Morgan Stanley’s Ruchir Sharma: Regulatory overkill biggest risk to India in 2018
KV Prasad Jun 13, 2022, 06:35 AM IST (Published)
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Ruchir Sharma, Head of Emerging Markets and Chief Global Strategist, Morgan Stanley Investment Management in an interview to CNBC-TV18’s Shereen Bhan spoke about India’s macro picture at the Rising India Summit. Below is the transcript of the interview Q: Over the course of past 24 hours, we have heard a lot of what is working …
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Ruchir Sharma, Head of Emerging Markets and Chief Global Strategist, Morgan Stanley Investment Management in an interview to CNBC-TV18’s Shereen Bhan spoke about India’s macro picture at the Rising India Summit.
Below is the transcript of the interview
Q: Over the course of past 24 hours, we have heard a lot of what is working for India, we are growing at little over 7%, macros looking little less favourable than last three years – on the basis of parameters that you track and you have 10 ways of identifying whether a nation is rising or falling, In 2018, how does India look to you?
A: My consistent narrative about India and this is something we have spoken about in the past is that ever since I have been tracking this for the last 25 years closely is that this is a country that consistently disappoints the optimist and the pessimist – if you get too lost with one narrative, you are likely to fail in India.
What we have seen is that a couple of years ago there was all optimism as if it was only a matter of time before we would get to 8-10 percent economy growth and that hasn’t happened. Now we are entering a critical period where the global economy is doing well but as far as India is concerned it is not been able to fully participate in this massive global economic revival that we have seen over the past 18 months or so.
Q: What has gone wrong?
A: I think there are two or three factors – the obvious ones are demonetisation and teething problems with GST. The one big problem which hasn’t been fixed in India and if one were to look at all the major economies in the world when they went through some sort of banking crisis, until the banking system was fixed it was very difficult for those countries to get back to their full potential – countries like US, Italy.
So, the financial system is really the archery, it lies at the heart of what a nation and do, and in terms of what its growth rate is and that for me has been the single biggest shortcoming of the last few years.
Q: It has been the biggest missed opportunity? You believe the government should have exercised the political majority it enjoys to be able to drive through banking reforms which in your mind means privatization?
A: Yes, there has been a lot of debate about privatization and whether that is the thing to do or not to do and all sorts of ideological debates have come about. However, to me it’s a simple number which tells you about what is going out here, which is that in India about two-third of assets are with public sector banks and this the highest of any democratic country in the world. The average across emerging markets is about one-third, so every country needs a public sector to meet social objectives. But there is no country like India where the figure is this lopsided.
For me that is the issue, and it is not about public versus private, it is about a balance that in the banking system the average number in which the share is there across the world is about one-third and India is at two-thirds. There is a side effect to this. If one were to look at all the incremental financial activity, it is all happening through the private sector banking – be it trade finance, credit cards, the massive retail leading that we are seeing — a bulk of it is happening through the private sector banks.
So, what India is seeing is privatisation by malign neglect, that it is not happening explicitly but the banking system is being privatized but at a huge cost. Whereas public sector banks are not only being destroyed in value but it is also choking the economic recovery.
If you ask me what is the biggest risk to India in 2018, the single biggest risk is that we have regulatory overkill
Q: Are we likely to see a regulatory overkill or we are already seeing it?
A: I think we have already seeing parts of it and this is manifesting itself in many ways. I do believe that some public sector banks are going to be completely frozen to lend given the sort of regulatory overkill that we are seeing currently.
Q: So you believe there is going to be a credit freeze?
A: Not a credit freeze because the private sector has seen such an increased share and they will keep lending but there are many side effects to this.
The first side effect is that the access to credit is going to get more and more directed towards the big companies with established credits. A problem in India, in the last few years and this is a global problem but it has been accentuated in India, is that big have gotten bigger. If one were to look at companies in each sector, the top companies have just kept gaining market share at the cost of the smaller companies and when there is this type of credit environment, it is the small and medium sized businesses that get hurt the most when you have risk aversion, which sets through. And a lot of private sector banks will be able to lend but a lot of public sector banks are going to be frozen.
Even the private sector banks are going to be much more cautious about who they are lending and what the credits are because the cost of making a bad loan has gone up a lot, it has almost become a criminal offence.
