The latest newsletter from Chris Woods of CLSA is out. Last week, the popular missive known as Greed and Fear focused on China and Japan. This week the letter titled ‘GREED and Fear (Heat, dust and policy)’ starts off with a discussion on India. The commentary is quite bullish on a country, which has experienced disappointing growth lately. Below is the full report.
GREED and Fear (Heat, dust and policy)
“Tapering off” fever continues to occupy financial markets. But amidst the extraordinary hysteria generated by a US ten-year Treasury bond yield at 2.1% investors would do well to remember that headline CPI inflation in America has declined from 3.9%YoY in September 2011 to 1.1%YoY in April 2013 (see Figure 1). As noted by CLSA’s legendary investment guru Russell Napier this week, that means that real interest rates are rising.
That may be US dollar bullish. But it is deflationary not inflationary, and makes it even less likely that Billyboy is going to normalise monetary policy despite all the talk to the contrary.
GREED and Fear on the Indian story
Policy paralysis in Delhi was the main concern of investors for most of last year when looking at the Indian story. But it is evident to GREED and fear following a visit to the Indian capital this week that this is a concern which is no longer as relevant from a market standpoint. If GREED and fear had a sense that this was no longer the case, it is encouraging to have it confirmed on the ground. What it means is that it is no longer a question of if the investment cycle will resume in India but rather when. In GREED and fear’s view there is growing reason to hope that there will be concrete evidence of a resumption in the investment cycle before the end of the current fiscal year which began on 1 April. This is despite the potential uncertainty posed by a general election which has to be held by May 2014.
GREED And Fear on Indian optimism
Why be so optimistic? The answer is that some of the key triggers of the investment downturn since 2009 have to a certain extent been addressed. In GREED and fear’s view there were three main triggers. One was a dysfunctional power sector and in particular a shortage of coal. A second trigger was a paralysis in decision making amongst officialdom caused by a series of corruption scandals. A third but less important factor was a sharp rise in interest rates caused by unexpectedly sticky inflation. Thus, the Reserve Bank of India (RBI) raised the repo rate by 375bp from 4.75% in March 2010 to 8.5% in October 2011 (see Figure 2).
If these were the key causes of the investment downturn, there is now some evidence of incremental improvement on all three fronts. On the energy side coal despatch volumes by Coal India are up by 7.9%QoQ and 5.8%YoY in 4QFY13 ended 31 March (see Figure 3). There is also a general sense that pressure from behind the scenes has led to faster clearing of projects. Thus, Cairn India has stated that it is receiving approval for exploration projects with far greater alacrity than in the past.
But perhaps the most significant development in the power sector of late, at least from a cashflow perspective, has been the State Electricity Board (SEB) restructuring announced in late September 2012 and the subsequent evidence of tariff increases. Thus, last fiscal year nearly all states save for a couple imposed tariff increases. While already in the first two months of this fiscal year 19 states have filed “tariff revision petitions” with regulators.
At the most basic level, if tariff increases are happening then an economic incentive is being created to produce more power. But India is also finally seeing action being taken to address losses in the system via the implementation of the so-called Restructured Accelerated Power Development and Reforms Programme (R-APDRP). This is using Indian IT technology to establish base line loss levels in the power sector.
GREED And Fear on tariffs
The above raises the potential of a virtuous cycle where loss reductions will kick in leading to a reduced need to raise tariffs for a SEB sector which has undergone significant debt restructuring. Under the Rs1.9tn debt-restructuring plan, 50% of the outstanding short-term debt will be eventually taken over by the state governments while the other half will be restructured by the banks. So far ten states have agreed to the restructuring. It should also be noted that one of the hoped for quid pro quos to the debt restructuring is the implementation of private sector participation in power distribution; though this is apparently not mandatory as of now.
What about the gridlock in terms of the lack of decision making by the bureaucracy? Here the worst point seems to have been passed with the most effective policy response the decision last December by hyper-active Finance Minister Palaniappan Chidambaram to set up a special Cabinet Committee on Investment (CCI) to fast track projects. The word from senior government figures is that the committee has already cleared some US$25bn worth of projects since its first meeting was held in mid-December. But it is not just the number of projects cleared. It is the incentive triggered by the existence of the cabinet committee to overcome delays when projects are stuck most particularly when, as often is the case, it is a question of a disagreement between two ministries. For example, the CCI cleared in February the Rs120bn North Karanpura power project of National Thermal Power Corporation (NTPC) that had been stranded for more than a decade as power and coal ministries bickered over its exact location.
GREED And Fear on Oil Industry
If the above all sounds quite bullish, GREED and fear would certainly not want to exaggerate the progress made. It is not as if India has undergone a revolution in governance. It is just that there has been some incremental improvement, with virtually all of that improvement occurring since Chidambaram took over as finance minister last August. It is also the case that there has not as yet been a lapse back into crude populism despite the growing proximity of a general election. Thus, the diesel subsidy has so far continued to be cut on a monthly basis (see Figure 4). On this point, the government decided in mid-January to allow oil companies to raise diesel prices by 45-50 paise/litre every month. This means that the cost of energy subsidies is likely to fall significantly this fiscal year helping to keep the fiscal deficit within the government’s official target of 4.8% of GDP.
But a real improvement in the fiscal deficit clearly requires a pickup in economic growth which, remember, has declined from a recent peak of 11.4%YoY in 1Q10 to 4.5%YoY in 4Q12 (see Figure 5). Finance Minister Chidambaram was quoted in the local press this week saying that India would grow at the 5-6% rate even if the government