Chris Wood on India

Both GREED & fear and fund managers are still waiting for evidence of a private sector-led investment cycle. Unfortunately, this is still conspicuous by its absence as is evident from the latest data on gross fixed capital formation. Thus, annualised gross fixed capital formation declined to 29.8% of nominal GDP in 4Q15, down from 30.3% in 3Q15 and 34.2% in 1Q12.

As regards addressing bad assets, a key point is to make sure that public sector bank
employees feel comfortable in terms of accepting haircuts on loans in a culture where such employees, who identify themselves as civil servants, fear investigation from what are described as the government’s “investigation agencies”. In practice this is likely to require some form of formal legal indemnity. The key point here is that it is understood in Delhi that such a process will be necessary.

It is also important to highlight that this problem is not just an issue of malfeasance.
Every bank that engaged in corporate lending in the post 2008 infrastructure lending boom now has a NPL problem, as the Axis and ICICI examples show, while the private sector banks focused on the consumer continue to do well. The consequence is that HDFC Bank’s market capitalisation at US$43bn is now bigger than all the public sector banks’ total market cap, even though they account for over 70% of the assets in the system and HDFC Bank accounts for only 6%.

The progress being made in the banking sector, as well as the many other long-term structural reforms introduced by Modi, means the market is building a powerful base in the context of the extended period of consolidation which has followed the dramatic rally in share prices that both preceded and followed Modi’s landslide electoral victory in May 2014.

GREED & fear hears that Rajan has Modi’s support since the Prime Minister understands that he is trusted by the markets.

There is a legitimate argument that the RBI has remained too tight, most particularly if real interest rates are measured against WPI rather than the new reference rate of CPI. Thus, the real repo rate deflated by CPI inflation is now 1.6% but is 7.4% if deflated by WPI inflation.

In GREED & fear’s view, Rajan’s policy is refreshing in the context of the monetary quackery going on in the G7 world, quackery which the Indian central bank governor has done the best job of criticising among all the world’s central bankers. This is why he will be a natural candidate to lead the IMF, or some other such institution, once those unconventional monetary policies have been fully discredited. But that is a story which has not fully yet played out, which is also why he should remain RBI Governor in the interim.

Source: Greed & Fear, ‘Addressing India’s banking stresses’ May 6, 2016


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