This is what India has to be careful about, we have to avoid this temptation for regulatory overkill and this has already been playing itself out in many ways, one is the banking sector.
The other statistic which is quite staggering is since 2014, 23,000 millionaires have left this country and in terms of what is going on here and to put it in global perspective – last year 7000 millionaires left this country, the largest number in recent times. The year before that it was 4000, so the number of millionaires leaving this country is going up. In absolute terms this is still behind China but as a share of total millionaires leaving this country, this is largest of any major nation in the world.
Q: How do you explain that?
A: Some will say this is a good thing that this is an anti-corruption drive and we are driving all the corrupt away but there is a major side effect of this because at the end of the day you need your own domestic people to invest in your country, which is very important. Foreign investment is important but domestic participation, domestic investors make a nation going forward. To me this has to be looked into that why are so many millionaires leaving this country and if one is happy about it because you think it is part of the anti-corruption drive, fair enough but when the number is highest in the world that should be a cause for concern.
Q: Since you talked about domestic investment, Deepak Karla who is part of start-up ecosystem had a point that India has taken ‘atithi devo bhava’ to a whole entire level, where you are welcoming foreign direct investment, foreign companies but at the cost of domestic entrepreneurship and not providing a level playing field? Does this number you gave us also perhaps has something to do with the point he made?
A: Yes that is absolutely true because if you go to Dubai today then you are likely to meet more Indians out there than in a restaurant in Bombay, Delhi.., so you can see where the capital is fleeing, what the magnets for capital are Dubai, Singapore, US and UK.
However, what is fascination about India is that how this country keeps on rising, your event is India Rising but I think this country is Forever Rising – it is on a continuous upward march but a chaotic one and for every positive story there is a negative story.
So, many domestic people are leaving, also the fact that big are getting bigger but this also remains a dream for investors like us because the highest number of quality companies in the world, we find in India. Over the last 5 years there have been about 70 companies in India with marketcap of at least a billion dollars, which have doubled in value. You don’t get that kind of richness in other emerging markets, for example in Russia we can find half a zone, in Brazil about 10-20. So, on one side you have this crony capitalism, which is out in all its ugly display. On other side you have this incredibly good companies that have given lot of value back to investors and they are high quality in terms of metrics like return on equity, consistent earnings growth, India ranks right up there compared to any nation in the world if you take it as a share of the total companies listed out here, is quite large.
So, it is a country we always want to be engaged with but obviously we keep looking at the fact that what more could be done for India to become like the next China. That has been the dream of so many who have been studying development economics and who have been in awe of China’s rise since the 1990’s and there I find no matter what happens, what the politics is, we consistently disappoint in terms of being the next China as an economic story.
Q: Where do you see the markets in India? You have talked about how you continue to be confident of investing in specific Indian companies that meet all the parameters and metrics that you have laid out for us – is it hard to find value in India today, given where prices are given where valuations are?
A: The biggest cliché in the world is that easy money has already been made because when you look back at the past and you find that it has been done. I don’t think there is always going to be an opportunity out here — yes, the fact is that a lot of optimism had crept in and some of that optimism is getting deflated very quickly but I don’t think this is ever going to be a market which is tank and be like Turkey, I see enough opportunities.
We are sufficiently engage, we see enough opportunity and there are enough high quality companies available out here. The good thing about the market is there is so much focus on this conference about politics – how much politics matters, elections are coming up what is going to happen as far as elections are concerned.
Q: You think it does not matter at all or is it limited?
A: I think the importance of politics in the India context is way exaggerated. I love following politics, I travel every time there is major election in India, I spend a week travelling with a band of people to figure out what is happening in that election and its fascinating. However, one thing I have learnt over the years is that do not draw any inference from the election results on what is going to happen to the economy or to the markets.
We think of market as an efficient beat but the Indian markets has always been wrong at least initially about the politics – what do I mean by that is that in 2004 when UPA first came to power, the market was limit-down for a couple of day, it was basically shut because there was such pessimism about what would happen under their regime, instead you ended up getting one of the biggest bull markets because we had this massive global boom which was going on. IN 2009, the opposite happens, UPA re-elected and on back of that all of the analyst who were skeptical of UPA think that government has come back, we will get political stability and the market was limit-up the next day and after that we had pretty severe downturn as far as economy was concerned because of global reasons. Similarly, in late 1990’s too similar patterns played out when Vajpayee government lost vote of confidence by one vote, the market was limit-down and then it began its upturn.
