Managing Environmental Unpredictability: Some Lessons of Recent Indian Macroeconomic Behavior

The recent months, especially from May 2013, have seen a rollercoaster ride of Indian economy. With the sharp reduction of GDP rate to below 5 percent, almost by 50 percent from the near double digit growth, and the free fall of the Indian Rupee by as much as 20 percent to Rs 68 to a Dollar, compared to a very stable foreign exchange regime for more than three years, experts have begun to suspect the tenability of the Indian economy as a sustainable global economic power. The various measures by the Indian Government and the Reserve Bank of India to control inflation, seemingly at the cost of growth, read liquidity of the banking system, have been ineffective in arresting the slide of the Rupee. With the movement of foreign institutional investors (FII) funds away from India, the stock markets also began experiencing decline and volatility. When economic behavior gets influenced by testy times, the common man and retail investor is distressed.

Macroeconomic behavior is governed by an as yet unexplained combination of three factors, namely, internal fundamentals of economy, linkages with external global economy and sentiment of national governance. On May 22, US Federal Reserve Chairman Ben Bernanke first talked about tapering the USD 85 billion worth of bond buying every month (called Quantitative Easing, or QE). This announcement pushed global markets, especially the emerging ones, into a tailspin, leading to a depreciation of most currencies vis-à-vis the US Dollar. India was probably more sharply impacted than others.  Internally, the growth rates of various economic segments declined to recent historical lows while the current account deficit (CAD) moved up to a record high of USD 88 billion and the trade deficit also peaked to USD 92 billion. In terms of governance, the Reserve Bank and the Finance Ministry were perceived to be in dissonance.  That said, the unpredictability of economic behavior is illustrated by the more recent positive trends.

Green shoots

After the new Reserve Bank Governor, Dr Raghuram Rajan, took charge on September 4, 2013 there has been a significant improvement in the economic sentiment, accompanied by improvements in certain internal economic fundamentals and assurances of global macroeconomic stability. Dr Rajan was seen to be less hawkish in approach towards a tighter liquidity regime, principally. US Fed also helped matters by discounting any immediate possibility of tapering the QE. Simultaneously, India began to post healthier economic results with CAD down to USD 60 billion and trade deficit down to USD 80 billion. Foreign investments began to perk up to USD 13 billion while the banks started bringing in dollars to an expected level of USD 20 billion under the FCNR-B route.  A bountiful monsoon began pointing to bumper agricultural output in the coming months. As a result, stock market index, SENSEX, rallied to the record high of 21,207 points on November 1 while the Rupee recovered to hover around Rs 62 to US Dollar.  

The Finance Minister says that green shoots are here and there, everywhere. He states that the core industrial sector grew 8 percent in September with continued growth momentum, and stalled industrial and infrastructural projects worth several billion dollars are being unlocked to progress. He says also that the call money rates have been going down as a result of the rollback of tight liquidity measures. The Reserve Bank Governor also believes that things will only get better in India. He places his optimism on increased agricultural production, acceleration of projects and enhanced exports. It is remarkable that over a period of just six months, the sentiment on the Indian economy should worsen first and improve so dramatically. The developments point to the earlier thesis of the blog post that an unexplained mix of internal economic, external global and national governance factors influence the macroeconomic behavior.  There is a need to resolve the inter se influence proportion of the three factors and enabling a more sustainable macroeconomic framework that enables a stable investment and growth climate for industries and investors, retail and institutional.

Rajan’s theory

Dr Rajan, in a recent interview to Mint, has stated that India needs two transformations; one of more investment and less consumption, at least of certain things and the second of more savings, especially financial savings. The interview which has been preoccupied with the banking sector issues threw no further light on the way Rajan would detail out the two transformations. The author believes that the elemental proposition by Dr Rajan would need to be expanded further, in a perspective of the three factors discussed earlier. An economy would be robust when the internal fundamentals are strong and sustainble (weight, 60 percent), external linkages are pro-market and positive (weight, 20 percent) and the governance is fair and proactive (weight, 20 percent). The internal fundamentals and external linkages are self-supporting in the sense that external funds would flow into stronger than weaker economies. The governance of a nation sets a fair policy and execution framework that distribute pains and gains of growth equitably.

The two transformations outlined by Rajan are also interlocked.  More investments are supported by more financial savings while lower consumption provides for more productive uses of physical and financial assets. Speculative use of capital, be it in commodities or stocks, and speculative investments into assets, be it real estate or gold, lead to asset bubbles which eventually explode causing much damage to the economy. Similarly, excessive resort to borrowings without accountability to efficient use of funds and excessive lending to businesses or individuals without control over viability result in non-performing assets (NPAs), which is one of the major problems of the Indian economy today. That NPAs are at 10 percent of the total bank borrowings or that the prices of real estate exponentially jump up in a matter of two or three years indicate that the Rupee is being less efficiently used than ever.  The governments, central and state, and the banks need to find a way of better capital management by the users, including recapitalization of the banks. 

Un-stalling projects

Both the Reserve Bank and the Finance Ministry are aligned on the objective of moving forward the stalled projects. Unfinished projects, especially those in power, transport and other infrastructure sectors, not only lock up huge doses of capital but also lead to escalation in costs besides stalling core and peripheral industrial activity. The time span for an infrastructure project in India is upwards of 10 years, and in the case of some power and steel projects, is upwards of 20 years which is simply unacceptable. While the Government has set up a project management group to monitor large projects, it is important to de-risk the projects at the conceptualization stage itself. Timely execution of projects strengthens India’s internal economic fundamentals, which is one of the most important aspects of providing macroeconomic stability. In several cases, there tend to be only a few bottleneck areas that need to be resolved such as access to feedstock, provision of land or economic tariff that can be resolved by inter-ministerial groups.

The issue of projects in commercialization which have turned non-performing is more challenging. Despite all the disclosures that exist for public limited companies, the real causes of sickness are never understood and are rarely addressed by managements and lenders or investors squarely. While the Finance Minister has held that there are no sick promoters but only sick companies the issue may have to be restated as that there are neither sick promoters nor sick companies but only sick managements. The ability of the managements to stand up to their owners, be they private promoters or the ministries, in pursuance of orderly management of businesses is a key factor. Equally important would be the ability of the managements to benchmark their performance against contemporary management principles. The abundance of penny stocks in the Indian stock markets and the 20 to 30 percent decline in the benchmark indices of small and medium cap stocks is reflective of an endemic deficiency in management in Indian industry and business.

Enabling predictability

Clearly, there is so much development and growth potential in the Indian economy, the mere exploitation of which would help strengthen the fundamentals of the Indian economy. Reinforcement of domestic markets and industry with infrastructural support would enable both microeconomic and macroeconomic stability. Efficient use of capital on the back of generation of financial savings would help the country rein in deficit. The twin transformations suggested by the Governor of the Reserve Bank and the growth of green shoots anticipated by the Union Finance Minister would be ushered in only with an integrated economic policy that is executed in synchrony by the Reserve Bank of India and the Ministry of Finance.  The overall management efficiency in the country’s institutions and entities needs to be substantially upgraded, including making key managerial personnel accountable to the Boards and making the Boards themselves independent and erudite under the provisions of the new Companies Act 2013.

Posted by Dr CB Rao on November 3, 2013