jonathan@emadvisorsgroup.

com April 26, 2012

Jonathan Anderson

The Seven Great Myths of an Indian Collapse

It's easy to grin When your ship comes in And you've got the stock market beat But the man worthwhile Is the man who can smile When his shorts are too tight in the seat Caddyshack (1980)

SUMMARY AND INVESTMENT IMPLICATIONS

Here are seven good reasons why the Indian economy is not collapsing. Which doesnt really make us big FX or equity bulls at todays prices ... but at the margin we would be tactical buyers on improving news flow.

Myth #1 The credit bubble

We dont see much need for a big introduction here. ber-bearishness on India is not quite like berbearishness on China nobodys seriously looking for Asian crisis-style turmoil in Delhi and Mumbai but its there nonetheless, with a profound sense of game over malaise among investors .... ... to the point where you start to hear, well, all kinds of nonsense about the Indian economy. Which is why we need to write this piece, i.e., just to walk through some of the more egregious myths in circulation. We settled on seven, and here they are. The first is the surprisingly pervasive idea that India has a credit bubble, one that is now bursting as households and companies start to drown in leverage, and one that threatens to bring down larger banks as well. And here, honestly, we have no idea what people are talking about. How do you know when you have a credit bubble and/or potential banking stress? At the macro level, as every regular reader will know, there are two indicators above all that tell the tale: (i) a sustained, rapid increase in the credit/GDP ratio, and (ii) a sharp, sustained rise in the aggregate banking system loan/deposit ratio.

Jonathan Anderson April 26, 2012

So here are the numbers for India. Chart 1 shows the peak five-year increase in the overall domestic credit/GDP ratio across macro EM economies ... and as you can see India sits near the bottom of the pack, far removed from the true-blue credit bubble countries in eastern Europe.
Chart 1. What credit bubble?
Peak five-year change in credit/GDP ratio, 2003-12 (pp) 70% 60% 50% 40% 30% 20% 10% 0%
Vietnam UAE Latvia Ukraine Estonia Korea Kazakhstan Lithuania Slovenia Bulgaria Slovak Singapore Romania Brazil Nigeria Hungary Poland Croatia Turkey China Czech Russia S Africa Malaysia Venezuela Saudi India Taiwan Chile Israel Peru Colombia Ecuador Thailand Egypt Argentina Mexico Philippines Indonesia Latvia Lithuania Ukraine Kazakhstan Estonia Slovenia Romania Slovak Bulgaria UAE Venezuela Nigeria Hungary Russia Poland Croatia Brazil Vietnam Turkey Saudi Czech Colombia Korea Chile Singapore Argentina Peru Indonesia Taiwan India Israel Philippines Malaysia China S Africa Ecuador Mexico Thailand Egypt

-10%

This is even more true when we turn to the peak cumulative change in aggregate loan/deposit ratios (defined as total domestic credit divided by broad money liabilities, see Chart 2). India is simply light-years away from the kind of numbers that normally point to trouble.
Chart 2. What funding bubble?
Peak five-year change in L/D ratio, 2003-12 (pp) 80% 70% 60% 50% 40% 30% 20% 10% 0% -10%

This doesnt mean that you cant get rising NPLs into a slowing economy, of course but as far as credit stories go, Indias is about as plain vanilla as it gets.

Myth #2 The investment collapse

And to be clear, there is no doubt that India does have a slowing economy. In fact, real investment spending contracted outright in the second half of last year (Chart 3 below), something we didnt see in the depths of the 2008-09 global crisis and the first instance of negative growth since 2000.
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Jonathan Anderson April 26, 2012

Chart 3. Investment falling ...

Real fixed investment growth (% y/y, 3qma) 25% 20% 15% 10% 5% 0% -5% 00 01 02 03 04 05 06 07 08 09 10 11

Chart 4. ... but still the second highest in EM

Share of constant-price GDP (%), 3qma 45% Gross saving Gross investment 40% Fixed investment 35% 30% 25% 20% 15% 10% 5% 0% 00 01 02 03 04 05 06 07 08 09 10 11

On the other hand, keep in mind that even after the recent drop-off, India is still investing between 30% and 35% of its GDP the second highest investment ratio in the emerging universe, after China, by a very wide margin (Chart 4). And as you can see from the chart, theres no sign of any collapse in Indias domestic saving rate, which is the main underlying support for investment spending at the end of the day.

