Ignore ratings, but not the confidence levels!

Everybody is busy bashing rating agencies and I am no exception. Only yesterday I was telling my colleagues why a time will come when these agencies would go out of business. Recently it was emphasised in the G20 meet also that reliance on rating agencies should be reduced. (see The Hindu article)

The best rebuttal of these agencies came from the markets which reflected the irrelevance of these ratings in the yield rates. The US bond yields went down after a downgrade and so was the case in UK recently. (see Bloomberg article)

Indian ministers would certainly be happy with this antagonism towards the rating trio – they are an apt scapegoat to blame and to divert the nation from what is ailing the Indian economy. However, would the Indian economy be doing any better if the agencies didn’t exist? I am not sure.

Each economic unit (household, companies, labour, etc.) is a de facto rating agency in an economy. If a household is gloomy because of high inflation it would impact growth by lowering demand. If a company is skeptical of growth in the days to come it will pass on the scepticism to its suppliers, its employees and so on. So if the economic units are feeling low about the economy, only positive policy actions or positive external shocks can help the economy and ratings aren’t that relevant.

So ignore the rating downgrades if you wish but do not ignore issues like increasing fiscal deficit on the back of irresponsible policies, poor governance, policy paralysis, and infrastructure constraints to name a few that hurt the confidence of the consumer as well as the investor in the Indian economy. You can ridicule 3 rating agencies but ridiculing each economic unit’s sentiment should be done at one’s own peril.

Fiscal and rural buffers of India missing this time?

In 2008 when the world was facing recession India appeared relatively calm. Its exports were certainly hit and the industry did face some degree of liquidity crunch however, a few fundamentals and policy events kept the economy kicking.

Pay Commission announced hikes and big lump sum packets of retrospective salaries were doled out, agriculture and therefore the rural economy was doing well, the central government was prepared for a fiscal stimuli and the RBI brought the bank rates down. The B and the R of the BIMARU states provided positive sentiment with their growth stories and the new middle class and the new set of salaried individuals entering the economy kept the engines warm.

This time around when the world seems to be stuck in a low level growth equilibrium India appears more pessimistic. It all started with the inflation that tempered the economy followed by RBI’s monetary tightening. Thereafter it was the loss of faith in the Indian Government in the wake of scandals and the loss of faith in the Indian currency as the Eurozone plummeted.

India is currently caught in a phase of macroeconomic instability where the twin deficits are high and the inflation is above the targets. This macro instability has derailed India from its high growth trajectory for now and it would need some positive policy actions in the next quarter or so. Few days back T K Arun of The Economic Times talked about irrational lack of exuberance in the Indian Economy and he almost derided experts who look at the stuff like twin deficits.

“The trouble is, respectable people see respectable things like the fiscal deficit, the current account deficit, inflation and the exchange rate, and feel discouraged. 

They see other respectable folk - foreign investors and their lobbyists, some of them state dignitaries - shake their heads in knowing disapproval and feel doubly disheartened. If only these respectable people would look into the grime and murk that is India's politics.”

The current situation I am sure would certainly make T K Arun think again, However,  what I am hopeful about and where I am on the same page as him is that once the government starts to show some constructive path, the economy can certainly come back to a high growth rate of about 8%. Also I think India is not likely to go below a 6% growth rate in its current form. The reason I hold such confidence in the Indian economy is facts like this:

• -          Competition between states is increasing and the states are at different stages of development. Bihar is still doing well and it needs, and is likely to attract significant investment even if the average mood in Indian economy is sombre.
• -          The Industry is showing signs of flexibility and is quick to shift to states that show better governance. Maruti for example is moving its plants to Gujarat from Haryana.
• -          The latent demand with the non-salaried class is quite high and is now beginning to surface. People are actually spending more – be it on child’s education, be it on electronics, be it on property or be it on alternative medicine like Ramdev’s.
• -          Indian households are still less leveraged compared to what is the norm in the developed world. In USA or Australia households are in debt up to 100% or more of their income while in India the ratio is about 30-40%. Such households as in India do not defer or change their durable or property buying decisions in response to minor ups and downs in interest rates or in the economy.
• -          Marriage and religion would continue to support the Indian economy even now.
• -          As mentioned in my previous blog rural demand is likely to be robust.

So while the fiscal buffer is certainly missing this time I would like to bet on the other buffers to help keep the economy in a 6% kind of state even in the absence of positive policy moves.

Indian rural demand enters coma?

That the consumer demand in the developed world is in a state of coma after the Global Financial Crisis is a well known fact. It is also well understood that this economic coma is bound to persist for a long period, possibly a decade.

However, what came as a surprise to me was the possibility of the Indian rural market entering such a coma recently. The Economic Times carried such news in the second week of February – Rural India Loses Steam. Thereafter I began to hear stories from people getting affected from the slump. One textile trader complained of the missing rural demand even while the Indian wedding season was in its full swing. In other instance a sugarcane farmer complained of receiving low prices. A bicycle retailer in Bihar contemplated changing trade even when the cycle doling scheme of Nitish Kumar is on. So what is wrong?

Before we think of the reasons we must take all of this with a pinch of salt. I have found it to be a common habit of business people to over blow their worries even when the changes have been marginal. Sometimes this is done to make others feel good about their sorry state of affairs. At another level this tendency has caught up with salaried professionals too who have become attuned to hyper returns year after year. So for example a 10% hike in salary might be considered no hike at all, when all it might mean is that it is not the usual 20% with the same firm or the usual 30% when job hopping.

So let’s come back to the allegation that rural demand has fallen and the proposed reasons to which this slump is attributed.

• -          The MGNREGS has spoilt the rural economy
• -          The hiked Minimum Support Prices (MSP) do not reach the famers – This could be the case but this has been true for ages.
• -          Price crash and crop failures – This indeed appears to be the case. Prices of crops like Potato, Cotton, and paddy indeed crashed in different regions.
• -          Lack of liquidity and high loan rates
• -          Election fatigue in north

 A careful look at these suggests that these do not lead to a coherent story. These reasons are either not backed by facts or in other cases the fact has been in existence earlier too and is not a novelty.

The most baffling statement seems to be about a slowdown in sales of ACs since November. I thought this was common sense.

“Manish Sharma, Panasonic India director marketing and sales, says in tier-II and tier-III markets, sales have fallen 10-15% since November with the worst affected being direct cool refrigerators, small-screen LCD television and window air-conditioners.”

Broadly then my gut feel is that there is no new structural development that would reduce rural demand. Although unsubstantiated, the demand may be down for a while but that cannot be the new normal in India.

My confidence in the rural economy especially gets summed up well in what Pradeep Kashyap has to say:

“The rural economy is an authentic economy while the urban economy is a bubble economy and a speculative economy to a large extent. In rural India, nobody speculates on housing, no one really invests in financial markets, and again there is no IT sector in rural India. So that’s why our rural economy continued to grow in 2008-09 and we did much better than even China back then as ours is a domestic consumption-driven economy and theirs is much more export driven. The rural economy now accounts for 50% of India’s economy. So half of our economy remains stable and that’s a huge advantage.”