The Indian Economy - the way ahead

Indian Institute of Ahmedabad Alumni Hyderabad chapter had invited me to be a part of the three
member panel to discuss on “The state of the economy – the way ahead” with Mr K V Kamath, Chairman ICICI Bank ltd as the chief guest on the occasion of “3^rd Ravi Mathai memorial lecture” on December 14^th, 2013 in Hyderabad. I didn’t want to miss the opportunity of interacting with friends in IIMA Alumni Hyderabad chapter of which I have been an active part till 2007-08.

I am reproducing here, with slight modifications, the talk I delivered on this occasion.

Let me start by trying to draw economic inferences by analyzing the voting pattern in the recently held state elections in 4 states.  Firstly, it was a vote by an angry voter whose voice was loud and clear. Let’s see state-wise what worked and what didn’t

Delhi – People voted for transparency in governance, against high prices and perceived corruption. People wanted change and are willing to try out a new party.

Rajasthan- The freebies in the shape of free distribution of medicines couldn’t turn the strong anti-incumbency tide. Whether the scheme really didn’t cut ice with people, whether it didn’t reach to all those intended or it wasn’t a priority, it did establish that freebies don’t always fetch votes and it augurs well for the economy if it’s true.

Madhya Pradesh and Chattisgarh – Infrastructure works and good infrastructure gets votes. Good governance matters.

While these are inferences at a very preliminary level, I do wish to highlight how the state of economy gets easily reflected in the voting pattern.

Now let’s discuss today’s topic – “the state of the economy – the way forward” in the Indian context.

India’s GDP growth moderated in FY 2012 and further in FY 2013, registering an increase of 6.2% and 5.0%, respectively. This moderation has been carried over to the current fiscal with the half-yearly growth (Apr-Sep) being 4.6%. Quarterly data indicates that GDP growth in Quarter 1 (Q1) of 2013-14 at 4.4% (year-on-year), was the lowest level over the previous 16 quarters (which was during Q4 of 2008-09, the peak of the global financial crisis).

India’s growth story, especially since the start of the 21^stcentury has been remarkable, with an average growth rate of more than 8 percent during the period FY2003 to FY2011, much above the growth rate of other emerging and developing economies and this factor should not be lost upon in the wake of recent crises. What are the reasons for slump in growth?

One of the key reasons of the recent flat performance in India’s GDP has been the deceleration in manufacturing. Manufacturing growth has lagged GDP growth, often time by a substantial margin, over each of the last 10 quarters. Consequently, the share of manufacturing in GDP has witnessed a decline. Manufacturing was the only segment other than agriculture, forestry and fishing to have witnessed a significant decline in its contribution to the country’s GDP during this period. The Industrial activity, as a result,  has been subdued over the recent past, on account of weak manufacturing output growth.

During the 2001-2011 period, trade deficit in manufacturing shot up from US$7.6 billion to US$ 160.9 billion (CAGR of 36%).  On analyzing India’s merchandise exports during the 10 year period 2002-2013, it is observed that close to 50 per cent of the exports constitute agriculture & allied products, petroleum products, and gems & jewelry products. Most of these products in which India has a substantial exports does not involve high end technology orientation. During the 2002-12 period, the import of manufactured goods by India has grown faster than exports of manufactured goods.

Policy logjams

what’s worrisome is that the annual growth rate of credit to infrastructure sector has dropped sharply from 2010-11 onwards as compared to the last decade which can primarily be attributed to 2 factors- (i) several policy logjams such as those relating to environment clearances, land acquisition, fuel supply and (ii) there was a growing squeeze on fresh sanctions by banks leading to a decline in investments.

I would like to talk about the specific example of the power sector. At present, owing to inadequate coal supply from Coal India Limited (CIL), about 12,000 MW of existing power capacity (excluding State sector) is not operative. Further, about 50,000 MW of capacity which is near completion or under implementation will face coal shortages on completion. About 12,000 MW of power projects which are under implementation by private sector are linked to captive coal blocks, the captive mines allocated to such projects have been inordinately delayed impacting the project viability. About 20,000 MW of gas based power capacity has been seriously impacted by non-availability of gas. It is estimated that total investments of about Rs 400,000 crores are impacted on account of current affected capacity of 78,500 MW (which is not producing at the desired PLF due to fuel issues). Generation loss on account of this is estimated at about Rs 42,000 crore (120 billion units @ Rs 3.50 per unit) which works out to about 0.45% of Gross Domestic Product (GDP). In case remedial measures for addressing the coal and gas deficit are not urgently initiated, the affected capacity will increase substantially as projects currently under implementation get completed.

International Trade & Current Account Deficit

Recent trends in global exports would highlight the increasing importance of India as a trading nation.  However, the country’s export growth has not kept pace with its growth in imports, resulting in expanding trade deficit. Trade deficit trebled from US$ 64 billion in 2006-07 to US$ 192 billion in 2012-13. The trade deficit as a percent of exports, which was 51% in 2006-07, increased to 64% in the year 2012-13.

