“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” These words of Albert Einstein apply not just to investments but to economic growth as well. A six per cent real growth for 20 years should conservatively increase India’s GDP per capita to $10,000 from $2,650 by 2045. A majority of Indians should live to see that day given that 63 per cent of the population is below 50 years of age. Even a 5.5 per cent real growth rate will take us there, but in 22 years. Whether it happens by 2045 or 2047 makes little difference in a nation’s journey. The key is to get there. The key is to grow for extended periods with low risk. (Assumptions in both cases of this exercise: 5 per cent India inflation, 2 per cent US inflation, 3 per cent INR depreciation and 1 per cent population growth, all per annum).
There have been countries that have delivered high growth fuelled by high borrowings, only to witness sharp slowdowns and/or restructuring in the future. Countries that run current account deficits are more vulnerable as debt-fuelled growth, even in local currency terms, is likely to eventually lead to rising foreign currency indebtedness, which in certain situations can lead to painful outcomes.
Recently, concerns have been raised about a moderation of growth in India. Apart from normal volatility in growth, this could be a result of multiple factors. It is common knowledge that Indian household indebtedness has gone up. Our forefathers typically borrowed only for emergencies or for acquiring appreciating assets. This has given way in current times to borrowing also for depreciating assets and experiences.
Click-driven EMIs, the influence of social media, the coming of stores to our homes courtesy of e-commerce, and the lack of incentive for cash down purchases over EMIs in many cases, have enabled this. Debt-led consumption merely shifts growth from future to present, and eventually payback time comes. Given the rising indebtedness of households, as also evident in rising retail NPAs, steps to slow the growth in personal loans are welcome and these are showing results. This could be one reason for a temporary slowdown in consumption, but this also sets the base for more sustainable growth in the future.
The long-term impact of debt-fuelled consumption should be carefully evaluated. The marshmallow test is a famous psychological experiment designed to measure a child’s ability to delay gratification. The test involves offering a child a marshmallow and telling them they can eat it right away or wait for a second marshmallow. The results suggest that children who delay gratification do better in life. An EMI, while it brings a high-end gadget/experience within reach of a lower-income person, also habituates them to these for life. It is debatable whether this impacts life positively or not. Tweaking risk weights on such loans, and ensuring that cash-down consumers get lower prices vs EMI-based purchases, can moderate this trend by encouraging the consumer to make a more conscious choice.
The second factor that could be impacting growth is the continued strength of Chinese exports. While China+1 is a favourable development, the results will be slow to come as a lot of work needs to be done before India can become a meaningful alternative. The Chinese manufacturing engine is firing well. The advantages of decades of large investments, policy support, great infrastructure, etc., that China enjoys will not make the going easy for India. Moreover, weakness in China’s domestic demand adds to its surplus capacity and is leading to deflation in export prices for merchandise goods, complicating things for Indian exporters.
Given our relatively small but decent manufacturing footprint, the government’s supportive role and favourable geopolitical status, India should be able to increase its share of manufacturing. However, we should not be complacent and be aware that progress is going to be slow and tedious.
Apart from these, there are a few other temporary challenges like the rising US interest rates, the low yield gap between India and the US at around 2.2 per cent, the strength of the US dollar and a sharp fall in net FDI. The latter is driven by the sale of equities not just by private equity funds but also by multinational companies (Timken, GE Vernova, Hyundai, Whirlpool, BAT, ZF etc). The sale of stakes in their Indian arms by MNCs is a first and is driven by prevailing valuations in these sectors, not by a lack of optimism regarding India. While these headwinds should pass over time, a conservative approach is desirable for now.
Stock markets, too, seem to have taken the narrative of sustained economic growth and a likely acceleration in the same to an excess. This is especially true for small/mid-caps. Nearly everyone I meet believes that small/ mid-caps create wealth faster. While this may be true in a few cases, I doubt whether it’s the case on average. The faster wealth creation post-Covid by small/mid-caps can be largely attributed to the much sharper fall they experienced. If 100 falls to 70 (representative of the fall of large-caps during Covid), the journey back to 100 returns 40 per cent; on the other hand, if 100 falls to 30 (representative of small/mid caps in the Covid downturn), the journey back to 100 yields more than 200 per cent. It is primarily for this reason that the returns experienced in small/mid caps have been much higher over the past four-five years.
It did not help matters that nearly 75 per cent of the current 20 crore demat accounts did not exist before Covid! This set of investors has no understanding or memory of the similar cycles of 1992, 2000, 2008 etc. Even the frenzied activity in IPOs calls for caution. Investors would do well to remember the golden words of the American investor John C Bogle: “Reversion to the mean is the iron rule of the financial markets.”
The writer is founder and CIO, 3P Investment Managers
