India: CSFB took a trip there to see what's what. Source: Google Images
Countries with divided democratic government that have to pay off constituencies to hold together coalitions often run up government debt and put at risk not only sovereign creditworthiness, but also economic performance. I have in mind Italy, Japan, Israel and Brazil. India, alas, is the posterchild of this phenomenon. By contrast, governments which alternate between parties or at least between stable coalitions of right and left often manage their debt burdens better. This is because if you mismanage the economy, you’re thrown out of office. The U.S., the UK, Germany, Mexico, and Chile come to mind. Granted, not a perfect rule — Mexico can’t raise much-needed non-oil taxes — but an interesting idea nonetheless.
CSFB took a trip to India to explore how the economy is performing, what the status of reforms are, and what the prospects for infrastructure investment are in this lumbering, rising power that links East to West and has every imaginable problem plaguing Emerging Markets from war, terrorism and ethnic tension, to poverty, growing pains, and inflation. See CSFB’s trip notes below.
India began reforming its public finances earlier this decade to get its government debt burden on a downward trajectory. At over 80% of GDP, government debt is high, and with deficits in the double digits, not set to decline. Luckily, GDP growth has been and is expected to be robust at 6-10% per year. Yet the country is very poor, with per capita GDP of $1000, making China seem rich with about $3500. This limits the government’s ability to raise taxes to balance the budget. Moreover, it imposes a constraint on monetary policy because inflation, especially of food prices, means people starve. So, an easy money policy has to be considered carefully.
Like Brazil, India’s problems are domestic — India’s debt is not external. It has amassed nearly $300 billion in fx reserves and has only a small current account deficit. The problem of late is that measures to improve public finances over the medium term have fallen prey to politics, as the statement made in the first paragraph suggests they might. Food subsidies and debt relief for farmers have been increased, and tax rates adjusted down in recent years. As CSFB noted, a planned direct tax reform is on hold.
With government finances in difficult straits, the only answer to improving India’s woeful infrastructure situation is through private investment, or at least public-private partnerships. CSFB writes about these below…
From CSFB 4/29/10:
India
Devika Mehndiratta
+65 6212 3483
[email protected]
We have just published a new report, India: Trip Notes (with a focus on infrastructure); we summarise our key findings below.
Earlier this month we were in India meeting corporates, banks and the government. Our focus was (1) on-the-ground feedback on sentiment, consumption/investment trends and any updates on government policy, and (2) specific meetings on infrastructure spending prospects in 2010 (year beginning April) given investor interest in this and market optimism that the government is giving a ‘big push’ to infrastructure spending in 2010 (particularly on roads).
Household consumption is apparently quite robust. We met with the CEO of one of India’s largest retail companies, who judged that growth in sales volumes was very strong and that some of the consumer goods companies (e.g., Fast Moving Consumer Goods or FMCG companies) were finding it a challenge to meet demand with their existing capacity. The picture on investment spending is still a bit hazy, however. Overall, while there does seem to have been some pick-up, it is not clear how strong this has been.
Housing prices have run up sharply. As the RBI recently indicated in its policy statement, housing prices in certain areas of Mumbai are already above their previous peak and, in Delhi, average prices are only about 5% below their previous peak. In our view, the RBI could tighten risk weights/provisioning norms for bank lending to the real estate sector sometime this year.
Direct tax reforms could be delayed by a year. In our talks with a senior government official, we learnt that implementation of direct tax reforms (scheduled for April 2011) could be delayed by a year.
On monetary policy, we maintain that the central bank is likely to hike the reverse repo and repo rates by 100bps by March 2011, coupled with more CRR hikes. The RBI stated at its meeting this month that it would like to “calibrate” rate hikes – as we stated then, in our view this implies that the RBI could end up having to deliver some intermeeting hikes in 2010.
We also had focused meetings with key players in the infrastructure sector to try to ascertain if infrastructure spending in 2010 is likely to pick up as strongly as many are expecting. Our meetings suggested that roads (national highways, specifically) is the only sector for which the government is clearly trying to speed up the awarding of new projects. Other than roads, the general assessment is that private sector investment in power is doing well and is likely to continue to do so in the year to come. Investment spending on railways, airports and ports, however, seems to be going on a slow/business-as-usual path.
Even within roads, it is worth remembering the government’s recent thrust is not across all categories of roads but is focused on national highways. Government estimates peg investments in roads (such as national highways, state highways, rural roads) in 2009 at about INR650bn (1% of GDP and 13.6% of total infrastructure investments). Of the total spending on roads, expenditure on national highways is likely to have been around 45%, according to government data.
Although the pace of awarding new highway projects has risen, actual construction activity is likely to pick up more in 2011 than in 2010, in our view. In a typical PPP (public private partnership) highway project, from the time that the project is awarded it takes about six months for financial closure, after which construction can begin. While the projects awarded in the past few months should start from 2Q 2010 (July to September) onwards, the clear step up in highway construction activity is likely to take place more at the end of 2010 and in 2011 (assuming the recent fast momentum in awarding projects is maintained through 2010).
Beyond 2010, many of the specialists we met made the point that financing could become an issue for infrastructure spending. Although land acquisition is highlighted as one of the key constraints in the infrastructure sector, many of the specialists we spoke to were concerned that in coming years financing of infrastructure projects is likely to become an issue, some estimating as early as in 2011. For debt, the Indian infrastructure sector is primarily dependant on credit from domestic banks, and most thought that the banking sector alone would not be able to meet the infrastructure sector’s funding requirements in coming years.
