When times are tough, any good news is an excuse for a party.
That was the message from India’s stockmarket last week. The Sensex soared 17% on Monday 18th after it became clear than the ruling coalition had won re-election with a far bigger majority than expected.
Undoubtedly the result is a major positive for India. But it’s probably not as big a deal as markets are suggesting. Prime Minister Manmohan Singh may now have a much stronger mandate, but he can’t work miracles.
Take a closer look and the economy faces plenty of obstacles, both short and long term. The euphoria is likely to run for a while, but India now looks especially vulnerable to a big pullback if we have another sell off later in the year…
A convincing win for Congress
First, let’s take a look at what’s so good about this result. The Indian National Congress and its partners in the United Progressive Alliance (UPA) coalition have won 262 seats in the Lok Sabha, the directly elected and more powerful part of India’s parliament.
That’s just short of the 272 seats needed for an absolute majority, but puts the UPA in a very strong position when it comes to forming alliances with other parties. Previously, the UPA had to link up with virtually every small party with whom it could conceivably work. Now it will be able to control or exclude some of the more awkward leftists with which it previously had to compromise.
That means more freedom for Singh and other reformers to push through measures to free up India’s excessively bureaucratic economy. And they should be able to resume plans to privatise energy firms over the next couple of years, using the proceeds to strengthen India’s deteriorating fiscal position.
Even more important that what did happen is what didn’t. The threat of the UPA being pushed out by a new Third Front coalition dominated by hard leftists was seen as a real one earlier in the year. That threat – which could have set India back many years – has totally failed to materialise.
More recently, pre-election polls had suggested that India might end up with a very weak coalition or minority government, dependent on political horse-trading to pass laws. In the event the UPA comfortably outperformed the polls (which are understandably pretty inaccurate in a country as large and diverse as India).
Finally, while the opposing Bharatiya Janata Party and its National Democratic Alliance coalition, which the UPA ousted in 2004, is pro-business and pro-reform, its Hindu nationalist policies aren’t helpful for reducing tensions in multi-racial, multi-faith India. The fact that voters swung away from both leftists and rightists and backed the centrist UPA is encouraging for India’s future both economically and socially.
Singh still can’t work miracles
That’s the good news. What’s the bad? Well, don’t imagine this means an overnight revolution in India’s governance. The country is still immensely divided, complex, bureaucratic and hard to rule. Politics remains hugely corrupt. Nearly a fifth of candidates in these elections were facing criminal charges, including murder.
Doing business can be very difficult. Bribery is often a necessity. India is ranked 85th on Transparency International’s latest Corruption Perceptions Index (a little below China). It also has other major structural problems: poor infrastructure and low literacy levels (66% according to Unicef) are two. On top of this, its understandable focus on its impressive IT industry has left no clear path for moving hundreds of millions of unskilled workers from subsistence farming to being part of an industrial workforce.
Of course, this is part and parcel of emerging-market development; all countries at India’s stage of development present similar obstacles. But overcoming them is hard; even with a stronger government, Singh – an impressive politician with a good track record – won’t be able to transform the country overnight. That’s why excited investors who talk about this victory putting India on a new track to quicker development are getting way ahead of themselves. A continuation of the last few years’ progress is all we can ask for.
The economy is still slowing
But first, India has to navigate the global recession – and here is where markets are really getting ahead of themselves. I’ve outlined here: Why India’s not safe from the global recession and here: India can’t escape the global recession why India is less immune to the global slowdown than many think. Key factors include the importance of the outsourcing sector (which is suffering from the financial sector implosion), the bursting of the domestic real estate bubble and the dependency on foreign capital.
What do the latest numbers tell us? Well, loan growth to companies – which collapsed in late 2008 – is continuing to slide, which isn’t encouraging.
Industrial production growth is also down sharply, turning negative year-on-year in the last couple of months. This suggests GDP growth, which was 5.3% year-on-year in 2008, has fallen further in the last few months
And while there’s no timely index to track the crucial software sector, you can see that revenues have slid at the big three firms over the last as Western customers cut back on business investment. Conditions in the US and Europe suggest that won’t turn around for a while.
A few shafts of light
On the other hand, there are hints that conditions are improving in some sectors. Cement dispatches have been strong recently at 10.3% year-on-year growth in April. That partly reflects increased government infrastructure spending ahead of the elections, but – surprisingly – demand from real estate developers is also reported to have picked up of late.
After property sales slumped last year, developers slashed prices and focused on more low and mid-income projects. There are some signs that this has succeeded in luring buyers back into the market (although the lack of any national property indices for India makes it hard to tell truth from developer spin). This may not do wonders for their profits, but it seems to have given construction activity a boost.
It also looks as if developers – many of whom were left severely cash-strapped by the bursting bubble – are managing to sort out their balance sheets. Banks seem to be willing to lend to the sector again, albeit after forcing them to restructure debts, pay higher rates and sell off assets. Several developers have taken advantage of the stock market rally to raise more equity.
