as people expected it to be. And those inflated expectations are being snuffed out. So, I do not see India doing much worse in relative terms from here. But in absolute terms the risk remains that if you do get an international correction finally the US corrects and at some point at the end of this year as the Fed does increase interest rates and you do get a correction, that is undoubtedly going to affect us in absolute terms.
Q: One of the other trigger is that global markets are watching out for is of course what happens to Greece. You are just back from Greece, so Grexit, is it a reality? July, 1 is looming large, what is the likely impact of what happens in Greece on equity markets around the world?
A: At this stage I really believe that the world is that many people are very prepared for what is going to happen in Greece, in terms of if there will be a Grexit. But Greece itself, will face the brunt of it. So, I hate to say it, but it is in a very unequal situation where if there is a Grexit, my suspicion is that the world will feel minor tremors, there will be some tremors for a while, but the real tremors will be felt in Greece, as everyone is saying that this is the next Argentina which is going down this path.
Q: But, what are the odds of a Grexit?
A: I still feel that some sort of a deal will be hatched at the last minute because of the fact that the most interesting number which I have kept a focus on is that 70 percent of Greeks in opinion polls say, they want a deal; they do not want to leave the euro. So, despite the intense pain which has been inflicted over the last five years and the massive cuts they have taken to their social security system and other welfare benefits, most people in Greece, want to remain within the euro because they think the alternative is worse. I think that logic is possibly going to dictate a deal in the end despite all this brinksmanship which is going on at this juncture. Having said that, there is scope for an accident, but if there is an accident and Greece does tumble out of the euro, they are the ones who will suffer. The rest of the world is much more prepared for this event. Even the European Central Bank is much more prepared to deal with this. So, everyone likes to think that Greece could be the next ‘Lehman moment’ that something happens and there is a disconnect in markets worldwide. But, I feel that the big change which is taking place is that the rest of the world is very aware of the risk is being telegraphed and a lot of the banks have gotten out of Greece. So, that contagion risk has been contained because of that.
Q: Since we are talking about Central Banks, let me ask you about the Central Bank in India and there is this constant battle on whether the Reserve Bank should be more aggressive when it comes to monetary easing. Look at what is happening around the world, look at what is happening in China an Japan and so on and so forth. And of course, the Finance Ministry has made no secret about the fact that they would like rates to come down significantly. Do you anticipate at least another round of rate cuts, another 25-50 basis points? What is your own expectation in terms of rates?
A: I think that to expect another 25-50 basis points is realistic, we could that because the global inflation picture still remains very benign. In India’s case, the increase in minimum support prices is something which contributed to inflation is sort of now much more moderate than it uesd to be. So, inflation does seem to be on a downward path. But I am also sympathetic with what the Central bank is doing in India because we have just had the worst inflation experience in India in its post independence history. The five year inflation track record of India up to 2014 was the worst relative to the world that India had ever experienced in its post independence history. Now, that is a shameful track record to have and that is something which the Central Bank really wants to set right here because they were clearly behind the curve and too slow in doing stuff between the 2009 and 2014 period and they really want to make sure that they stamp out this inflation expectations once and for all. So, I would say that eventually the Central bank will do what inflation does. It is just being over cautious given India’s inflation experience in the past. But, we should put this in perspective that no country went to as bad an inflation track record, no major emerging market. We love to boast that how we are one of the fastest growing emerging markets in the world among the large economies. But let us also not forget that we have had one of the worst inflation track records of any major emerging market in the world in the last five years and we are trying to correct for that. So, growth and inflation and what the Central Bank is trying to do that is to sort of sniff that out. So, I still feel that rates will come down and the Central Bank is possibly being a bit cautious.
Q: Since we are talking about emerging market, in the last conversation that we had, you were extremely bullish about the turn around that we were seeing in the US economy and you said that the US economy was the one bright spot along with India and a few other countries that you were watching out for. 2015, what is looking good to you and interesting to you?
A: Well, the US economy is still healing and I think that the first quarter was weak but the US economy is still healing. The second quarter we have seen consumption do quite well, the unemployment rate is falling, jobs are being created, the middle class in general is feeling much better out here. You walk around New York, you can see the buzz in the city. So, I feel that the US economy is okay. But the other bright spots in the world, there are few and far between. Every emerging market I go to, we are seeing a big slow down. In the case of China, the growth rate is possibly currently running at five to six percent or so if not even lower.
Q: And it is being inflicted by the kiss of debt is what you call it.
A: Yes because China has seen this debt binge which has taken place in the last five years. Whenever any country has taken that kind of debt over a short span of time, it is always paid back in terms of lower growth in the subsequent five years and China is following that path. But, even some of the other large emerging markets, like I was in Indonesia last month. Even there for the first time, I am really seeing signs that consumption in Indonesia is beginning to fall significantly. So, there are signs of a slowdown everywhere across emerging markets.
But, ironically, in the developed world, we are seeing some bright spots now. So, the US is still healing albeit at a slower pace. Europe, the real surprise in the data this year has come out of Europe. If you look at the data out of mainland Europe, from Germany to even the like so Italy and France, we are seeing some increase in economic activity in economic activity in Europe because they have suffered two recessions in six years so, there is a lot of catch up for them to do. And the other surprise has been Japan too. In Japan, the data has been much stronger this year with economy growing at two percent or so which for a Japanese economy where the population is contracting is a significant number.
