Marbles are safe

Neelkanth Mishra of Credit Suisse had given a comprehensive interview to Business Standard. It makes for good reading. I have copied and pasted his responses to key questions – on whether the government is tackling tough issues, on ‘Make in India’, on whether the lack of bank credit growth is really a sign of lack of credit availability, etc. Clearly, the problem lies with corporate balance sheets and they are trying to make the government the scapegoat. Surely, the government has to get its act together in a few areas. But, the truth is more nuanced than a blanket judgement that the government has lost its marbles. The marbles are safe.

What are the top concerns that might derail the sky-high expectations that investors have from the Indian market?

We see two India-specific factors that could derail the market further: if political rhetoric turns away from good economics, and if the banking system asset quality stresses somehow permeate into the rest of the economy. However, both these are low probability risks, in our view. A greater risk lies outside India. Several catalysts could drive a global risk-off, which could then affect Indian equities negatively.

The government has been making a host of announcements and is attempting to roll out reforms. How do you see this impacting corporate India?

The central government’s presence in the economy has shrunk dramatically since 1991. There are only five economic sectors of size that the Centre dominates — banking, railways, commercial mining of coal, defence production and nuclear energy. Each needs structural reforms that are difficult, and will take time. We continue to believe more exciting reforms need to happen at the state level.

That said, the government is doing much better than we expected. On banking, the refusal to recapitalize PSU banks shows a strong intent to reform. People question why government entities like Air India get allocations in the budget. But no one questions why PSU banks need to get Rs15-20,000 crore every year. If the banks were performing efficiently, they should have been able to raise capital from the market: for most of them, the government holding limit is not a constraint. This is the first government to be raising the issue of moral hazard of recapitalizing banks that misuse capital. Letting them lose market share improves the efficiency of capital allocation in the economy. We had not expected this to happen, and it has been a welcome surprise.

Similarly, we had not expected the government would be able to undo Coal India’s legal monopoly on commercial coal mining in India. In the Coal bill passed in March, it did exactly that, and the unions did not oppose it. When the government monopolies on telecoms and airlines were cancelled in the early 1990s, the markets may have ignored this initially, but these industries were completely transformed, with sharp increases in efficiency as government companies steadily lost share.

But, as one would expect, the impact on corporate India of these changes will only be visible several years later. In the near term, the key driver will still be the government’s fiscal spending. The central government was forced to aggressively curtail spending in the last several months of the fiscal year that recently ended, and that drove the sharp slowdown we saw. In the last few years, the June quarter has become much stronger than the March quarter, as the spillover of curtailed spending from March boosts the economy. We should start seeing that now. In the second half we also do not expect the government to be forced into a spending crunch like in the last few years, as this year’s fiscal numbers look credible.

What is your view on Make in India and is it expected to give a boost to the manufacturing sector?

Tired of explaining what it means to turn the fortunes of a sixth of humanity, I now carry around a map of India in which for every state I plot the name of the country that comes closest to it in population. So, UP is bigger than Brazil, Bihar has as many people as Mexico, Maharashtra is like Japan, Karnataka as big as France, Kerala is like Canada, etc. With that in the background, let’s start discussing what it takes to drive change. A Pena Nieto in Mexico is like Nitish Kumar in Bihar. An Abe in Japan is like Devendra Fadnavis in Maharashtra.

Changes on this scale cannot happen in a day or even a year, and cannot be encapsulated in a presentation. They must start with a bigger vision, a slogan, which then drives changes to people’s thoughts and actions. It takes many years to develop global manufacturing competitiveness in a sector. In the first few years, gains may only come in sectors we are strong in already, like IT Services, generic pharmaceuticals or auto components. But over time, as states compete to improve their own ease of doing business rankings, we should see India’s manufacturing competitiveness improve. In new sectors initially it may not appear in large factories employing thousands of people, even though those are the factories that get the media coverage. But momentum does seem to be building in terms of states projecting a more industry-friendly image. The West Bengal CM tweeting about the lack of strikes in WB during her tenure is a strong sign how political drivers are also changing.

So far, the RBI has cut interest rates by 50 basis points. How many more cuts do you expect and is this enough to revive corporate investments?

At Credit Suisse, we expect another 25 basis points cut. But I don’t think rate cuts are that important. First, think about transmission. With a large part of the banking system under-capitalised and some banks even struggling with liquidity stresses, even if the RBI were to cut rates it would not necessarily translate into lower costs of borrowing for corporates. This does not mean we should rush to recapitalise the broken banks, particularly as the reason for low loan growth right now is not lack of funds, but lack of loan demand.

There is a misconception that that if public sector banks are unable to grow then the economy cannot. This needs to be more nuanced: more than 40 per cent of outstanding loans are to sectors like metals, power generation and energy, where loan demand is justifiably weak (other than for ever-greening). That overall loan growth is still 11-12 per cent, meaning that the rest of the loan book is still growing at 20 per cent. So growth is not being constrained.

Also, look at the trend of disintermediation. The BoP (balance of payments) surplus has brought down bond yields much lower than the base rate, and the good quality corporates are moving to the bond market. So the bank credit growth number is also a bit misleading, in our view.

The full interview – half of it is here – is well worth a read.


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