Myth #3 Disappearing growth

Which brings us directly to the issue of overall growth. And there are two important points to make here. First, fixed investment may be weak, but consumption spending is holding up much better in the face of the corporate downturn (Chart 5).
Chart 5. Consumption holding up well
Real growth (% y/y, 3qma) 25% 20% 15% 10% 5% 0% -5% 00 01 02 03 04 05 06 07 08 09 10 11 Fixed investment Household consumption

Chart 6. And an investment pickup now underway

Real level (index 2006=100) 160 140 120 100 80 60 40 03 04 05 06 07 08 09 10 11 12 Fixed investment Industrial production

Second, and crucially, if you look at the investment and production figures on a sequential rather than a y/y basis, you will find that the real decline came in the first half of last year on a seasonally adjusted basis (Chart 6 above) and that levels have already recovered visibly over the past few months. Were not talking about a massive recovery by any means, but we are likely talking about stabilization and even a relative pickup in y/y growth trends through the middle of 2012.
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Jonathan Anderson April 26, 2012

Myth #4 Out-of-control inflation

What about Indias out-of-control inflation situation? Everyone knows that India has a severe and rather unique price problem by EM standards ... but as best we can tell, everyone is wrong. Why? Well, just compare the two charts below.
Chart 7. This is what CPI tells you
CPI inflation (% y/y) 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 01 02 03 04 05 06 07 08 09 10 11 12 Overall EM India

Chart 8. And this is what the deflator tells you

GDP deflator inflation (% y/y) 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 01 02 03 04 05 06 07 08 09 10 11 12 Overall EM India

The left-hand chart shows Indian CPI inflation compared to the EM-wide average. As you can see Indias inflation situation is far worse, to the tune of nearly five percentage points and while most other countries are enjoying a disinflationary respite, Indian CPI growth is actually accelerating once again. Meanwhile, the right-hand chart shows Indian vs. EM-wide GDP deflator inflation. And here the story is very different; in fact, with the exception of the 2010 monsoon-led spike in food prices, theres virtually no disparity at all between Indian inflation and the EM average. And, importantly, both are declining at the same pace over the past 12 months. Why the gap? Why does GDP deflator inflation run a couple of percentage points higher than CPI inflation in most EM countries, but a couple of percentage points lower in India. Part of the answer is the poor shape of Indian CPI statistics, reflecting an extreme underweighting (and in most cases absence) of services prices in the official CPI basket and an offsetting over-representation of foodstuffs. Were not saying dont watch CPI after all, the RBI certainly does, along with related WPI indicators but what we are saying is that there are better measures of price pressures in the economy that dont tell nearly as onerous a story.

Myth #5 A cost of capital crunch

Next on the list is the idea that Indias yawning budget deficit is causing a bruising credit crunch in the financial system, crowding out most of the available lending to the corporate and household sector and driving up interest costs significantly.

Jonathan Anderson April 26, 2012

Its true that the RBI has had to adjust reserve requirements to ensure continued liquidity in the system ... but look, so far thats about it. Chart 9 shows the path of (i) shorter-term one-year treasury bill rates and (ii) longer-term sovereign yields in India, and its very clear that while short-term rates have been rising as a result of policy rate hikes by the central bank, there has been virtually no change whatsoever in longer-term funding costs over the past couple of years.
Chart 9. Hardly a liquidity disaster
Percent per annum 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Nominal GDP growth 1-year T-bill 10-year bond

Moreover, both short and long rates are comfortably below the pace of nominal GDP growth, a far cry from the situation ten years ago (and as we will discuss in these pages tomorrow, this is crucially important for the structural sustainability of the India story).

Myth #6 The mountain of dollar borrowing

This one is perhaps the most ludicrous of all: the oft-heard fear that Indian corporates and banks are loaded to the gills with foreign borrowing and are now facing a severe repayment crunch.
Chart 10. Simply nothing to talk about here
Short-term external debt (% of GDP) 50% 45% 40% 35% 30% 25% 20% 15% 10% 5%
Latvia Estonia Slovak Slovenia Taiwan Bulgaria Hungary Ukraine Israel Malaysia Thailand Croatia Poland Czech Lithuania Korea Turkey Romania Argentina Saudi Chile UAE China Kazakhstan Venezuela S Africa India Russia Peru Colombia Philippines Mexico Vietnam Indonesia Brazil Egypt Ecuador Nigeria

0%

Jonathan Anderson April 26, 2012

You can see short-term external debt exposures for major EM countries in Chart 10 above. Look at where India sits. Enough said.

Myth #7 The end of the rupee

Finally, we need to address the near-universal panic that accompanied the big drop in the rupee exchange rate in the second half of last year. As we never tire of repeating in this pages, there was no rupee sell-off. Rather, there was a sell-off across all high-yield currencies, including the Mexican peso, the Brazilian real, the Hungarian forint, the Polish zloty, the South African rand, the Indonesian rupiah and others. And as you can see from the chart below, the rupee fared almost exactly the same as its comparator basket we repeat, exactly the same, no worse, no better.
Chart 11. Just another high-yield currency
Exchange rate index against the US dollar (Jan 2012=100) 150 High-yield EM basket Indian rupee 140 130 120 110 100 90 80 70 05 06 07 08 09 10 11 12 Depreciation

The only reason Indian investors get frantic about the rupee is that, well, most of them sit in India, or elsewhere in Asia. And as a result, theyre simply not used to looking at other high-yield deficit economies in Latin America and EMEA. Once you do, its awfully hard to get worked up about whats happening in India.

So what?
So what does it all mean? Well, um, it means that India is not collapsing ... and in fact that there is some recovery in the sequential data now underway. Which makes interested in tactical buying opportunities if the news flow improves. But would we be buying structurally? Maybe yes and maybe not. Well have much more to say about that tomorrow, so stay tuned.

2012 Emerging Advisors Group Limited