While this scenario is partly because of imports of coal, oil and gold, the challenge is to make these items contribute smaller proportion of the country’s overall trade. High oil imports would remain considering that the current level of per capita oil consumption (at 3 bbl/day per 1000 persons) is among the lowest – given the annual increase in India’s population of 10 million, even to maintain this current level remains a challenge.

India’s share in global services exports has risen from 1% in 2000, to 3.2% in 2012, Nonetheless, growth in India’s services trade has not been as dynamic as deficits in merchandise trade during the 2006-07 to 2012-13 period and could only partially compensate the growing deficit. During 2008-09, the surplus in services trade catered nearly 46% of trade deficit. This has come down to 34% in 2012-13.

The slow down sentiments across the world, and within the domestic economy have catered to decline in capital inflows (both FDI and FII). While FIIs found India less attractive due to slowing down of economy, FDI inflows were hampered due to mixed policy signals. As the capital account could not generate surplus fully to compensate the CAD, there has been decrease in forex reserves both in 2011-12 and 2012-13. Sizeable portfolio capital outflows and large external financing requirements triggered downward pressures on the Rupee from late May. This phenomenon was not India-specific and most emerging markets with large current account deficit such as India, Indonesia, South Africa, Brazil witnessing the steepest fall in their currencies.  Though the currency depreciation makes our exports competitive, it highly impacts our import bill also, especially oil imports which accounts for one-third of our total imports. Also, non-oil imports, especially, precious and semi-precious stones and metals (gold and silver), chemicals and capital goods add to the cost of manufacturing and thereby nullify the benefits gained in the export front. Import costs of oil and gas too shoots up, but since it is invariably not passed on to domestic consumers, the level of subsidies and with it the size of the fiscal deficit is likely to shoot up

Rupee's depreciation has a direct link with escalating non-Plan expenditure, two biggest components of which are interest payments and subsidies. External debt servicing cost in terms of the rupee, due to the latter's depreciation, shoots up, putting a strain on the exchequer. According to estimates, 10% currency depreciation brings down growth by at least 1%, which means further GDP contraction is imminent if corrective measures are not taken to boost the economy.

Immediate policy initiatives

The government and RBI stepped-up policy actions and some calming in investor sentiment provided support in the last few months. The measures include: liberalization of FDI in various sectors, enhanced FII limits in government and corporate bonds and relaxed ECB norms for NBFCs. RBI also announced two concessional swap facilities, under which banks can swap dollars raised through foreign currency non-resident (FCNR) deposits, and overseas borrowings, with the RBI. To contain the outflows, both in current account and capital account, a set of measures were taken. Financing for gold imports was curtailed, and gold import tariffs hiked. In mid-August, the amount domestic private sector firms can invest overseas was cut from 400% to 100% of their net worth (later rolled back to 400%).

Though there are incipient signs of recovery, coupled with good monsoon, signs of rupees stability and decreasing CAD. While the CAD has come down from a peak of 4.8% to 1.5%, it is expected to be around 3% for the year as above. Fiscal deficit has also narrowed and the Government is keen it should not go beyond 4.8% during the year.

Medium terms and long term measures

First and foremost - we need a stable central government post 2014 elections - a government capable of taking decisions even if hard ones and has a vision for the next decade. A weak coalition government would be recipe for economics disaster as the governance is likely to be marred by indecision and weak populist decisions which may not augur well in the long run .

However, most of these are short term measures and what’s required are series of medium terms and long term measures to ensure a robust and consistently high level of growth. Let’s look at the areas requiring focus:

Is there a need to relook welfare programmes?

India has made remarkable progress in reducing the absolute poverty and those below poverty line during the last two decades. The average per capita income has gone up and so have been the savings. In order to ensure more equitable growth process, Government has launched a number of welfare programmes. Mahatma Gandhi National Rural Employment Guarantee Assistance Programme (MGNREGA) provides a minimum of 100 days of assured employment to any individual seeking it. Likewise, Government provides food subsidy, ranging from 56% to 90% on foodgrains under the Targeted Public Distribution System (TPDS) to about 120 million families. Subsidy on diesel and Petrol has been in existence for some time now and so are fertilizer subsidies which incidentally are extended to fertilizer companies at source and not to the ultimate farmers.

The moot question is – whether subsidies extended under these schemes are reaching the intended beneficiaries and whether they are leading to any positive impact on the economy.  For instance,  MGNREGA is indeed a laudable scheme in terms of its intentions to create employment but the unintended consequences of shortage of labour, hiking up the cost of production especially in agriculture and lack of conversion of this employment into productive assets in a cause of worry.  

Let’s look at the subsidy provision in the Budget 2013-14:

Fertilizer subsidy – Rs 65,971 crs

Food subsidy – Rs 90,000 crs
Petroleum subsidy – Rs 65,000 crs
MGNERGA – Rs 33,000 crs

Add to these major outlays, the subsidy burden on account of other schemes such as National social assistance program, Rashtriya Swasthya Bima Yojana etc and the total outlay on account of such subsidies per annum works out to about Rs 300,000 crs p.a and the capital formation in the country is deprived of this much amount. Ironically, the annual disinvestment target is in the range of Rs 30-35000 crores which is about 10% of these recurring schemes year after year. I personally feel a time has come to take stock of these schemes and decide what’s good for the nation in the long run and not just about short term gains.

