Might India benefit from the discrimination of global businesses now looking for relatively less risky countries?
Events in the Arab world have awakened global business to the ever-present, but often underestimated, dangers of political risk. New analysis in The Wall Street Journal, The Economist, and elsewhere warns of “contagion” and of a renewed sensitivity to political risk.
There are a number of countries with authoritarian political profiles akin to the Arab world’s, China’s most prominent among them. Chinese censors have shown themselves in recent weeks to be aware of this risk. The Wall Street Journal wrote recently of China’s vulnerability to “Nile Fever. “
In February, RBS polled emerging market fund managers about global business risk and prospects for emerging economies. The answers to three of the questions seemed to HC* to militate in favor of India being a relative beneficiary of current risk assessments, and a potential beneficiary (that is quasi-hedge against) of the potential shocks that these analysts are probabilistically forecasting (see below).
Mind the Gap!
Francis Fukuyama has even weighed in with an analysis based on a re-warmed version of Huntington’s classic “Gap” theory of political change (Political Order in Changing Societies, 1968). The argument goes like this: the rising expectations of ever more educated and dynamic aspiring classes are not met by the political institutions and leadership in their countries those aspiring classes will seek to change the system.
Fukuyuama and others think the CCP and the Chinese government are now able, and will be able in the future, to mind the Huntingtonian gap.
We will see. HC suspects that global investors and business will consider the Arab revolts as information that will cause them to revise upward their risk assessment of China.
China Uncertainty, India Risk
That risk assessment by China watchers is driven by uncertainty, not quasi-calculable risk of things like macroeconomic variables, electoral competition-driven policy changes (or persistence), or climate. These risks that can be calculated with probabilities are what shape Indian outcomes. And, while things like inflation, policy stasis, and corruption are high on the list of India-watchers, they are “normal” politics and economics. Fundamental change in India will always, now, be slow.
Everywhere in Asia, forecasters see “shades of grey.“ As direct and portfolio investors reevaluate, the question is not whether they will pull back (they will), but: where are political risks relatively lower?
Below is a table from a February, 2011 RBS research report called “EM Equity Flows by Country”, that shows recent equity flows from emerging markets. It shows that India has suffered along with the rest of the emerging economies. However, this also suggests that India is becoming less expensive for foreign buyers. As discussed below, domestic investment will pick up after early June and, if the monsoon is reasonable, it may pick up significantly.
Global businesses face a host of risks in India; some are national, many are sub-national or sectoral. But the scale of risk, while significant, is always mitigated by the multitude of channels for managing conflict and seeking resolution. Democracy, common law legal practice, jurisdictional arbitrage, and an increasingly pervasive business-friendly culture (as India’s inherent entrepreneurialism sheds its Nehruvian business constraints) provide a tedious, if predictably tedious, environment.
Rapid, traumatic Arab world-like events that would transform the entire national business environment in India are significantly less likely to occur in India for the reasons described above. Compared to China, Vietnam, Cambodia, or Malaysia (to take a few analogous emerging markets), the costs of tedium in India are offset by the banality of a slow-grinding, wide and deep federal democracy.
A good example of how this works is the November 2008 terrorist attacks in Mumbai or, sadly, the February 2002 massacres in Gujarat state. Short-term disruptions in the nation’s financial capital (2008) and in its most commercially dynamic state (2002) were soon followed by a return to the banal, steady state of commerce and growth.
If we take portfolio investment as the best proxy for risk, HC will be looking in the coming weeks and months to see how outflows of portfolio funds from India compare to those of China and the other countries mentioned above.
The drafters of India’s budget carefully weighed the measures they can take to send signals that will exploit the fears of “Nile Fever” in areas such as infrastructure, insurance and — surprisingly for the Indians — manufacturing. Explicit measures were announced in the budget to expand infrastructure investment through foreign portfolio investment into infrastructure bonds (supplemented with tax benefits and efforts to make investment and turnover more attractive by building a market for interest rate swaps).
The problem of inflation — a real but low-level risk for global business in India — is not one that can proactively be addressed in the budget. Fuel and agricultural subsidies will probably see less liberalization then would have been the case in a low-inflation year. Same for labor market reform.
India is not vulnerable to some of the key risks facing major emerging markets. HC has culled some key points related to India from the recent RBS informal survey on the debates about emerging markets in 2011.
Shocking! There is Corruption in India?
Corruption is the big issue on the minds of investors after revelations following the Commonwealth Games, the 2G Telecommunications scandal surrounding a minister in the ruling coalition, and stretching back to the Satyam accounting scandal of 2009.
