The Political Premium

13 April, 2012

Sometimes you wrestle with a question for years and then in the space of a fortnight a sequence of events take place which gives you the answer you need. This week I experienced such a revelation.

Two years I ago I was having lunch with a journalist friend of mine who had worked in a range of Emerging Markets. My friend made the point that because India was the most visibly corrupt amongst the rising Asian economies, it could not possibly make the transition from third world to first world without. He believed that India's path to prosperity would be riddled with strife and civil war and his parting shot was that I needed to appreciate that Continental Europe and America's journey from the third to the first world had been soaked in blood.

Since my job brings me into almost daily contact with corruption in the Indian financial system, I found it difficult to forget my friend's warning especially during my long drives home through Mumbai's slums. However, as the 2G investigation has gathered momentum and even more importantly as the "Jasmine Revolution" has gathered steam in the Middle East, I think I can now confidently tell my friend that India's unique status as the first large economy to make the transition from third world to first world WHILST BEING A DEMOCRACY gives us some specific advantages. Let me elaborate.

As explained in my previous column, once every decade the political machine in Delhi freezes as the excesses of the ruling class get out of hand and are capitalized on by an equally opportunistic opposition seeking to generate political capital out of these excesses. Given the dense interlinkages between our political system and our economy, this period of political gridlock has a cost in terms of foregone economic growth. However, in return for this cost, we get a number of benefits:

â Firstly, the process of the political system pulling back from its most egregious excesses (think of the 1976 Emergency, Bofors in the late 1980s and now the 2G scam) to a more moderated form of corruption takes place in India without violence. As events in the Middle East are showing us, the same is not true in dictatorships elsewhere.

â Secondly, once the political system has pulled back from the brink, we are not left with a power vacuum (as is arguably the case now in Libya, Egypt, etc). Instead, in India, either the Government of the day continues after eating humble pie or is displaced by the opposition. This ensures that the economic slowdown is temporary rather than long lasting and permanently damaging.

â Thirdly, the nexus that exists in India (and elsewhere) between the politicians, government officials and businessmen is usually shaken by these 'once in a decade' cleansing affairs. This checks to some extent the ability of select business groups to hijack the political process to their benefit and to the detriment of their rivals and the broader public. The fact that, government in India operates at three levels centre, state and local acts as a further check on this front.

Why does all this matter now? It matters because it shows that our political system has some self-corrective mechanisms. These mechanisms might not be as strong as some might like them to be. However, they exist and they prevent India from having to go through the violent upheavals that other countries have had to go through as they have sought to make the transition from third to the first world. In this regard it is worth reading a book called the "People's History of the United States" by Howard Zinn which vividly describes how both the American War of Independence and the Civil War were underpinned by the desire of a small section of American society to economically dominate the country (at the expense of other rival elites).

Over the last ten years India has traded at 20-25% premium (on a forward P/E basis) to the MSCI Emerging Markets countries. This P/E has usually attributed to India's superior economic growth rates. Now that that premium has almost disappeared in the wake of the recent correction, it is worth appreciating that that premium will return once political stability makes a comeback in New Delhi. In that context, if you buy into my line of thought, the "India story" becomes a bit of a political miracle rather than solely being an economic story.


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