India’s economy is not doing as well as many had hoped. Growth has been slowing for several quarters, and even if there’s a slight recovery in coming quarters, the signs for the medium term aren’t propitious. There appears to be no end in sight to a slow-moving banking crisis. And private investment has crashed, reflecting pessimism at Indian businesses about the future and possible returns. India’s government looks less and less likely to carry out the kind of deep reform that the country’s economy needs, while its inexplicable decision to withdraw 86 percent of the country’s cash overnight — a decision that was as badly implemented as it was poorly conceived — has gravely damaged Prime Minister Narendra Modi’s reputation as a manager of the economy.
So the question is: Why aren’t these facts, which are easy to ascertain, reflected in the giddy statements regularly made about the Indian economy, especially by analysts and advisers to global investors? The answer goes to a problem at the heart of how global finance is organized. Economic theory tells us that advice is only as good as the incentives of the adviser; if he or she will do better by insisting things are good than they would by saying they are bad, then there’s a strong bias toward the construction of a narrative that all is well.
That’s part of what’s going on in India and emerging markets in general. A friend of mine a long time ago gave me a useful piece of advice: When asking questions about India or any other emerging market, never go to a sell-side analyst. Always ask the buy-side person — the one who actually has to make choices, not the person offering them. I’d actually go further and suggest a simple rule: When Indian businessmen and investors are acting cautious, it’s that caution I would heed.
Consider how odd and illogical our general approach to investing in a strange market is. We rely for advice on those who have a clear interest in talking up that particular market. Giant firms and global investors behave, in this respect, like an old lady convinced a door-to-door insurance salesman is giving her the best possible advice about which plan is right for her. Investors who would never for a moment consider investing in a company on the basis of a headline, a quick trip to the office, or a word from an investment adviser with dubious incentives are doing exactly that on a global scale when it comes to evaluating entire economies.
Even if you go to someone who has an interest in emerging markets overall rather than in one in particular, you might not be able to overcome this problem. Will that specialist ever turn around and say: “Look, at the moment, no particular emerging market looks great”? No, she will emphasize the qualities of the one that looks the best. This dynamic is helping to boost the India story right now, given that its macroeconomic numbers look stable and are easy to talk up — even if the stability is essentially fragile and dependent upon low energy prices.
So what needs to change? For one, investors who care about returns and correctly judge that there are places and sectors in emerging economies that will deliver those returns for them need to beef up in-house expertise. You need to have people with the right incentives giving you advice. I’m regularly shocked by the inexperience and lack of expertise that many firms have in-house; a career looking at emerging-markets macro data is no replacement for an understanding of the microeconomic truths in the economies that produce that data. It’s no replacement for an understanding of what the data conceals and where it may be deceptive.
If you are serious about investing in emerging markets in the long term, ensure you have people who understand those markets in the long term — and that their incomes and career trajectories aren’t linked to the advice that they give. If you hire, say, a Southeast Asia specialist who imagines that if she says Southeast Asia isn’t a good destination for the next couple of years, she’ll lose power in your organization, then, once again, you’re setting yourself up for bad advice. It’s a fact that there are a lot of great opportunities out there — yes, even in over-bought India, if one looks carefully. But unless investors go into an emerging market with their eyes open, with the right advice and with caution, they’re setting themselves up to get burned. Look beyond the headlines and the sound bites, the executive summaries and the pretty graphs. Somewhere beyond them is where the truth lies.