The corruption itself is not a major new issue for growth and commerce as a first order issue. India has survived and persisted despite high levels of corruption for a long time. The effects on the process of governance (the Cabinet’s hours spent considering “real” issues, parliament’s passing of legislation, and possible major political instability in Delhi — is a second order issue that could provide a significant short-term shock to growth.
Indian Corruption ~ Compared to What?
But the question is: compared to what? Again, China and Indonesia are useful points of comparison. Corruption in India is regularly revealed and litigated, and there is sometimes even new policy devised to mitigate parts of it in the future. Investors with no appetite for corruption and the risks it involves should be even less willing to invest in countries with fewer political, media, and institutional mechanisms for dealing with corruption (even if, as is true for China, they have better scores on corruption from evaluators such as Transparency International).
As major new sectors grow as a percentage of the economy in India (or in any developing and transitional economy for that matter), the scale of business-as-usual graft will accord with the amount of money involved in such new sectors. Such is the case with the railway boom in China and the revelations regarding corruption there. Did anyone think that there was not corruption in the railway construction process? Economist Barry Naughton has long argued that corruption as side payments to “keep the development pace going” can be a tolerable and not fatal part of Chinese growth.
The 2G and other corruption cases in India recently are not a surprise and should not, as The Economist recently argued, be considered a producer of business- and investment-related uncertainty. Indeed, HC is arguing precisely the opposite, as a relative matter—that is, compared to China or, say, Indonesia.
What Canaries in the Chinese Coal Mine?
How will we know if the risk of a major disruption is building in the Chinese system? As always, HC will look for financial indicators.
Political Scientist Pei Minxin proposed a rough and ready model of regime decay and collapse for China.
If Chinese elites detected a threat to their monopoly on power, Pei wrote:
“Such a realization would prompt the agents of the regime to increase their discount rate for future income from the monopoly and, consequently, intensify their efforts to maximize current income while maintaining a high level of repression to deter challengers. In addition, the collapse of a foreign regime with similar characteristics may make fears of losing one’s own power even more acute and real. The net effects of the combination of a growing sense of long-term insecurity and the demonstration effects of a fallen fellow autocracy may be those akin to a run on the bank, with agents rushing to cash in their political investments in the regime, quickening the collapse of the regime’s authority.”
It seems that it will be hard to spot indicators of insiders “bets” on the demise of the regime, but I think that we should still try.
So, where would we look for evidence of Pei’s “run-on-the-bank theory”? If elites were “cashing in”, or making bets on the increasing probability of regime change in China, where would it be most likely to be observable?
I put this question to Victor Shih (Northwestern University) and William Hurst (UT Austen), whose suspicions are in agreement with some of my initial thoughts on this.
Bill Hurst: “First, there is the question of whether owners of capital are trying to move their money out of China because they think the Chinese economy may be in danger of decline or collapse. I agree with Victor’s original point that it is very hard to tell the difference between diversification and capital flight. What makes it harder in China’s case is the difficulty firms and individuals face in moving any money out of the country. Add on phenomena like roundtripping and “hot money” and I am not sure I can see a good easy way to trace or measure this.”
But, as Victor added, some are things we may want to track, such as listing of Chinese firms in the US (or at least off the mainland); reverse mergers (much the same as US listings); and real estate purchases in places like Hong Kong, Vancouver; and Sydney. All of this has been going on intensely for several years before the Arab revolutions, however. Will it intensify in the coming year?
This will be a test of how well the Chinese elite (particularly the Party and the government) can discipline its own members. The “cash out” conduits listed above will also be obvious to Party managers and it is as yet unclear if they are still capable of calibrating a constriction of these cash-out conduits (I think Pei should have turned the phrase around). HC’s sense is that there is still such capacity and that a good indicator, a “canary in the Chinese coal mine”, will be measures to constrict these “cash-out” conduits. So, where will the “run-on-the-bank”, “cash out” efforts turn to after the ones described above are constricted?
Back to India – May (or June) Flowers?
In May, there will be state-level elections in four Indian states (Kerala, Tamil Nadu, West Bengal and Assam). Three of those states are consequential contributors to GDP and commercial output in the country. Domestic investors are waiting to see that the dispensation in those states will be and what the state-level results mean for political stability in Delhi. HC predicts that domestic Indian portfolio investment (and domestic direct investment) will pick up after the elections. Already, in late March of 2011, UBS proprietary “Leading Economic Indicator” suggests a “mid-cycle” recovery in Indian industrial production.
HC is suggesting that mildly risk-acceptant investors may wish to reconsider their worries about “run-of-the-mill” issues in India such as corruption, labor-, insurance-, and retail-market reform. Those concerns should be put in context against the deeper uncertainties in China and the broader flight from other, smaller, and less-deep emerging economies.
China’s Trapped Transition: The Limits of Developmental Autocracy