Emerging markets surge in India, but hazards lie ahead
The departure of the central bank’s governor signals political change, Joe Chidley writes.
When everything is up, everything is expensive. North American stock markets have been on a roll, and bonds have become pricey. So in this environment, it’s natural, and probably even smart, for investors to look farther afield for returns.
For many, that may mean reconsidering emerging markets, which have been the dogs of global investing. Yet perhaps the worm has turned. True, the MSCI Emerging Markets index has a paltry one-year return of -7.2 per cent, but since mid-February it has posted a strong rebound. And among the top performers has been India, where both major stock indexes (the Nifty 50 and the Sensex) are up more than 20 per cent in the past five months.
This should, perhaps, come as no surprise. As Chinese growth slows, India is Asia’s new juggernaut. It now lays claim to being the fastestgrowing large economy in the world, setting a pace of 7.6 per cent GDP growth in fiscal 2016, which ended in March. Fitch Ratings, in giving India a BBB-credit rating recently, projects growth will hit 7.7 per cent this year and 7.9 per cent in fiscal 2018.
Under Prime Minister Narendra Modi, India is rationalizing and opening up its economy. Foreign direct investment has soared by 46 per cent in the past two years, in part as the result of Modi’s Make in India program, which seeks to position the country as an international hub for investment, innovation and manufacturing.
Fortune has been good to the Indian economy, as well, in the form of low energy prices since 2014. India imports most of its oil, and demand growth is strong — last year it was more than double the mark set in the previous decade.
There has also been welcome stability in monetary policy. Reserve Bank of India governor Raghuram Rajan, formerly the chief economist at the International Monetary Fund, came to the position as something of a superstar, and he has largely delivered. Rajan has tamed the inflation tiger — his primary focus — bringing it down to a modest 5.6 per cent. (It was nearly 15 per cent in 2009 and 11 per cent in 2011.) The rupee has stabilized, as well, in part thanks to Rajan’s caution on rates. Since last cutting them, to 6.5 per cent, in April — for a cumulative total of 150 basis points since his tenure began — the RBI has held steady, citing concerns about continuing inflationary pressure.
Yet beneath the strong growth and sound monetary management, there are some concerns in India that might give international investors pause.
Chief among them, at the moment, anyway, is the impending departure of Rajan, who announced he would not be seeking a second term as RBI governor. Modi’s government has still not announced a successor, and there are dozens of names currently in the ring. That, in itself, suggests some uncertainty about India’s economic stewardship, but there are signs in the circumstances of Rajan’s departure — he’s returning to academia and a post at the University of Chicago — that may advise caution.
Rajan has not said specifically why he is leaving, but it’s accepted wisdom that harsh criticism he received from several loud government voices had something to do with it. His harshest critic is upper house member Subramanian Swamy, a powerful member of Modi’s Bharatiya Janata Party (BJP), who has charged that Rajan’s high interest-rate policy is killing growth and hurting small and medium businesses.
Swamy, an outspoken Hindu nationalist, has also suggested that the MIT-educated Rajan was not Indian enough to be RBI governor — a somewhat ironic charge, given that Swamy himself is an economist who studied at an American university. Then again, his renowned alma mater, Harvard, kicked him out of a job as visiting summer lecturer several years ago, after he published an anti-Muslim rant that advocated, among other things, annexation of parts of Bangladesh.
Whatever the reason, Rajan is soon to be out. And one of the telling side-effects has been that Indian bank stocks have done very well since he announced his departure in mid-June. That might be good news for stockholders, but it is troubling in the long term — because one of the likely causes for the rally is the fact that investors expect Rajan’s successor to take it far easier on India’s troubled banking system.
Besides fighting inflation, Rajan made it a pet project to force India’s financial system — dominated by state banks — to recognize and deal with a serious case of bad loans. According to RBI’s audit, well more than 10 per cent of all loans are non-performing, and the proportion is even higher in the public-sector banks.
Investors are also likely expecting that Rajan’s successor, whoever he or she may be, will be a relative dove — which may be supportive of stocks, but will not bode well for either inflation or the stability of the rupee.
The next RBI governor will also have more limited autonomy, as weak as that autonomy proved to be during Rajan’s tenure. That’s because monetary policy decisions will now be made by a six-person committee —including three governmentnominated members—although the governor will have a deciding vote when necessary.
Granted, Modi himself has taken useful steps toward cleaning up India’s bad debt problem. One of the most significant is recent legislation that establishes a national system for bankruptcies, which has long made the winding-down of debt a significant problem for Indian creditors. According to the World Bank, India ranks among the world’s worst jurisdictions for resolving insolvency, in terms of both the time it takes and the ultimate payout to creditors.
No doubt, India is a dynamic and alluring place for investors to seek returns. Many of Modi’s reforms are promising. But some — like bankruptcy laws and clearing bad loans, not to mention labour reforms — might take years to have a real impact. In the meantime, a strong and tenacious leader at the monetary-policy helm is being replaced with a committee.
Until it’s clearer which way the Indian juggernaut is headed, investors might want to navigate with care.