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February 2019

Modi versus Kahneman's Peak-End Rule

Despite some big moments recent complications may take more than their fair share of the public's evaluation of Modi's India.

Modi vs “peak-end” rule

One of the interesting cognitive heuristics researched by Daniel Kahneman, a Nobel laureate, is “peak-end” rule. The rule suggests that our evaluation of any experience is not a rational one. We tend to judge an experience based on the average of how we felt at its peak intensity and at the end. Our brain takes a shortcut by not considering an objective average of the whole experience. Outside of the peak and the end, “remembering self” effectively ignores the rest when evaluating the experience. 

Hence, the peak and end experience stages are very critical. When I take my daughter for a dental check-up and the reception desk gives her a snazzy little toy at the end, I can see its manifestation clearly.

Peak-end rule is probably one of the important concepts Narendra Modi, the Prime Minister of India, needs to keep in mind this year when campaigning for votes. His regime has had some big moments – a single party majority, demonetisation, winning elections in Uttar Pradesh and GST (general sales tax) implementation to name a few. Different segments of the Indian population will define their own “peak” of this experience. The “end” of his term however is turning out to be slightly more sour than many of us imagined: a current account deficit, weak currency and the still-unresolved IL&FS crisis, of which more shortly. 

Over a barrel...

To be fair, this “end” is not of Modi’s making. Oil prices have done what they always do, namely expose India’s dependence on cheap energy imports for high growth. But when the voters go to the ballot boxes, this “end” will matter and perhaps more than what is rational.

Perhaps realising the need to deliver a better ending, the government finally relented on its planned deregulation of fuel prices in September. Pricing was cut with the government and the corporate world both sharing the burden. It’s too early to say whether fuel price deregulation will be relegated to a historical footnote, but clearly an unfortunate precedent has been set. The stock prices of oil marketing companies obviously collapsed. Thankfully, our philosophy of buying quality businesses that we can understand meant that we were absent from this space entirely.

Creaky lending...

Meanwhile, the default by IL&FS, a AAA-rated infrastructure lender, spooked markets and led to questions about rampant wholesale borrowing by non-bank financial companies (NBFCs). NBFC lending has been growing quite meaningfully in recent years and a shakeout seems normal.

In a separate development, the Reserve Bank of India blocked the founder of Yes Bank continuing as CEO, giving credence to pre-existing doubts around the quality of its book and processes. Higher quality lending businesses, which we prefer, remain unscathed by these developments; and we think should emerge stronger.

In recent years it hasn’t been easy to ignore the fast growing lower-quality NBFCs given the extent of the market rerating. Finally though, our patience was justified and the market has come around to our more cautious view. A lesson again to us in the importance of sticking to your investment philosophy and taking the long-term view.