Investment Outlook , Published Feb 19, 2020
The massive economic clean-up is resulting in a short-term slowdown. The “jugaad” economy has to die, for the new, innovation-led economy to emerge, grow and succeed.
Over the last few months, the Indian economy has been slowing, and many economists, soothsayers, and political commentators have been trying to ascribe this slowdown to the general mismanagement of the economy. While additional efforts can certainly be made (and indeed are being made), the underlying reasons for the slowdown are different, and require a more nuanced understanding. It is my belief that the Indian economy needed to take this short-term pain for extended, long-term, quality economic growth.
The biggest economic achievement of the current government is the massive clean-up being undertaken, where large swathes of the parallel economy are being forced to come into the formal economy (although with much kicking and screaming), alongside the large numbers of crony capitalists, who while operating in the formal economy, are only now being held accountable and not being allowed to loot the public exchequer anymore (resulting in the bankruptcy of companies that did not have real businesses in the first place, or at best were businesses that built on fraud, tax evasion and money stolen from public sector banks and investors). The impact of this twin clean-up will naturally result in a slowdown.
By some measures, the shadow economy accounted for almost 30-40 percent of the overall economy. The money looted by the crony capitalists, just in recent years alone, is already a matter of record as it is showing up as bad debts across the banking sector. I would humbly submit that it’s a miracle we are growing at all! One would almost expect a short term contraction of the economy as these required policy changes and the implementation of the rule of law are finally brought to bear across corporate India and middle India.
For a healthy economy (one that is based on the rule of law, unleashes the true power of entrepreneurship and innovation, and creates measurable long-term value), the old ways must be put to bed for good. Even if it results in a temporary slowdown (or contraction). It’s time that a few people don’t have undue advantage because of what they are willing to do (or ignore) when building and operating companies in India.
We have been suffering from a dual cancer of crony capitalism and institutionalized corruption, which has restrained India in all kinds of ways. It’s time all of us collectively said enough!
What many (including parts of the government) are also missing is that as the tide turns, new capital formation is not going to scale up as quickly. It will require both a new type of credit underwriter (one who lends on merit – not on “name” or on the basis of “kickbacks” received) and a new class of entrepreneur or business builder (who has a real business model and is looking to create a real project or business – not one that siphons off money through creative accounting or tax evasion, or has special policy dispensation, or some other fancy and new “jugaad”) to emerge. But this will not happen overnight, and certainly will not happen by relying on the same people who got us here in the first place. After all, old habits die hard. The “jugaad” economy has to die, for the new, innovation-led economy to emerge, grow and succeed. And we have to find new cheerleaders for it.
The real estate sector is always an important barometer, and perhaps the largest catalyst of economic growth in any country. Its growth and contribution to India’s GDP, too, is crucial to achieving the US $5 trillion GDP vision. It’s also amongst the most opaque sectors. In India, the sector is expected to contribute 13 percent to the country’s GDP by 2025 (up from 7 percent in 2017), and reach US $1 trillion by 2030. The government has undertaken various reform initiatives, such as the Real Estate (Regulation and Development) Act, 2016 (RERA), the Goods and Services Tax (GST), and the IBC code that should force the real estate sector to professionalize and increase transparency and result in the maturing of this very important industry, which has traditionally been unorganized in large measure, and a hotbed for corruption. The government’s proactive approach to dealing with the liquidity crisis in the residential real estate space may help. However, ultimately the players in the sector need to professionalize and be held accountable. This will provide the required fuel for further investment by both domestic and international investors, and weed out both the fly-by-night operators, and those that may not be the fly-by-night variety but have certainly been flying by the seat of their pants over the last many years, taking liberties with bank loans, investor monies, customer deposits, and showing a general lack of respect for rules and regulations.
In the commercial office sector, a historical trend of strong rental growth, low vacancy levels, and steady demand-supply dynamics suggests strong performance, especially as India fortifies its position as a global economic leader. It is interesting that while economists have complained of a slowdown last year, few seem to have registered that we net absorbed over 40 million sq. ft. of office space across the top seven cities alone. This was the highest in the last many years. Net office absorption has always been the best measure to quantify formal job growth. It’s also a relatively easier measure to track. At 75 sq. ft. per person (which is the Indian benchmark) the net absorption last year signals that 533,333, new, white-collar jobs were created in these seven cities. Given recent densification through co-working (to almost 50 sq. ft. per person) the actual number may be about 10 percent more. Much of this growth came from highly skilled jobs as global companies investing in India grew their presence in the country both for domestic expansion and for providing global services. For example, Amazon opened a 9.5-acre campus in Hyderabad – its largest in the world. The growth also came from new entrepreneurial ventures being set up and scaled – creating new employment opportunities. What is crucial to note is that this is happening in the midst of a general slowdown in the unorganised sectors and the manufacturing sector, where job growth was slow or even declined, and in the midst of a slew of layoffs and corporate bankruptcies of large employers like Jet Airways. It shows that the composition of economic growth is perhaps slowly changing as we add to the formal sector what was previously in the informal sector. Of course the task at hand is enormous, since the formal sector needs to grow very rapidly for it to absorb large chunks of the informal economy. And skilling and education will be critical in this endeavour. But last year’s numbers suggest that it is already starting to happen.
From a retail industry perspective, India continues to be amongst countries that have very low retail penetration both online (US $35 billion compared to US $2 trillion for China) and offline (1.3 sq. ft. per capita vs. 23.5 sq. ft. per capita in the USA), reflecting the massive untapped potential of this sector. Retail currently accounts for about 10 percent of the total GDP, and thus is the second sector that needs to be pushed to create jobs as it is one of the largest employers worldwide, in most developed economies. Recent policy measures suggest that the government is trying. However, the need for continuous professional training cannot be overstated in this ever-evolving industry. Social media marketing, data science, and design thinking are new skills that retail employers are demanding as new technologies take away low-skilled, informal jobs. Retail spaces will no longer be static; they will require continuous re-purposing to serve the changing preferences of their surrounding communities. New ways of doing business will evolve, and it will require constant upskilling and multitasking to succeed in this challenging sector.
Although I am usually happy enough to just be a realist, as we begin 2020, I am actually cautiously optimistic. Optimistic of a country and economy governed by the rule of (progressive) laws. I am optimistic of a young and restless demography finding creative and innovative economic outlets to spend its energy creating value, rather than venting energy through the twisted, and sometimes wholly misguided, narratives that are being peddled by many political parties. I am optimistic for the Indian people, both the diaspora making us proud across the world and for those at home building a new nation, as they build on the network effect to take their rightful place in the global economic order.
And finally, I am optimistic that the equal applicability of every Indian law to every Indian citizen, across the economic and social spectrum – without fear or favour – will finally unleash India’s true potential.
About Sid Yog
Sid Yog is a global investor, entrepreneur, philanthropist, and business school professor. He is the founder of investment firm The Xander Group Inc. that manages US $3 billion in equity, and is Founder and Chairman of the community-centric shopping centre developer-operator, Virtuous Retail. He is also a Professor at Harvard Business School where he teaches a popular MBA course on Investing in Emerging Markets.
Investment Outlook 2020