Therefore, my entire point is that it is fascinating to watch politics but the economy is such and the natural momentum is such that regardless of what happens in politics, a basic trajectory for the economy will continue.
Q: So you are saying will course along on a 7 percent plus kind of growth rate whether it is NDA or another form of government in office at the Centre but every time we talk about 8 percent plus growth rates there is talk that India needs to do structural reforms – these require political majority, political will, significant amount of political capital, so then can politics be really irrelevant to the economic story?
A: I think we are underestimating what the Indian polity is about and there was an interesting survey that was carried out – ‘World Value Survey’ carried out at the beginning of this decade where different countries were asked what is your attitude towards the private sector and India ranked amongst the lowest – most Indian had skeptical view about the private sector.
So I think there is no constituency for carrying out the kind of reforms that all the economists, Washington consensus wants the country to do. There was an opportunity possibly in 2015, when you had government with a majority and it took only a barb about ‘suit-boot ki Sarkar’ for them to shift course on that.
In Feb 2015, when the government presented is first full Budget that was the one opportunity this government had of trying to something absolutely dramatic. There were some proposals on the table – like cutting corporate tax rates down to Asean levels in a very dramatic way to Make-in-India a fillip. Also possibly thinking annulling the Bank Nationalization Act – these proposals were very much on the table but at the last minute the political will do to anything about it was limited – partly because they felt there was a constituency for it. At the same time we changed our GDP methodology – so all of sudden we started to grow at 7 percent during the worst of times and the feeling sank in that if we can do 7 percent at worse of times then why bother doing so much more. Therefore that played a real big role out there.
So, if there was a chance for something dramatic to happen, it could have happened in 2015 and also because you have a Prime Minister who has such great oratory skills that he could have tried to market this to a pretty skeptical Indian public. The Indian public is very skeptical of the private sector and there is great faith in wanting government jobs, although things have changed but that skepticism is still there.
So, that was the only time when I was waiting with baited breath, otherwise my approach is tune out of the politics, its total waste of time from an investing standpoint, from knowing where the economy is going to go and that the country will continue because of its very low per-capital income, a very low base and there is so much penetration opportunity across sectors that the country will keep growing at a natural buoyancy rate.
Q: You believe that the Indian economy is more or less decoupled from its politics and we will continue to traverse this 7 percent kind of growth rate?
A: I am not going to stick myself to 7 percent because if the global economy has a downturn there is no way that you get to 7 percent. There is a lot which can be done but that is just the reality of India which is that we all have a long laundry list of what needs to be done, some of it gets done but it is more in the form of incremental changes. When a new government comes to power they all carry out some incremental changes and by the time the government its term, it gets pretty much into quite complacent and much more about winning the election through populist schemes, that is just the pattern as far as India is concerned.
However I think that there is a bigger debate to be had here at some point in time which is that, why in this country is there such sort of skepticism also about the politics? One of the recent researches that we have done shows us this, that two out of three elections in India are lost. This is the mirror image of let us say the United States. So, in United States we did a similar exercise looking at the Presidential elections and looking at the state governed elections and there are more than 500 such instances since 1977 in the US as well and India, what we found here was that in US the opposite happens – which is the incumbent ends up winning the election and in India the opposite happens.
Q: So, there is no anti-incumbency there.
A: This term anti-incumbency has been coined in India. When I try and use the anti-incumbency in any of my columns which I write internationally, the editors have come back to me and said, what is this term? I think it is a very natural term but whoever deserves credit for it – anti-incumbent is the word which has been exclusively coined in India and it is an Indian phenomenon.
Even if you look at the other parliamentary democracies such as the UK, in the last two elections in the UK, 80 percent of the sitting members of parliament got re-elected.
Q: So, why is this the case here in India then?
A: This is where there has not been enough thought given to it that why is it that in India the default option is throw the bums out? In India we keep thinking that what will the politicians do? What will the government do? and what is the Congress Party doing etc, it almost doesn’t matter. The default option for any party is to lose, of course there are one third which win.
