February 2016: India unleashes second generation of reforms

This year’s budget is just out and although we have not had time to look at the fine print, we would like to point to some of the key policy measures announced which we think affect India’s long term economic prospects. A good government does not wait for annual events like the budget to make policy changes – we are happy to observe that this government understands that. We have seen some path breaking reform in recent months – the first was when the government made the small savings rate flexible (the interest rate applicable for PPF, NSC etc.) – this rate shall now be linked to the yield on government bonds of a similar tenure, and shall be open to change on a quarterly basis. This may seem like a technical thing, but it is very critical to ensure effective transmission of RBI’s monetary policy – earlier, even if the RBI were to cut rates, it would not get transmitted to the rest of the system because the government was offering a higher rate for small savings, and depositors would simply move to these products, and thus neutralize whatever effect the RBI was trying to achieve. This new move will go a long way in removing distortions in the Indian financial market, and thus move our financial system closer to that which exists in developed markets.

Another significant reform is the proposal for a Railway Development Authority which will become the tariff setting body and will decide on the quantum and timing of tariff changes, for both passenger and freight traffic. This will hopefully remove political interference from the pricing decisions of the Railways. During the budget, we have seen further momentum on the reform path. We would like to point to two key proposals – of according statutory status to Aadhaar and the RBI’s monetary policy committee. The first will significantly enhance social benefit delivery and the second is critical to establish the central bank’s independence from the government. While this has always existed in practice, a statutory status adds far greater comfort both to the RBI and to investors in India. We sense that the government is making a serious effort to remove distortions in India’s financial market. All these measures, along with several others undertaken earlier like the auction of resources, deregulation of fuel prices, extension of Direct Benefit Transfer (DBT) to more areas, and others taken together, can in a true sense be called the second generation of reforms which are needed to unshackle the Indian economy.

Meanwhile, one senses a pall of gloom that seems to have spread to markets over the last few months. Mr Market is in an ugly mood! Mr Market refers to Ben Graham’s personification of the manic depressive market – the man who knocks on your door every day to either sell his share of the business, or buy your share of the business by offering a two way quote. It is our dharma to not be swayed by Mr Market’s moods but to use his ever swinging moods to our advantage. The Indian equity market has delivered 14-15% p.a. over the long run – if one were to extend a 15% trend-line from the Sep-01 value of 850 for the Nifty, one would reach the roughly 2525 low hit in Mar-09. If one were to extend that to now, we would be roughly where we stand today. A pessimistic Mr Market is good news for the intelligent investor as per Ben Graham – because it allows you to buy fabulous businesses at better and better prices.