Singapore: ‘Make for India’, which includes building infrastructure, should be the country’s focus rather than ‘Make in India’ for exports, as global consumption patterns, dynamics and demographics, have all changed over the last six years, says Sanjay Guglani, chief investment officer, Silverdale India Equity Fund, and chief executive officer, Silverdale Capital Pte. Ltd, Singapore.
In addition to infrastructure, the government should also look at reforms in other key areas where Indians spend the most—children’s education, housing and healthcare, he added in an interview. Edited excerpts:
Do you agree with some analysts that while the Narendra Modi government has made big announcements, it has not done enough on the ground? What are the key areas that need urgent reforms?
As a nation develops, it requires increasingly less number of big bang reforms, and much more removal of numerous bottlenecks. Compare the euphoria of the annual budget in India in the 1990s to the recent annual budgets being relatively non-events. While elections across the world are over-hyped events, as long-term investors, we prefer ground zero changes. From that perspective, significant ground has been covered to improve efficiency, transparency, judiciary, etc. Especially commendable is the eco-system for commercial dispute resolution. I am referring to the constitution of the National Company Law Tribunal, which is a game changer. Rather than arguing complex financial matters in numerous courts that hear alimony and theft cases, it would go to a professionally qualified bench with a strict code of conduct and time-line for resolution of financial disputes. Add to it the passage of Insolvency and Bankruptcy Code-2016, overhauling of Companies Act and adjunct regulations, India is finally working towards contracts that can be enforced “within time”.
In order to avoid, obsolete and onerous labour laws in India, four-fifths of the manufacturers in India officially employ fewer than 50 workers. This limit has been removed, and state governments are quietly moving in to increase the limit…
Having said that, India has a very long way to go: while petroleum prices have been deregulated, kerosene to fertilizer still have huge subsidy burden. India’s households hold approximately $1 trillion of gold. While the gold bond has been announced, it is far from being called a success.
Besides..,India also needs to think strategically. Many are awed by China’s export-led progress. We do not believe that is the best poster-boy for India. Every year since 2010 global trade has fallen, even in years when commodity prices were much higher. It is not that consumption has reduced. It is just that global dynamics and demographics have changed. The key export destinations—US, Europe, Japan—are increasingly consuming less. Not only that, the consumption pattern has shifted over the last decade from being more goods-oriented to being service-oriented … from buying new cars to vacations and healthcare. Hence, rather than focusing on ‘Make in India’ for exports and port construction, India should focus on ‘Make for India’ and building road infrastructure. Trucks in India spend up to 60% of the journey time waiting to cross the check-posts and only 40% of the time is spent on covering the distance.
Also, the health and education spend percentage of the Indian wallet is among the highest in the world. Hence, besides infrastructure, the other key reform areas where Indians spend most are: children’s education, housing, daughter’s wedding and healthcare.
One thing that is not discussed when initiatives like ‘Make in India’ is discussed is India’s skills shortfall—how challenging is this factor to Modi’s ‘Make in India’ drive?
Skills is indeed India’s Achilles heel. With average years of schooling in India around 4.4 years, it is a very uphill battle. The entire education system, on an average, is woefully anarchic with abysmal infrastructure. Rather than creating multiple IIMs (Indian Institutes of Management) and IITs (Indian Institutes of Technology), with current ease of movement, it may make sense to create MOOC (Massive Open Online Courses), create multiple Khan’s Academy. Create a massive IIM and IIT each of which could house at least 100,000 students, with world-class infrastructure and teaching aides, attract top talent from global schools. Let’s not forget over 240 million youth will join the work force in the next 10 years; however, India would create fewer than 150 million jobs. If India does not get its act in place soon, the demographic dividend could well become a demographic disaster.
Do you think there will be hurdles to goods and services tax (GST) implementation? Which sectors will benefit most from GST?
India’s GST will be world’s most complex version of a GST with five different rates for different categories covering every single item in over a dozen different languages with special exemptions for north-eastern states, J&K, etc., and non-GST credit items such as oil and gas, alcohol etc. It requires a tamper-proof IT infrastructure in over a dozen official languages working on real-time basis across India from Leh to Kanyakumari. It requires effective dispute resolution bodies across the length and width of India…and professionals to man these. All this after the GST bill is passed by all state legislative assemblies, GST committee finalizes the GST rates, and there is agreement as to exact quantum of revenue compensation to be paid to various states. As investors, we look forward to be positively surprised if it is indeed implemented in the next six months.
While it would benefit the entire economy, the bigger winners would include firms subject to widely varying rates of multiple levies such as entry tax, sales tax, VAT (value-added tax), excise duty, service tax, etc. Although the exact GST rates applicable are not yet announced, the likely winners would be automobile and auto ancillaries, cement, consumer goods, etc. which have multiple warehouses and high logistics costs; EPC (engineering, procurement and construction) contractors paying both excise duty and service tax; film exhibitors which overall pay much higher than proposed general GST rate of 18%.
Rajan demits office as Reserve Bank of India (RBI) governor in September—what do you think have been the key highlights of his term?