We tried to figure out is there any common factor as to why these one third of these people who win elections, why do they win elections? And is there a common factor as two why these two thirds of people who lose elections, why they lose elections? It is easier to come up with why the two third lose elections based on my travels and I think the single biggest reason why those two thirds of politicians in India lose power is because the state is broken and I believe this, which is that the average person sort of interfaces with say the local police person, the municipality person, the local bureaucrat and his or her interface with that is extremely harsh. It is a very tough experience. So, even if the Chief Minister or the Prime Minister maybe well intentioned, for the daily person dealing with this grind it is a very tough experience and you can see it – it is oppressive, it is corrupt and also it is understaffed. So, it is a very hard experience.
The average person basically every five years just wants change because he or she perceives that not much has changed for them on the ground. Of course there are some other peculiarities which make the default option in this country to just throw the bums out, one of them is that it takes very small vote shares – 4-5 percent vote swings and you get massive swings as far as seats are concerned. The other reason is that the political funding in this country is all done privately. So, winning an election has almost become like a business, which is that you need to spend money to win it and then when you win it, you want to try and recover the money and it is very tempting not to keep a part of it as far as the math is concerned. So, the allegations of corruption are very easy to stick as far as people are concerned.
However this for me is a very fascinating point that why are politicians not thinking more about why do they keep losing elections? It is such a tough country to win elections. Whether it is US or UK or the other mature democracies, there the default option is that the politician gets re-elected.
Q: So, the BJP should be worried, the NDA should be worried at this point in time?
A: It is very hard to predict as it is so early in the game. However my point is the fact that, that is the default option, that is just the history of Indian elections. Now the question is that there are some states which have been able to beat this trend – Gujarat was one of them, Orissa, Madhya Pradesh, they were able to beat this trend of anti-incumbency. Question is was there a common explanation? But for every explanation I have an opposing case. Chandrababu Naidu who was the hero of the reform movement in the early 2000s, he lost in 2004. I still remember traveling to Rajasthan in 2003 and of the 25 odd election trips that I have done, that was the one election trip where I can say that the group read it wrong. Usually when we go out on the road and we talk to people, we are able to sort of get the feel right and part of it was because just before we had gone Ashok Gehlot who was the Chief Minister, he had just been awarded as being the best Chief Minister of the country, the growth rates had picked up dramatically in Rajasthan, it was very visible in terms of what was going on. So, we went with a pre-conceived notion of almost that he is going to win and even though we got some discorded noises, we ignored it on the ground and he lost. He lost pretty badly that election.
So, that just showed you that even if you carry out lot of economic reforms and you do something, the default in many states is still to lose. There are many states in this country – Rajasthan, Karnataka where every five years no matter what happens you just change the government. Same thing was happening in Tamil Nadu until she beat the trend in 2016 and she beat it for all the wrong reasons. All the business people when we went there told us about how poor the state was being run on the ground, there was rampant alcoholism but yet because the opposition was sort of fragmented and she was able to do a lot of populism including alcoholism which she sort of abated, they were able to win that election. The same thing happened in Punjab. Since 1968 or something Punjab had never re-elected a government and it went the other way once and broke a trend.
So, this is the broader point, that the average experience of the average Indian is so harsh with the government or what it perceives to be the government, that their default option every five years is just to change.
Q: Global growth is looking strong today and India in fact hasn’t really converged with what we are seeing in the global economy, do you believe that that is likely to continue? Do you believe that the US stock markets for instance are likely to continue to rally or do you believe we are at a peak?
A: One very important reason as to why markets across the world have done so well like over the last decade was because you had zero interest rates, you had easy money. I think that has been a very powerful explanation for why markets have done really well. I think that era is coming to an end. The question is how quickly but it is a question of not if but when. I think that has major implications because it is only when the tide runs out do we know who is swimming naked. I suspect there are lot of people out there without clothes that we will find out in 12-18 months’ time.