Quality of infrastructure –

There’s an urgent need to clear various bottlenecks which are coming in the way of faster and sustained infrastructure development. The Cabinet Committee on Investment (CCI) constituted under the chairmanship of Prime Minister monitors the progress of stalled projects. As on 11^th December 2013, there were a total of 394 stalled projects under review by the CCI (each with an investment of Rs 250 crs or more) with a total investment of Rs 17.68 lakh crores in sectors like Power, Steel, Road, Shipping, Coal, mining and petroleum. It has, in the last six months, paved way for 122 projects with an investment of Rs 4.01 lakh crores. Inter-ministerial coordination has to improve. Ways have to be found to pave way for these stalled projects so that cost over-runs could be contained and all the funds already invested could be put into use.

Increasing manufacturing activity

As already pointed above, losing out on manufacturing implies not only lower employment opportunities but also increasing imports as most of the manufacturing demands are of inelastic nature. There is an urgent need to increase manufacturing by providing all that what it takes to get the competitive advantage. MSME sector needs to be encouraged and industrial clusters are a step in the right direction. Government of India has come out with a Credit Guarantee scheme for MSME sector which will ensure smooth flow of credit from banks to the sector.

An obvious blame is often passed on the manufacturing sector and its lack of competitiveness as the reason for slowdown in growth. However one needs to see the co-relation between money faceting & GDP growth. The investment rate of 38% in 2009-10 with an ICOR of 4:1 implied a growth rate of 9.5% during the year. However, the investment rate which has since fallen and is around 30-32% in 2012-13 should have implied a growth rate of 7.5% but the actual rate is around 5% implying that slow-down in growth rate is much stronger than slowdown in industrial growth.

Vocational training & Skill development– Along with the increase in the manufacturing activity, there is an urgent need to encourage vocational skills and training in a sustained and planned manner. There is thinking that one needs more skill personal in vocational trades rather than low or poorly employable engineers. The cabinet has recently approved a Credit Guarantee Scheme for education & skill development. Once operational, this will ensure sufficient credit for all students seeking skill development.

Better business regulations – Can we have a "SARAL" kind of model for business clearance which would be a single point clearance rather than going to 42-50 levels of clearances. The need to ensure proper transparency in approvals will not only cut down time and costs but will also help minimize corruption.

Better and deeper financial system – Finance is not just about making profit availability of credit, need to encourage savings which is a function of returns, ability to borrow at affordable rates are some issues which are required to be looked into. Financial system should not require constraint subsidization.

 RBI in order to create an enabling environment is concentrating on the following five development pillars:

(i)              Monetary policy framework – RBI in order to set up a clear agenda for monetary policy just one the lines of what Sukhamoy Chakroborty report did in 1980s has appointed a Committee under the chairmanship of Mr. Urjit Patel and report is expected by this month end.

(ii)            Expanding banking infrastructure – RBI has relaxed norms in order to create better infrastructure facilities among the bank including norms for branch opening and so on.

(iii)            Broader and deepen financial markets – As per CRISIL’s latest estimates, a total of Rs 26.3 lakh crores of investment is needed which would comprise of Rs 8.1 lakh crs in equity & Rs 18.3 lakhs crs in Debts.  Power, Roads, Railways and Urban infra would account for 85% of this overall investment. While Rupee debts from Banks will be Rs 8.7 lakhs crs and ECB of Rs 2.6 lakh crs, Debt from Bond market are expected at Rs 7 lakh crs ie 40%.

(iv)          Access to finance especially to MSME and other needy sectors in the informal, unorganized, rural and small scale sectors. The use of technology needs to be encouraged. Financial Inclusion and new inclusion methods including mobile banking, mobile valets, and the Business Correspondents are some of the steps initiated to create a frugal and trustworthy Indian model of Financial Inclusions. A Committee has been constituted under the chair of Dr. Nachiket Mor which would submit its report shortly on Financial Inclusion.

(v)                Create systems to deal with corporate and financial stress –  the total GNPA (gross non performing assets) at the end of Sept 2013 for all Public Sector Banks was Rs 2.03 lakh crs or 4.82 % of the total credit. Out of these, a total of 9330 accounts (each with an outstanding of Rs 1 cr or more), in terms of ABC analysis had Rs 1.09 lakh crs in them and need to be concentrated upon.

The emphasis would be on early detection of the stress and “deal with it early” rather than ignoring and hoping to tide over at the same time. There is a need to act strongly against willful and un-cooperative defaulters.

 What’s required is an all out efforts to achieve and maintain an annual GDP growth rate of 8% per annum consistently for the coming decade. This would mean an increase in the per capita income from the present $ 500 per annum to about $ 8000-10000 by 2025 making India as middle income country.

It is, as RBI Governor says, a sober recognition of a healthier, better and educated India in coming years since ‘catching up’ is always easy than keeping up with Jones.