DON'T FIGHT THE FISCAL

2019-10-09 3pm EDT  |  #India #fiscal

Over the past year you have probably heard me rail about the folly of monetary madness too many times. Negative rates are an abomination that demonstrate the sheer idiocy of current policy. History will not be kind to countries who have adopted NIRP. But the last thing you need is another post of me shouting at the top of my lungs about the reckless reliance on extreme monetary policy in Europe. You don’t need another diatribe about how easy money and fiscal austerity is a perfect recipe for anemic growth. Maybe if the ECB cuts another 25 basis points to negative 75 basis points then the company which was previously on the fence about CAPEX investing will finally reach the point where they want to take out a loan… Yeah, nope. Not a chance. Monetary policy has reached its limit and Central Bankers should be like that hero in the war movies - you know, the shy quiet kid with a few lines that jumps on the grenade when it gets tossed into the foxhole saving everyone.

This admission has been slow in coming. Whether it’s the Federal Reserve’s rewriting of financial history with their newly submitted economic papers which claim negative rates would have been beneficial during the Great Financial Crisis, or the ECB’s continued insistence they are not out of bullets and that even more negative rates will be supportive to the European economy, the Central Bankers are like Peter Pan and the gang - just a little pixel dust and the belief that they can do it - and gosh darn - they can fly.

What a load of crap! The longer they continue to believe they can fly, the more damage the will inflict on their economies.

Which is why it is so nice to see a country take a different tack.

India stuns the world

A couple of weeks ago, India’s government announced a new financial plan for their country that dramatically cut corporate taxes.

From Bloomberg’s article “India Joins RBI’s Efforrts to Boost Growth with $20 Billion Plan:

India’s government unveiled a $20 billion plan that entails cutting tax on businesses to one of the lowest in Asia and supplements the central bank’s interest-rate reductions to bolster economic growth from a six-year-low. Domestic companies will pay 22% tax on their income from April 1, 2019, versus 30% previously, Finance Minister Nirmala Sitharaman said Friday. The effective rate, including all additional levies, will be 25.2% and applicable on companies that aren’t availing any incentives or exemptions.

On news of the tax cut, the Indian stock market initially did its best Katniss-Everdeen-coming-into-the-Colosseum impersonation, but has since slumped with the rest of the poorly performing global equity markets:

But this move poses a real dilemma to traditional economists. Surely India should not be cutting taxes and increasing their deficit at this time of growing global indebtedness. Don’t they know that all that debt needs to be paid back and that they should be trying to decrease it, not increase it?

Yet at the same time most of those traditional economists sure do like tax cuts, and it seems they often especially like it when they are given to corporations, so many of them are flummoxed by recent developments.

I have no such worries. Moribund economic growth with millions under-and-unemployed is far more concerning. Maybe at some point fiscal policy will cause inflation, but the world is so far from this point, it’s laughable to worry about.

Now I have concerns about India’s external debt - you know, the kind denominated in another currency. However so far, the fiscal stimulus has caused no weakening of the currency. Absent any major decline in the Rupee, I view fiscal stimulus as a good thing.

India takes a page out of Trump’s book

Ask most market pundits why the United States has been the best performing economy over the past couple of years and you will usually be given some line about America’s corporate dynamism. Although I agree America is a unique Juggernaut of capitalism, that’s nothing new and not responsible for her stock market’s outperformance.

I am firmly of the belief the United States has done better than most other countries because they have not been tied to this self-immolation-esque-need-to-balance-the-budget. This year’s deficit as a percentage of GDP for the United States? 4.4%. How does that compare to other countries? Well, Brussels loves to give Italy a hard time about their spendthrift ways. Italy must be terrible. Probably something like 10%. Nah… Italy is running a 2.1% deficit as a percentage of their GDP. Hardly crazy policy.

How does this relate to India? Well, what did Trump do a couple of years ago? Eight years into an economic expansion, when all the Keynesians said he should be balancing the budget and the Austrian economists were screaming that rates should be cranked higher to reflect the true value of money, Trump enacted a monster tax cut.

You might not like it. You might think it’s not prudent. However it’s hard to argue that it didn’t spur America to being the strongest economy of the past couple of years.

