Ruchir Sharma, managing director, Morgan Stanley, believes a QE3 would be disruptive for India given that it might once again push up prices of commodities. Sharma doesn?t see any big burst of reforms from the Indian government and therefore estimates that GDP would grow at roughly 6%. In a conversation with Shobhana Subramanian, Sharma says the role of RBI in kickstarting growth has been overestimated.
You have been saying that the spurt in India?s GDP had more to do with the ?rising tide lifts all boats? trend and also that the criticism of policy paralysis may be overdone?
Some of the criticism by the business community against the government is no doubt legitimate. But the point is that between 2004 and 2010 there were no really significant reforms; policy actions like MGNREGA or higher minimum support prices had more to do with government spending rather than reform. But there seems to have been little reaction at the time because the economy was booming, primarily due to global factors. Secondly, although government spending went up as a share of GDP, it didn?t go up too much because nominal GDP was accelerating sharply. Of course, GDP will grow faster if there are reforms, but that?s nothing new; it?s always been valid.
Perhaps, earlier, clearances were coming through faster and there weren?t so many supply-side bottlenecks?
That?s true, but this could be a reaction to crony capitalism. When crony capitalism was creeping into the system in 2008 and 2009, the attitude, both on the part of the government and business, was that it was a necessary rite of passage for growth. My point is these fault lines were being built in 2010 but we were willing to ignore them, including crony capitalism. In other countries, too, when there is this perception that only a few people are benefiting, there is a backlash. But corrective measures need to be taken and countries like the US, for instance, have taken measures to see that there is greater equality.
What do you think could be the impact of a QE3?
I expect there could be some monetary easing and some co-ordinated central bank action because there is some softness in the economy, but QE3 could turn out to be counter-productive, especially for countries like India. Look what happened with QE2, in October 2010. All the money went into commodities and sowed the seeds of decline. The lesson to be learnt is that you can pump in as much liquidity as you want, but you can?t control where the money goes, whether it moves into the banking system or into commodities. Of course, over the longer term, the impact of QE is also diminishing; for instance, the US economy, as also other economies, got a much bigger lift out of QE1. The best thing that India has going for it today on the external front is that commodity prices are declining. But the risk, if there is a massive QE3, is that this tailwind will go away.
So you think the commodity cycle is turning?
Yes, from a fundamental perspective, I think it is. Demand in China is clearly slowing down and you hear reports now of inventories building and they?re unable to finance contracts in steel and copper. The only support that commodity prices have for them is this whole QE3 prospect; also, what has held up oil prices a little more is that there has been a significant build-up in China?s petroleum reserves over the past few months; you can gauge that from the gap in the import and consumption data.
What can pull India out of this trough?
When governments have their backs to the wall, they reform. That?s what happened in countries like Brazil, Mexico and Turkey. Of course, there are nations that have had success and then frittered away the gains and then reformed again. We are in the midst of a synchronised global slowdown. So, while the global upturn was due to global liquidity, now that the global liquidity bubble is deflating, we?re in a downturn. These cycles have become synchronous, and if we look at the delta in India?s growth, the changes are similar. The numbers for India?s export growth during the boom period were really mind-boggling, but my base case is that India should grow at 6%?that?s what the rate used to be. As long as the global economy remains in a slow growth phase, 6% is what you will get, based on the natural buoyancy of the economy. If you want to do more than 6%, you need the global economy to do well without pushing commodity prices higher and you need a huge burst of domestic reforms. And the probability of both to me currently doesn?t seem to be very high.
What do you make of the talk about stagflation in India?
Inflation should be falling given how slow growth is, but it?s proving to be much stickier. The important point is that there?s not a single economic boom in the world that has taken place with high inflation. If you look at any boom in history, they were all accompanied by relatively stable inflation. Look at China?s performance?inflation in the last decade was 2%. India?s inflation has been particularly troublesome in recent years. While inflation is relatively well-behaved globally, even in emerging markets, India?s inflation has been worse. Basically, private capex has come off and investment is being held up by government spending, which has increased dramatically in the last five years. There?s no other emerging economy that I know of that offers MSPs, and India raised prices by 15%! China, in its early stages of development, never did any kind of MGNREGA. India?s food inflation performance is amongst the worst in the world.
Can lower interest rates kickstart investments?
The role of RBI is overestimated. We are in a globalised world today where the global price of money matters more than the local price of money. RBI can be a follower; as global commodity prices fall it can adjust policy, but the belief that RBI can kick-start growth by cutting interest rates is a complete fallacy. It?s a global price taker, not a global price setter. The system?s transmission mechanism too is complex; there have been occasions when RBI cut rates but the banks didn?t follow through because they needed to garner deposits. Both China and India are facing this problem: their capacity to cut interest rates has been constrained by the fact that deposit growth has been sluggish. In China, too, deposit growth is an issue.
What do you make of the fall in the value of the currency?
I think the currency, which has adjusted now at levels of close to 56 against the dollar, seems to be fairly valued, but I don?t think it?s dramatically cheap. Currency valuations are a function of inflation differentials in the long run. I track the Four Seasons Index, and you would be surprised how much cheaper currencies are in some Southeast Asian countries.
Do you see a further de-rating of the Indian stock market?
We have already been de-rated, but from here on we?ll track global markets. I doubt there will be a further de-rating even if earnings are slowing down because you will get some multiple because of lower interest rates. Multiples tend to move inversely with interest rates. As I have said in my book Breakout Nations, India for me is the country I?m conflicted about, whereas on most countries we have a definite view. We?re negative on Russia and Brazil, and also have a negative bias towards China. We have a positive bias towards some of the South-Asian countries, even Turkey. In India, there?s no compelling case either way. It?s not as though India is dramatically cheap compared to its peers, but it?s not too expensive and the currency has adjusted. Right now, we?re at a 50:50 weightage.
Your book has generated considerable interest?
That?s probably because India wants to know what?s happening in the rest of the world and, moreover, it?s come at a time when we?re seriously questioning our economic boom. I?m not sure it would have found so much resonance a few years ago. Initially, most people thought I was being too skeptical by giving India a 50:50 chance. Today, they?re asking whether I?m being too optimistic about India being a breakout nation. People in Brazil and South Africa, two countries that I?ve been critical of, were quite accepting; it set off a debate. The timing is such that the emerging market boom in many countries is coming off, so everyone wants to know how their country will do versus others. The people in Philippines were surprised to have been called a breakout nation; they?ve been asking why I think they will do well. The Russians haven?t reacted though I?ve been somewhat harsh. In India, there haven?t been policy reactions; even people in government are despondent and many are waking up to the reality that growth will not be on auto-pilot.