Signing of Monetary Policy Framework Agreement which provides a clear mandate to RBI to control inflation. And probably for the first time since independence, it provides RBI with a specific inflation target of 4%-6% and real interest rates of 1.5%-2%.
When governor Rajan took over the office in 2013, Inflation was around 10.2%, the market was buzz with rupee tripping over 75 (per dollar). As of last month, the inflation is down to 6.1% and INR (Indian rupee) is resilient at 67 (to one US dollar) with forex reserves at a historic high of $354 billion.
Having achieved stability of both currency and inflation, he managed to successfully cut interest rates by 150 bps (basis points) while creating more liquidity in the system and cutting down cost of funding. With deposit growth at a 50-year low, he has also softened the penalty on banks for extra borrowing from RBI to encourage lending. However, when banks refused to pass down the interest rate cuts, he mandated MCLR- (marginal cost of funds-based lending rate) based lending, pushing them to reduce lending rates.
He has done an excellent job, making Indian banking sector robust by getting NPAs (non-performing assets) recognized and provided for. Thus taking out systemic risks to the economy, something that could have plunged India into a crisis. What is interesting to note is that he did not push to declare NPAs till the banks were in position to resolve NPAs. When banks enforce SARFESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act), to recover NPAs, the conflict invariably moves to courts which favoured equity holders—promoters—over lenders. Hence, RBI worked with the central government, Company Law Board, Sebi (Securities and Exchange Board of India) etc. to get a debt-to-equity plan, the so-called strategic debt restructuring policy, enabled foreigners to own 100% of ARCs (asset reconstruction companies) to provide capital to buy NPAs, etc. Finally, changing the definition of NPAs to stop ever-greening of loans and colouring of accounts. As result, in just three months, banks have reported an additional Rs.2 trillion in bad loans; taking the total NPAs to Rs.6 trillion. A big black cloud has been moved.
But he has also been criticized for failing to significantly reduce interest rates, hurting growth.
Well, it is only in a low-inflation environment that the real interest rates can come down without hurting the saver. Otherwise, low interest rates coupled with high inflation results in negative real effective interest rates, which in turn pushes the saver to buy gold as a hedge against inflation, thereby depleting the forex reserves. In case of the current account deficit, this blows up and creates a crisis as it what happened recently in 2013. May I add that the 1.5% interest cut has not been fully passed down by banks, and further with the summer inflation spike behind us, RBI is now in much better state to cut interest rates, credit for which would be given to the incoming governor.
Post amendments to the India-Mauritius taxation treaty, indications are that the India-Singapore treaty will be renegotiated. Watching India closely from Singapore, what is your take on it?
India has very little legal clarity. Laws are first made, then thought through and then amended, leading to litigation. The India-Singapore tax treaty is co-terminus with the Indo-Mauritius treaty. With the amendment in the Indo-Mauritius tax treaty, the benefit of residence-based capital gains tax exemption under India-Singapore tax treaty will also end. The new Indo-Mauritius treaty has sensible provisions relating to grandfathering of investments made prior to 31 March 2017. If similar grandfathering provisions are not extended to the India-Singapore tax treaty, we would have extremely serious consequences, impacting multi-billion-dollar investments into India. With just six months to go, it is critically important that India provides necessary clarity, especially so because Singapore is the largest FDI (foreign direct investment) investor in India, it is—unlike Mauritius—a FATF (Financial Action Task Force) country, and a regional hub for Indian companies. We witness same issue being repeated in terms of notice given by India to 57 countries demanding that existing BITs (bilateral investment treaties) be terminated. Thus, seriously dissuading the long-term investors. We find this aspect of Indian polity most painful: making laws, then thinking, then amending, and finally litigating.
Will dollar and masala bond markets pick up in the rest of 2016? Will investors accept masala bonds with hedging risk looming large?
Because of the prevailing low interest rates in developed countries, global investors are chasing yield across to emerging markets. This has tightened both the yields on Indian US dollar bonds as well as INR bonds—the masala bonds. However, for most US dollar investors, they are looking at returns in dollar terms, that is, post-hedging of INR depreciation risks. Therefore, for local currency bonds such as INR or CNY (Chinese yuan) to succeed, the necessary condition is very liquid offshore INR or CNY market. At current interest rates being offered on masala bonds, it does not make economic argument to invest into them. For example, a three-year masala bond may offer 5% interest rate, while a three-year US dollar bond of the issuer may offer a 2.5% interest rate. However, if one were to hedge INR depreciation risk of masala bond, it would cost north of 5%, making effective return to dollar investor to be close to nil. Therefore, numerous firms from NTPC to smaller private companies failed to garner sufficient investor interest for masala bonds. HDFC (Housing Development Finance Corp.) masala bonds are a bad example because HDFC’s stand-alone rating would be around “AA” but for ceiling due to India’s sovereign rating being “BBB-”. As a result, it pays an interest rate higher than what would be paid by typical AA-rated firm, making this masala bond interesting though still not attractive! It would serve retail US dollar investors well to be cautious.