Thursday, July 5, 2012

Pranab & Mamata Out, Mulayam In: Reforms on - II

All the messaging from the Prime Minister’s Office continues to point towards only one thing - reforms are on!

In my story last week (Pranab & Mamata Out, Mulayam In: Reforms on!), I pointed out how, with Mamata sidelined, Mulayam in its fold and Pranab as president, Congress has not had it so good in many years. And that meant the reforms process was now on.

In fact, I had pointed this out as far back as May 2012 (Reform Initiative: Mulayam to decide, not Mamata nor Manmohan). This was after Mulayam “pledged” support to the UPA government.

“So what does that mean now for some of the major reforms and other governance measures that have been on the backburner? Many of those measures are likely to go through … Mulayam is expected to be flexible …”

The government’s decision to postpone implementation of GAAR-related tax provisions by one year, and a promise to clarify the provisions and remove uncertainties in the minds of foreign investors, was a major sentiment booster, with equity markets going up nearly 5% over the past week.

This was followed by an interview of the prime minister with Hindustan Times yesterday, where the messaging continued. “The India growth story is intact. We will continue to work, as we have been doing for 8 years, to keep the story going,” said PM Manmohan Singh. He further said that in the short term the plan is to focus on bringing complete clarity on all tax matters, control fiscal deficit, revive mutual fund and insurance industries and provide a major push to infrastructure.

This messaging continues with reports that the government might bite the bullet on diesel subsidies, with partial decontrol of diesel prices after the presidential elections.

So why had the reforms process stalled for so long? There was a nice story in FirstPost a few days back (PM-Pranab-Sonia hiatus was key cause of policy paralysis), which captures some of the background dynamics that might have contributed to this situation. Here’s what it says:

“It seems the PM wanted to keep the finance ministry with him even in 2004 but was dissuaded from doing so by the party. So Chidambaram got the job. When Chidambaram was removed in 2008, Pranab Mukherjee got it. After UPA’s resounding victory in 2009, the PM made another bid for the job and failed.”

“What this history makes clear is that Dr. Singh was always keen on doing the finance minister’s job himself, or getting another economist whom he trusts to do the job for him.”

“The gap between the PM and his FM grew widest during the tenure of Pranab Mukherjee, when the latter subtly kept the PM out of the loop. The possible reason is ego: Pranab felt that he was Manmohan Singh’s senior in politics. (Mukherjee was FM in the 1980s, when Singh was just a bureaucrat under him.)”

All in all, after a very long gap, there seems to be some real hope that the reforms process is getting back on track.

Rainfall Shortage at 30%: Are we heading for another drought?

A report from the India Meteorological Department (IMD) indicates there was a whopping 49% rainfall shortage for the week ended July 4 and a shortage of 30% for the season to date.

This reminds of 2009, when the IMD kept hoping the rainfall shortage in the initial part of the monsoon season would be made up in later parts. But that never happened, and finally the season ended with a 23% rainfall shortage, supposedly the worst drought since 1972. If things don’t improve soon, then 2012 could become the worst drought year in nearly 40 years.

I came across a nice story done by Akshat Kaushal last year in Business Standard titled Has India’s Met Dept failed us? Here’s what he says about the IMD’s forecast accuracy:

“The failure of the IMD to predict the monsoons correctly in 2009 was not a one-off incident. Consider this: Since 1988, in the last 23 years, the IMD has been able to successfully predict the monsoon only nine times – a success rate of just 40 per cent. Significantly, the IMD has never predicted a drought. In fact, in the last decade, the country experienced droughts on three separate occasions, and the IMD’s predictions in every one of these years pointed towards abundant or normal rain.”

However, even if there is full-fledged drought in the country this year, my analysis of last week (Rainfall Shortage: Even if there’s a drought, the impact is likely to be minimal) shows that the impact on GDP growth would be minimal.

Well, let’s see how things pan out for the monsoons over the next few weeks.

Corn Price Rise: Impact on India limited

Global corn prices are showing a sharp rise just as they did in 2008, this time on expectation of a poor yield in the U.S. Take a look at this 20-year chart of U.S. spot prices (from Vix & More). U.S spot prices for corn are up nearly 30% over the past month.


In India, the prices are up about 15% over the past month (see the NCDEX chart below – Maize Feed, Davangere).


As far as India is concerned, the largest impact would be on the price of poultry as more than half of the corn produced in the country is consumed by the poultry sector. With the poultry market growing by about 20% annually, as long as corn prices remain high, that would continue to put additional pressure on poultry prices.