So, this flood of liquidity is currently ebbing and that is what is going to pose problems for markets over the next 12-18 months globally. Also global growth isn’t what it used to be and one of the most important reasons for that which I have been speaking about has to do with demographics. This is where India had the opportunity but hasn’t capitalised on it. What do I mean by that? There are two drivers of economic growth – one of them is the increase in productivity and second is the increase in the number of people coming to work – the labour force.
Across the world we have gone from a situation of worrying about the population bomb to now worrying about the population de-bomb which is the fact that we are beginning to see a big fall in the world’s population growth rates and the working age population growth rates. Today there are nearly 40 countries in the world where their working age population is shrinking. This is absolutely unprecedented over the last century or so.
In the mid-1980s there were only two countries in the world where the working age population was shrinking, I think it was Afghanistan and Hungary but now we are seeing 40 countries in the world where the working age population is shrinking or close to that, including China, including Japan, Italy, Germany. So, that is a major headwind to economic growth because you just don’t have enough people there. So, that is one of the ironies that we sort of speak about, that we speak here about an employment crisis or whatever is going on and across the developed world today, unemployment is at a 40 year low. Even globally when we look at it since we have data over the last couple of decades, this is the lowest unemployment rate that the world has seen. So, everywhere in fact there are jobs, jobs and jobs because of the demographic shift that we have seen across the world. The irony is here that we keep speaking about lack of jobs. So, to me that is a very stark contrast more than even the growth disconnect. I think the growth disconnect – we can make up for it after these shocks sort of pass although we will never get to full potential but to me this is a much deeper problem which is that when the world economy today and the developed world has the lowest unemployment rate in 40 years, why do we even have any concern about job creation out here.
Q: What do you believe is going to be the remedy to that? The government is putting out its own set of data to show that the unemployment situation isn’t as bad as its made out to be by the opposition but we do know that there is a problem not just on the jobs front, there is a problem on the skills front as well. How bad is it likely to get from hereon given the demographic dividend that we haven’t been able to capitalise on?
A: If you look at the success stories across the world, their key to success was all the same thing which is they all exported their way to prosperity. They exported their way to prosperity by producing low end manufacturing goods. It is low end manufacturing goods where you end up getting a huge amount of employment growth as well.
Q: That bus we have missed. Manufacturing share to GDP for the last five years has remained consistently at 16 percent, we haven’t moved higher at all?
A: The global environment has got more difficult but to say we have missed the bus may not be quite accurate because in our neighbourhood, look at Bangladesh, Vietnam, Cambodia, all these places are picking up the low end manufacturing share from where China is vacating it. We haven’t been able to do that. It also gets more difficult because we are now in an era of de-globalisation which is the fact that it is becoming much more difficult to export your way to prosperity. For the great period from 1980s right up until the global financial crisis, global trade increased at 2-3 times the pace of global GDP. Now global trade as a share of GDP is in fact falling. So, this is a major headwind that we have run into. However the focus has to be on low end manufacturing. It sounds a bit unsexy because we all want to talk about technological prowess and do very high end manufacturing and stuff but that is just not the formula. Even China, it is only now migrating towards high end manufacturing.
Q: Are we competitive enough to be able to capture that share of low end manufacturing?
A: The evidence has been no but a lot of it has to do with the fact that the infrastructure that we provide, the labour laws that we have in the country, those are the factors which have really disappointed it. However we did see in last decade the main reason the economy grew at 8-9 percent was because export growth every year was 30 percent and now we are down to 10 percent. So, when you get 30 percent export growth, that is the way to do it and now we basically have regress where it is getting very difficult for us to even clock double digit export growth. So, that is the big shift which has happened.
Q: You rightly pointed out that the export engine isn’t firing for us, in fact after several years of decline, we are now starting to see an uptick and we are clocking at about 10 percent today. Without that how realistic is this 8 percent growth number?
A: I don’t want to get wedded to a number. Firstly in the global economy today nobody is growing at above 8 percent. Even among the smaller nations, at the peak in 2007 when you were at peak of the boom, there were 40-50 countries which were growing at above 7-8 percent. Today there are may be 4-5 countries.
Q: So, we will continue to be the fastest growing economy?
