Morgan Stanley isn’t exactly bullish on the Indian macro economic outlook due to stagflation and has drawn up three distinctive scenarios, none of which are too optimistic
In their new report titled ‘Where Are We in the Boom-Bust-Adjustment (BBA) Cycle?’, Morgan Stanley Asia/Pacific Research (MS) notes out that India is stuck in the threatening stagflation stage, caused due to weak productivity, high inflation and policy inaction. It also believes that the consolidation will take time as India is in the “early stages” of the readjustment cycle, which can only be helped by an “aggressive” actions whoever takes hold of the next government post-elections.
However, MS are also on a look out for external facts such as the US dollar and US 10-year yields. If the latter moves up, it could be trouble for India. The report said, “On the external front, we would be watchful of any sharp upward movement in the US dollar and US 10Y bond yields while we remain concerned about the potential negative effects of a sudden stop in capital flows.”
Reasons for stagflation and decline in GDP
According to Morgan Stanley, there are four reasons to explain for loss of productivity, resulting in stagflation, and weak productivity over the past three years.
Fiscal deficit: Firstly, India’s fiscal deficit remains in grave danger of breaching the double digit mark. If it does, it will put a severe dent to India’s growth prospects. According to MS, “the fiscal deficit was lifted from 4.8% of GDP in F2008 to 9.9% in F2009 and has remained above 7.5% for the past four years.” It is likely that double digit figures could be achieved if the National Food Security Bill is implemented.
Rural wages and NREGA: Secondly, there is a mismatch between rural wages and productivity. While rural wages have shot up, productivity hasn’t, thanks to the NREGA programme which has been beset with poor implementation and misuse. According to MS, “We believe the national rural employment scheme (NREGA) has been one of the key factors pushing rural wages without matching gains in productivity.”
Low capex: Thirdly, an “Unfavourable business environment resulting in deterioration in productivity of corporate sector, as well as, declining private investment to GDP” caused by global factors caused corporate confidence to decline, thereby reducing investments. This chart shows how capex has plummeted.
Negative real rates: Lastly, Morgan Stanley feels that negative real rates are the cause for India’s widening current account deficit which caused funding problems. The report said, “We believe that discouraging financial saving by maintaining negative real rates has only exacerbated the macro stability risks and has been instrumental in widening the current account deficit further, exposing India to external funding risks.”
All the four reasons collectively led to macro-economic stability issues, including persistently high inflation, widening current account deficit and a bad-loans crisis. The three graphs below are self explanatory:
Inflation: Even though inflation remains elevated, MS expects food inflation to worsen even as headline inflation hovers around the 8% levels, till April-May, during election time. The report said, “Even as we expect further deceleration in food prices, we expect CPI inflation to remain elevated around 8.5%-9% over the next 4-5 months.
Non-performing loans: Moneylife had predicted this way back in 2012, with a cover story on how the public sector squandered public resources leading to grave situation of bad debts. The same story can be accessed here: . MS expects bad loans to rise. “As per estimates from our Financials team, impaired loan ratio could rise to 11.1% by March 2014,” according to the MS team.
Current account deficit: Current account deficit widened from 2.7% of GDP in F2011 to 4.2% of GDP in F2012 and an all-time high of 4.8% of GDP in F2013.
Three possible scenarios
MS has drawn up three distinct scenarios: moderate, bad, and worse.
Benign scenario (medium): This would be helped by “strong policy actions” of the next government. MS believes that this could not only reduce fiscal deficit, but also moderate wages and keep headline inflation to 6.5%-7% levels by March 2015.
Sub-optimal (bad): Interestingly, MS thinks that if the government is unable to do anything (i.e. if the government is weak, without a mandate), then the RBI will do something. The report says, “if the outcome of the general election were to produce a weak coalition government, it could hamper the pace of implementing the required policy reforms... the central bank will have to tighten monetary policy further, potentially in an aggressive manner to bring about a more credible and quicker adjustment in inflation expectations.”
Disruptive (worse): The worse case scenario is forced market adjustment. Such a scenario is described as “the persistence of high inflation and inflation expectations keeps real rates in negative territory and brings about a widening in the current account deficit all over again, exacerbating the macro stability risks... the central bank would need to tighten monetary policy in a potentially disruptive manner... and could entail a sharper deceleration in growth rates.”
Did regulatory red tape choke KG-D6 output? DGH being itself the party challenging the claim made by Reliance cannot be the mediator to resolve the dispute!
In 2010 the output of KG-D6 and MA fields of Reliance was around 61 mmscmd, which began to fall, instead of reaching the original target of 80 mmscmd. The contractors claimed, after carrying out various technical studies and investigation, that the fall in gas supply was due to a "geographical surprise". After serious discussions against the claim made by the contractor,, Reliance and the Director General of Hydrocarbons (DGH) made a counterclaim that the fall in production should be actually attributed to the contractor not drilling more wells in the area to obtain the gas.
After a series of endless exchanges, Reliance, it may be recalled, suggested that an international technically qualified expert in this matter be called to investigate the the root cause of the problem. In the meanwhile, there were floating charges that the contractor was "hoarding" gas because of the imminent revision of contract when a new price structure will be installed from April 2014 onwards.
The current output of KG-D6 and MA fields has increased to 13 mmscmd, from 10/11 mmscmd, a few months ago. Reliance contended that drilling extra wells in the same area would not have simply increased output.
In a recent interview to the press, Sashi Mukundan, regional president and country head of BP Group stated that had it not been for the delays in getting approvals the output would have doubled to 20 mmscmd! He reiterated that red tape simply choked up the output from KG-D6 wells! He also rebuffed the charge that the fall in production had nothing to do with the anticipated price change or its official notification later. He reconfirmed that KG-D6 has still great potential to be one of India's top gas fields.
Take for instance the major oil discovery in 2013 (around May) in D-55 or MJ1 in the block, appraiser wells are being drilled. Work is in progress and it would take some more time before the potential and viability can be established.
In the next few years, the RIL-BP group hopes to invest around $10 billion in exploration and development in the east coast, provided timely regulatory approvals are received. If work goes smoothly, uninterrupted by delays and red tape, contractors feel that there is potential for quadrupling our production by the end of this decade. They have plans to participate in the next round of new exploration licensing policy i.e. NELP X, when the details are made public.
In regard to the present dispute with the contractor, for which Reliance has been made to provide a bank guarantee, media reports indicate that the regulator may turn to be the mediator in the KG-D6 row. Organisations like ONGC think that the Director General of Hydrocarbons should play an assertive role in settling disputes. At the end of the day, such matters should not be allowed to drag on for months on end; but, DGH being itself the party challenging the claim made by Reliance, cannot be the mediator to resolve the dispute! How can the judge and jury be the same person?
It is high time that Veerappa Moily takes the leadership role in having all the parties to the dispute, supported by their technical teams, to sit and resolve the issues. If need be, they can choose a third party technical expert to make an assessment of the actual situation at site and give the recommendations, so that Moily can take the final decision on the matter.
At the same time, he should ensure that all pending matters relating to the oil and coal industry which are "pending" for any clearance should be expeditiously handled within a time frame, so that at least we can start the next fiscal year with a clean slate!
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)
Vikram Malik (name changed) is a safe investor who made investment in tax-free bonds last...