What happens if domestic prices continue to rise? Given that India exports a large part of its corn, my sense is that government will intervene to arrest the price rise, most likely by banning exports. That is exactly the kind of thing it did during 2008, when corn prices were showing a sharp rise.

The only strange part in this whole phenomenon is that global prices are rising even as the International Grains Council is expecting a higher global production this year. Here is what it says in its report of July 2, 2012:

“Overly hot and dry Midwest weather conditions have led to a downgrade in the U.S. maize production forecast, with projected yields now likely to be below the ten-year trend.  Despite the downgrade, the crop is still forecast at a record 350m. tons, although the risks are to the downside.  However, projections for some other countries, including China and India, are increased this month.  Consequently, world maize production is still expected to rise by 5.7% to 917m. tons in 2012/13.”

It almost seems as if corn prices have been driven up more by speculation than by lower yields in the U.S. And just as in 2008-09, when the price dropped sharply, there’s every likelihood of the same happening this time.

Either way, although higher domestic corn prices would impact poultry prices and consequently food inflation, the overall impact on the economy would be fairly limited.

Capital Economics’ India Report : Another example of poor research

There is a research report from a macroeconomics consultancy firm called Capital Economics, which seems to be getting some degree of visibility in Indian media. As per news reports, the firm attributes the recent slowdown in India to governance issues, estimates sub 5% GDP growth for Q1 and believes no reforms would happen till the 2014 general elections.

Based on all my analyses of the past one year, I believe that Capital Economics might have got some of its economics wrong. I don’t mean to pick on Capital Economics in particular, but this is another example of shallow analysis by a set of experienced folks.

Growth slowdown caused by governance issues?

Lets take a look at its first point about attributing the recent slowdown to governance issues. That seems a little far fetched, when seen in the context of strong growth that has happened during the past five to six years, a period marked by an acute lack of governance. The slowdown of past few quarters is purely short term business cycles playing out, driven primarily by a slowdown across the globe.

Take a look at India’s GDP chart below, which shows the absolute value of GDP at fixed prices over the past seven years. I guess the chart very clearly shows that the long term trend has been pretty much intact, though interspersed with short term cyclical slowdowns. Key point to note is that YoY growth rate charts are not always the right way to interpret these numbers.


Sub 5% GDP growth in Q1 2012-13?

As for sub 5% GDP growth in Q1, I really don’t have a call on such a short term and error prone number. But even if the YoY growth was less than 5% GDP and in say 4.5% range, the long term trend would still remain intact. All that it would mean is that there was a short term cyclical slowdown.

No reforms till 2014?

Regarding Capital Economics’ third point about reform process remaining stalled till the 2014 elections, they might have got this one horribly wrong. In one of my previous analysis I had argued how, with Mamata sidelined, Mulayam in its fold and Pranab as President, Congress has not had it so good in many years. Mulayam provides the numbers in parliament to pass through some of reform measures and Pranab was seen as somewhat as an anti reformist. My sense is that the reforms process will pick up steam as the elections come closer, in order for the government to showcase its developmental story.

Capital Economics past record

Lets now take a look at Capital Economics past forecasts. Copying below an excerpt from a Bloomberg story dated Dec 7, 2008

"Capital Economics` Khan expects India`s $1.2 trillion economy to grow 5 percent in 2009, less than the 6.3 percent forecast by the International Monetary Fund”

In 2008-09, Actual GDP growth was 6.8% and the forecast was being made when half the year was already over and they still got it horribly wrong !

Low quality research from top ranking firms

In my previous analyses, I have been very critical of the quality of research at some of the top firms including Goldman Sachs, Morgan Stanley, Fitch and S&P`s of the world. I guess Capital Economics falls in the same category, though it is in no way considered a ‘top’ research firm, so to say.

But good research also exits

Amongst the top research firms, I have found JP Morgan India (Kalpana Morparia?), to have a very good sense of India’s long term growth story. They had the courage to publicly talk about their confidence in India long term growth trend right during Oct 2008 also, at the time Nifty was around 2500 levels. They continue to stick to their stand on the long term growth trend for India.

There is a nice analysis in NY Times from Vivek Dehejia. He is amongst a handful of economists who has been able to differentiate between long term trend and short term business cycles.

All my detailed analyses of past nine months have continued to suggest that he India long term growth story has been very well intact for the past decade.

Related Analysis