On the foreign capital side, things also look slightly better. Foreign institutional investment (FII) has picked up as a result of better risk appetite among global investors. The election result should help that continue: more than $1bn of FII flowed into Indian equities last Wednesday. Foreign direct investment (FDI) has weakened a little, but remains healthy by pre-2007 standards
Auto sales are also showing signs of improvement, with data from the Society of Indian Automobiles Manufacturers showing three straight months of year-on-year growth. However, as you can see below, this is a volatile series and it doesn’t seem to have a especially strong correlation with the wider economy (contrast it with the industrial production chart above).
What’s more, the strongest growth seems to be among rural customers, who are less dependent on the wider economy and more on the outlook for the harvest; and also in motorcycle sales (ie, as with housing, consumers are going for cheaper, lower-end product). Sales at manufacturers catering to urban consumers are weaker, as are commercial truck sales, suggesting weak business investment.
Investors are getting carried away
Overall, any improvement in the broad economy seems to be very narrow for now. Most seems to be in the real estate sector, but even if developers’ claims of stronger sales can be taken at face value, they seem to be driven entirely by lower prices – scarcely a sign of a robust economy. Given the sizeable run-up in real estate in recent years, there’s still potential for a much bigger bust in this sector once the boost from price cuts wears off.
Still, it’s possible that the economy could bottom soon and pick up later in the year. But as I outlined here: We’re heading for a summer sell-off, we’re likely to see another sharp global sell-off within a few months, before the bear market is over. This would probably send foreign flows into reverse and bring on another credit crunch at just the wrong moment.
What’s more, investors seem to expect that the new government will soon push through more fiscal stimulus. That simply doesn’t look practical; the budget deficit is over 10% of GDP (when state governments’ spending is included) and ratings agencies are threatening to downgrade India’s credit rating to junk, which would hurt foreign capital flows. The government has very little room for manoeuvre. About the only thing working in its favour is the drop in oil prices since last summer, which reduces the amount it needs to spend on energy subsidies.
All told, the economy still seems to be sliding and there’s little coming down the line to prop it up. The Reserve Bank of India is forecasting 6% growth this year, yet it dipped far below this in less severe global conditions back in 2002.
Investors simply aren’t allowing for this. Obviously, after such a good election result, this rally can run for a while. But even through the India story looks even more encouraging than it did pre-election, markets seem to be getting carried away and ignoring the risks. I’m holding back in the expectation that I’ll get a chance to buy in more cheaply in a few months.
In other news this week …
| Market | Close | 5-day change |
|---|---|---|
| China (CSI 300) | 2,741 | -2.0% |
| Hong Kong (Hang Seng) | 17,063 | +1.6% |
| India (Sensex) | 13,887 | +9.2% |
| Indonesia (JCI) | 1,882 | +7.5% |
| Japan (Topix) | 876 | -0.7% |
| Malaysia (KLCI) | 1,045 | +3.1% |
| Philippines (PSEi) | 2,317 | +0.3% |
| Singapore (Straits Times) | 2,245 | +4.9% |
| South Korea (KOSPI) | 1,404 | +0.8% |
| Taiwan (Taiex) | 6,737 | +3.8% |
| Thailand (SET) | 554 | +3.7% |
| Vietnam (VN Index) | 405 | +3.7% |
| MSCI Asia | 90 | +1.8% |
| MSCI Asia ex-Japan | 375 | +4.4% |
South Korea is in shock after former president Roh Moo-hyun apparently committed suicide last week. Roh, who left office in 2008, had been under investigation for alleged corruption.
In Sri Lanka, the government’s 26-year war against the Tamil Tigers seems to have ended with the death of the group’s leaders and the capture of the last Tiger-controlled area in the northeast of the island. The government hopes to attract international aid and investment into a promising economy that grew at 6% last year, despite the war and global slowdown, and offers a moderately skilled workforce with a 90% literacy rate. However, the ability to calm community tensions will be vital; while the majority of Tamils did not support the Tiger terrorists, they resent the dominance and discrimination of the Sinhalese majority.
Indonesian president Susilo Bambang Yudhoyono has chosen central bank governor Boediono as his running mate for the presidential elections in July; his current vice president Jusuf Kalla will be running for president in his own right. Yudhoyono looks likely to be re-elected after a strong showing by his Partai Demokrat in the April parliamentary elections. Boediono, who like many Indonesians only has one name, has previously served as finance and economics minister and is a well-regarded reformist.
UK and Hong Kong-listed banking giant HSBC has been approved for a renminbi-denominated bond issue in Hong Kong, making it the first non-Chinese company to get authorisation. The group has also applied for a listing on the Shanghai market, although it’s not yet clear whether this will be granted. The moves seem to be largely political, as a way of cementing its ties to the Chinese economy, which it sees as a key part of its growth plans.
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