So, what we are seeing here is the world being turned on its head. Last decade, we all were celebrating the various emerging markets and how these markets were going to converge with the developed world. Now, after the crisis we have seen many emerging markets are paying the price for having taken on too much debt led by the likes of China and even the in the case of India. We are suffering from the fact that we had this big debt build up last decade in the public sector banks in particular they are paying the price for that now with large non-performing loans. And in the case of the US, Europe and even Japan, we are seeing signs of healing finally. So, the world is being turned on its head and that is what makes it more difficult to attract capital towards emerging markets when the developed world is healing and doing better than it was last decade.
Q: So, for India to compete with the developed world and other emerging markets to actually get the capital coming in whether it is institutional investment or a strategic investment. We have talked about some of the things that you would like to see this government address, of course, non-performing assets as far as public sector banks is concerned, subsidy rationalisation. You were quite bullish about this business of devolution giving more power to states. At least they have seemed to have moved in that direction. Especially, with the acceptance of the 14th finance commission’s recommendations, so, what else would you like to see beyond that?
A: The most important thing is tax reform. Just look at the mess we have on tax reform. And this has just not got to do with the entire thing of retrospective taxes, but even the current tax code, the way it is structured two leg interpretations. It just is a very big complicated tax code and at a time when the world is really bringing tax rates down to try, in corporate taxes.
Q: So, they said that they would like to bring corporate taxes down to 25 percent.
A: But it is still very gradual. If you really want to give a big boost to investment and even here in the US, if you look at what the US presidential hopefuls are talking about on the republican side in particular, they are really talking about trying to lower the corporate tax rate to try and bring more money back into here. So, everyone is competing for capital and if you want more capital, you need to reduce tax rates particularly on corporate tax rates. That is something which in India, you could do more and possibly like a bit faster to compete with the RCR nations. We speak about this whole manufacturing debate and we speak about the fact that how difficult it is now to compete on manufacturing given what is happening in the rest of the world with de industrialisation and de globalisation. But, in countries like Vietnam, or even Bangladesh, manufacturing is actually doing quite well. So, there is something to compete there. Now, take the case of Vietnam. This is a communist country. You expect this communist country to not be that market friendly and yet when it comes to attracting foreign investment, foreign direct investment (FDI) is pouring into Vietnam. Now, if you see that around us, maybe not nations the size of China, the likes of Vietnam, the likes of Phillipines, the likes of Thailand, the likes of even Bangladesh, these countries are doing their bit to try and attract manufacturing and we have to compete with them. So, the one attitude in India which has to change is where else will this money go.
Q: So, given where things currently are, what looks good to you in India at this point in time? What are the themes that you think will be able to outperform whether it is incremental reforms, the lack of big changes as far as taxes are concerned? Which sectors would you continue to feel confident about?
A: If you look at what our team is doing India, in terms of where they are really putting their money where their mouth is, which is that they continue to invest in private sector banks, they continue to invest in pharmaceutical companies as far as India is concerned and they are playing parts of the recovery story in things like some recovery in auto sales which is taking place. Some recovery which is taking place in industrial activity at the margin, we are playing that. So, that is where they are and I feel that in India, it is a quality regime and that is one of those things which has frustrated many investors which is that they all though that as you get this big hope and you get this big revival in India, a lot of the junk will also rally Instead what we are seeing in India is that the quality regime has continued and all these advocates of buying these low quality stocks in India has got burned over the last few years and particularly over the last year. And I do not see a change in that regime. I still feel that quality is the way to go as far as India is concerned because the recovery is in the works but it is a gradual recovery. And the entire dynamic is changing. Now, unfortunately a lot of the action is taking place in the private markets as well which is where you get all this e-commerce, this entire new tech emerging now. There is a lot of money available in that space. So, there is a new India which is emerging right in front of us, but it takes time for that to become apparent in the stock market. And that is really where the energy is being directed. But the old India is continuing to slide away and I do not see that changing.
Q: The Finance Minister is here in New York and in fact he is going to do this nine day tour though New York, DC and San Francisco trying to reassure investors about the India story. What is it that you believe that investors are going to be watching out for specifically?
A: From a Finance Minister, they are going to ask questions related to possibly the Finance Ministry that I bet he is going to be bugged about the question about the whole taxes. That is going to be everyone’s favourite question and stuff. But, you know how it is, that these road shows take place, I have seen them in many countries. We get all sorts of Finance Ministers who come and visit us here and try and tell us about what is happening in their country and these official lines is not something which we really go by. You try and read between the lines, you try and see what exactly is the body language, what exactly is being said. So, it is fine to do these kind of road shows.
Q: So, if you were to read between the lines today, what would your headline be on India?
A: The headlines on India will be that the window for this big bang reforms is possibly behind us, but we are still hoping that some marginal reforms can continue, there has been some talk about labour market reforms being accelerated and the other story in India which is the action lies in the states and at centre the capacity for the Centre to do much is not that much. So, in that case the story for the last 20-30 years has been that always be short on what the government does and be long on what the private sector does in India because the government systematically disappoints. I do not see that changing too much. Sure, we have been offered a so called cleaner government and stuff but in terms of execution it always lags what has been promised and we get excited periodically about what is going to be delivered and we systematically get disappointed and yet the private sector in many ways the quality people in the private sector continue to march ahead. I still feel that regime is in place in India despite all this hype which takes place every few years.