Don’t send me your warnings that it will end in tears. The simple fact is that if you let your philosophical aversion to fiscal stimulus cloud your thinking, you missed a monster rally in American equity markets. I don’t know about you, but I don’t want to miss those sorts of rallies (regardless of what I believe this might or might not do to the long run health of the economy).

And herein lies the opportunity. While most of the world is trying to push more and more monetary stimulus down the global economy’s throat, we have a country bucking the trend.

India is taking a page out of Trump’s play book and dramatically cutting corporate taxes. My favourite part? When asked about the deficit, India’s finance minister said, “We are conscious of the impact all this will have on our fiscal deficit.” In essence, we hear your concerns about balancing the books, but we are ignoring them.

If you are a hard-money-balance-the-budget hawk, then you should be shorting India with both fists. They are going against traditional economic advice and instead doing something the MMT’ers would be advocating. Personally I have been buying India for the past week as fiscal boldness will be rewarded handsomely.

Longer term view

Now I know next to nothing about India. It’s cheap with lots of potential, but it’s one of those stories that gets traction at some point every decade, with all the foreigners piling in until they are inevitably disappointed and leave. Or that’s at least the reputation within the macro trading community.

However, at the risk of saying those four words that induces shudders, maybe this time is different. To make the argument, I will rely on a terrific article by the great macro thinker - Raoul Pal in Mauldin Economics.

But it is very rare indeed that a country develops an outsized technological infrastructure breakthrough that leaves the rest of the world far behind. But exactly this has just happened in India… and no one noticed.

India has, without question, made the largest technological breakthrough of any nation in living memory.

Its technological advancement has even left Silicon Valley standing. India has built the world’s first national digital infrastructure, leaping at least two generations of financial technologies and has built something as important as the railroad was to the UK or the interstate highways were to the US.

India is now the most attractive major investment opportunity in the world.

It’s all about something called Aadhaar and a breathtakingly ambitious plan with flawless execution.

What just blows my mind is how few people have even noticed it. To be honest, writing the article last month was the first time I learned about any of the developments. I think this is the biggest emerging market macro story in the world.

Everyone thinks they know about the Indian economy - crappy infrastructure, corruption, bureaucracy and antiquated institutions but with a massively growing middle class. Well, that is the narrative and has been for the last 15 years.

But that phase is over and no one noticed. So few people in the investment community or even Silicon Valley are even vaguely aware of what has happened in India and that has created an enormous investment opportunity.

The future for India is massive technological advancement, a higher trend rate of GDP and more tax revenues. Tax revenues will fund infrastructure - ports, roads, rail and healthcare. Technology will increase agricultural productivity, online services and manufacturing productivity.

Telecom, banking, insurance and online retailing will boom, as will the tech sector.

Nothing in India will be the same again.

FDI is already exploding and will rise massively in the years ahead as technology giants and others pour into India to take advantage of the opportunity…

Now I don’t know if Raoul is correct about India’s long-term prospects. It sure sounds like a good story, but that article was written a couple of years ago. What has the market done since then?

Well, for most of 2018, India ran higher - outperforming the world index and pushing to new relative highs.

But look closely at 2019. After a big run-up, the second half saw India sag badly against the rest of the world. We were actually hitting lows last seen in 2018 before this latest financial announcement.

What’s the trade?

Although I am worried about global stock markets, I am probably most worried about the United States. The country I like best? India.

I think buying India and shorting either the US or the entire MSCI world index is a great risk reward trade. You might think Raoul’s argument holds water. I sure hope he is correct. But I don’t think he needs to be right for this trade to work.

At the end of the day, the world is starved for fiscal stimulus. Most governments are running extremely tight fiscal policies with a stupidly-loose monetary stance. I yearn for countries that recognize this is not working and instead of continuing down this misguided path, try something different. India falls into that category.

Buy countries willing to engage in fiscal stimulus, sell those relying on monetary stimulus. It really is that simple.

Way back when Martin Zweig coined the line, “don’t fight the Fed.” I am coming up with a new one - “don’t fight the fiscal.”

Thanks for reading,
Kevin Muir