A: Yes but that is a great marketing tag, the entire issue with that is that our base is much lower. China’s base is 4 times higher than ours in terms of per capita income, in terms of economic size and it is much easier to grow from a much lower base compared to a higher base. India has enough natural resilience and there is enough sort of policy tinkering which is done to make sure that we keep growing at a steady pace. I don’t know whether the real number is 6 or 7 percent but it is somewhere in that corridor. However to aspire for 8-10 percent economic growth has not only become more difficult because the global environment is much more challenging but also the fact that if we couldn’t carry out the kind of breakthrough reforms for which we had the window in 2015, the odds that any of that is going to happen in the foreseeable future is very low. So, it is unlikely that is going to happen in terms for us to get to 8-10 percent unless the global economy all of a sudden confounds me and goes back to growing like it did last decade and our exports then can somehow pick off on the back of that.
Q: One of the other challenges or constraints that we are going to have to deal with as an economy and perhaps one of the most important ones is income inequality. This is one of the parameters that you look at when you judge whether a nation is rising or falling, on that parameter specifically how concerned would you be today?
A: Income inequality is a global concern. Question is that when does it become such a big concern that it begins to cramp your space for carrying out reforms and that leads to an anti-rich kind of movement? In that regard I think India has made some progress over the last few years. There are two or three ways that we look at it – we look at the list of billionaires because that is very real time way of looking at it and seeing that how many billionaires in the world – so called bad billionaires versus good billionaires, it is a broad categorisation that sort of billionaires coming from sectors where the government is involved or you need government help to do that, typically we classify as bad and good is when they come in sectors such as manufacturing, technology which is basically less state reliant to grow. India has become very skewed at the beginning of this decade in terms of the good to bad billionaire kind of ratio. Believe it or not over the last 4-5 years that ratio has changed favourably. The number of good billionaires in India coming from sectors such as manufacturing, technology etc has gone up considerably. This has been helped by the fact that global commodity cycle has collapsed and lot of bad billionaires do come from that segment but at least we have seen a massive pickup on it.
However the thing that still jars for me a bit is the number of inherited billionaires in this country. The number of inherited billionaires in terms of people who have technically inherited their wealth is about 60 percent in terms of the total number. That is again about twice as high as the emerging market average or global average and I think there are only couple of countries in the world where the number is even higher, possibly I think Indonesia and South Africa. This is why the culture of dynasty pervades across our society. It is not just politics, it has got to do with business as well. When you have 60 percent of your billionaires basically have inherited their wealth and that is twice as high as the average number for other developing countries, that just tells you that this is a societal issue, it is not an issue about just politics or business.
Q: In terms of your to do list, what is the number one priority that you would put down?
A: There is a theoretical stuff and there is realistic stuff. Theoretically as I said the banking system privatisation would have been top of my list but it is unlikely to happen. The best hope India has is to keep ushering in an era of competitive federalism which is that the action has to be more and more decentralised and the states have to do more and more. Whether it is the BJP government or that could even be one of the upsides of a coalition government, is that you have to give more and more power to the states – whether it is labour laws, whether it is other things to set up SEZs or manufacturing, the states have to get more and more power. In that regard, I don’t like it when the Centre imposes cesses which only go to the Centre, don’t go to the states. So, if you ask me most realistically what can be done given the way the Indian polity is moving, is basically much more competitive federalism where you get much more competition between states to attract investment and to improve things.
Q: We are seeing competitive federalism, we are also seeing much more co-operation now on account of the advent of the Goods and Services Tax (GST). You have got the GST council which is virtually deciding indirect taxes now for everybody. So, the states have had to give up that autonomy altogether?
A: Give up the autonomy but to participate in it which is a good thing. However much more power to be given to the states in terms of what to do with their stuff. So, the more competitive federalism you have and the Centre just sticks to the basics, I think that is the best hope for India given the way the polity is moving over the next few years. So, that is the realistic hope. The theoretical stuff, is there any constituency at all here which is going to say that lets privatise these banks? No.
Q: In Air India they still might retain about 26 percent but are you surprised with that one?
A: You can get one marquee privatisation but I am talking about the culture. The banking system is at the heart of it, that is where no economy is able to grow rapidly without a vibrant banking system. As I said the share that India has there of the government is about the highest in the world.
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KV Prasad Journo follow politics, process in Parliament and US Congress. Former Congressional APSA-Fulbright Fellow
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