Of Indian bourses and reforms

For much of the nineties, I worked as an analyst for equity brokerages that had a large number of foreign institutional investors on their client list. The most difficult questions we faced in our effort to peddle Indian stocks to somewhat sceptical foreign fund managers related to reforms in India and the complexities of the Indian political system.

This was not mere academic interest. Indian politics, with its ability to spring unpleasant surprises and the sluggishness of the reform process, was actively priced into stock valuations. Indian markets got a rather heavy discount as a result.

Things seem to have changed quite a bit since then. I have recently started pitching in for our bank's equity business and have started meeting foreign fund managers again. Most of the money managers that I knew in my earlier stint have moved on to other roles. The new crop of India hands has a new set of queries and concerns. Strangely enough, Indian politics or policy hardly ever figures.

This indifference to the Indian policy environment is clearly visible in the way markets have moved over the last couple of years. I can think of a number of developments on the policy front that would have rocked the markets a few years back but have barely caused a flutter in the market's untrammelled bull-run.

Let me try and list some of them for you: the demise of the privatisation agenda, the prospect of job reservations in the private sector, the de facto reincarnation of the administered price regime in the oil sector, the complete lack of traction on the implementation of the Electricity Act or the current imbroglio in the policy on highway development.

These have hardly made a dent in India's image as the preferred destination for equity investments. Even a policy announcement that has a direct bearing on asset markets such as the capital account convertibility road-map announced a couple of months back barely caused a ripple.

What explains this indifference? Part of the explanation lies in the fact that a number of investment professionals who run India funds are relatively new to the game. It is quite likely that they have a limited sense of recent Indian economic history and its chronic "structural" problems.

They entered the market during a particularly rare and propitious conjunction of events. A cyclical up-tick in the Indian corporate sector has coincided with a phase of easy liquidity in the markets.

At the same time, critical reforms in segments like telecom and highway development began to bear fruit at the same time. Thus, despite the dire warnings from the few seasoned Indian hands who have remained behind in the business, corporate profits and market momentum have not slackened.

This in a sense has vindicated the faith of these newcomers. The new formula for making a killing on the Indian bourses seems to focus entirely on companies' bottom line and stop worrying about the macro-environment.

The large-scale participation of hedge funds in this bull-run has also played a role. Hedge funds, by their very nature, are short-term investors. They are nimble, and enter and exit a market without much ado, quite unlike the "long only" asset management firms, which sink their roots a little deeper into a particular market.

Can investors afford to ignore the realities of Indian politics and the inertia in policy making? I have no ready answers but at a time when the valuations in the market suggest that investors are building in sustained growth over the long term, this is a question worth asking.

There is of course a view that a growth rate of over 8 per cent is here to stay and India Inc will continue to grow at a steady clip even if the policy environment were to remain bleak. This seems to be based on factors like demographic transition, rising corporate productivity, large flows of foreign capital and the growth of off-shoring as growth
drivers that are unlikely to fade away suddenly.

Being from the old and somewhat discredited school of India watchers, I am not entirely convinced. For one, I can see that the skews in our education and labour policies are leading to a massive imbalance in our labour markets.

While there are clear signs of skilled labour shortage manifesting in wage escalation, there is massive oversupply of labour if you move down the skill chain. Again, while there can be no doubt that corporate productivity has improved quite dramatically, there is also a limit to which Indian companies can keep compensating for the inefficiencies in the operating environment.

This is particularly important since exports, both of goods and services, have played a
critical role in the current economic upswing-thus remaining competitive in global markets is key to sustaining the growth momentum.

My thesis is simple-a number of the "enabling" factors like a large low-cost work-force are in place. Indian companies have indeed become more competitive in the last few years.

Until recently, a lot of us failed to recognise this, perhaps because we were used to getting dazzled by China's achievement. Over the last three years, India's enormous potential has been recognised, particularly by the international investment community, and this has led to "re-rating" of its asset markets and is perhaps justified to a degree. However, whether the existence of these "enablers" alone can help us find the holy grail of an 8 per cent plus average growth rate is another story. It is perhaps time the India bears paid a little more attention to that plot.