Between A Rock And A Hard Place

Indian politics has appeared confusing and frustrating to most people who have watched it. Given the stage of development the country is at, its politics has never been more important. Policy paralysis is the buzz word of the day and there is common consensus that unless India reforms policy and puts the economy back on the political agenda, the country will find it very hard to grow and achieve its potential.

Politics in India is complicated. India is a multiparty democracy with all kinds of regional and national parties competing for votes. It is not uncommon for voters to have a choice of more than 25 to 30 candidates during elections. India is a diverse and very large country. To put it into perspective, let us compare India with the European Union. The EU has 27 member countries with 23 official languages and a population of 500 million. India has 28 states in a federal union with 22 scheduled languages and a population of 1.2 billion people.

Representative democracy has unleashed rent seeking in India at a massive scale. This rent seeking has manifested itself in power struggles for ideology and policy as well as through rent seeking for scarce resources that have resulted in corruption on a large scale leading up to the highest offices.

There are two primary national parties in India. The Indian National Congress (Congress) and the Bhartiya Janata Party (BJP). Neither has a strong enough voter base to form a national government on a standalone basis. It is the era of coalitions in India and each of them have lead coalitions to power at the center. The BJP lead National Democratic Alliance (NDA) ruled the country from 1999 to 2004 and the Congress lead United Progressive Alliance (UPA) ruled the country from 2004 to 2009 and now is in its second term due to end in 2014. While the Congress and the BJP remain the anchors of their respective coalitions, minor regional parties enter and exit the coalitions as politically convenient for them. India was ruled by a third front called the United Front for two years from 1996 to 1998. This was motely bunch of smaller parties that had come together to form a government at the center without the Congress or the BJP. Their government barely managed to stay in power.

The UPA in its second term has had an absolutely terrible track record on the policy front. The expert view on this is that the Chairperson of the UPA, the Italian born Sonia Gandhi is a left leaning politician and does not understand economics well enough to care. There are also several power centers around her that prevent the change of the status quo. Her son Rahul Gandhi is widely considered incompetent and the country is ruled by a proxy Prime Minister Manmohan Singh. Businesspeople are at their wits end and cannot bear the torture of the UPA's policy paralysis for another year until elections. There is nothing to suggest that anything will change until then.

Unfortunately for India, the prognosis for the 2014 election does not look good either. The Congress lead UPA is likely to lose votes and may not be able to form a government. Even if it did form a government, one is hard pressed to see why it would be different from the government that is already in place right now. The BJP as a party is in complete shambles. With the exception of Narendra Modi who is their leader from the state of Gujarat and has done well, the entire top brass of the BJP is in disarray. With Modi's branding as a non-secular Hindu fundamentalist, it is unlikely that Modi will appeal sufficiently to a national audience. While businesspeople are indulging in wishful thinking of Modi as Prime Minister (hoping for a repeat of the Gujarat miracle at a national level), it is very unlikely that he will be able to form a government at the center.

The most likely outcome in 2014 is therefore a third front government without the Congress or BJP that will probably not last more than a year. Even if the Congress or the BJP were to form governments, their coalitions would be so large and weak that they would not be significantly different from a third front government.

So India truly finds itself between a rock today and a hard place in 2014. Is there no hope for India and should the country be written off? Is it finally time for me to answer the call from that headhunter in London? I don't think so.

Investing in India has been a painful experience over the last 5 years. However, the outcome was the result of a perfect storm; weak financial markets globally and poor risk appetite in general, a cyclical slowdown in India's economy after several years of above trend growth, weak export demand from the developed world, high food and energy prices and finally poor policy action from the government compounded by even poorer image and sentiment management. Since most of the above are very large and macro factors, it is very hard for investors and commentators to get their hands around them in a finite manner. Therefore, everyone has hung their hat on the poor performance of the government and blamed it for all the ills plaguing the Indian economy.

I believe that things on the political front will not improve for India. However, I believe that as the perfect storm abates and India's economic cycle turns up, sentiment will improve and risk will come back on the table in India. The positive sentiment will also make the government look a little better, even though not much will change in terms of policy action. And if the gods smile on India and the country gets a strong government that can implement reform, India will become the best performing economy and market in the world.

As a value investor, what I like best though is that prices reflect the worst and the margin of safety against all the above potential outcomes has never been greater.

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