Economic Independence of India: Need for Multiple Regulators, Three Missions and Three Objectives

As India celebrates the season of sixty seventh anniversary of Indian Independence, there is a new hope and aspiration, which is reflected by the President Shri Pranab Mukherjee who said in his customary pre-Independence Day speech, that the twenty first century belongs to India. The Prime Minister, Shri Narendra Modi, reinforced the message while unfurling the national flag at the Red Fort on the Independence Day with a call to make India strong with economic growth and social equity. A cornerstone of the new aspirations will need to be economic independence for the country. This has a connotation greater than non-independence on economies of other nations. True economic independence means the emergence of a policy structure that rests on the logic of economic growth and social equity than on dogmas like self-reliance or maximizing foreign direct investment (FDI).

True economic independence happens when every adult in every family has a productive and earning job, whether through agriculture, manufacturing or services. The Prime Minister has given a number of inspirational slogans ever since he took office; these could verily serve as credos of development for a New India. Some of these are; ‘Skills, Scale and Speed’, ‘Per Drop, More Crop’, ‘Minimum Government, Maximum Governance’, ‘Come, Make in India’, ‘Zero Defects, Made in India’, ‘Reduce Imports, Maximize Exports’, ‘Zero Defect (of Product), Zero Effect (on Environment), and other exhortations are reflective of Modiji’s passion to develop India as an economic power. To these, if ‘Zero Unemployment, Productive Deployment’ gets added as the exhortation that is translated gainful realization through tangible action it could lead to micro level wealth creation. The issue with economic development is that there tend to be no easy solutions. A holistic approach is needed to make things work for true economic independence.

From licensor to regulator

One of the first tenets of economic liberalization of the 1990s was that licensing stymies industrial and economic development. The two decades of liberalization has demonstrated how unshackling of industries and businesses can lead to unleashing of growth. Two caveats are, however, necessary.  Firstly, growth cannot be fuelled only by continuous removal of licenses or liberalization of investment caps. All said and done, there would continue to exist sectors of strategic importance where licensing or investment controls would be in play. Barring a few such strategic sectors (defence, multi brand retail, railways, insurance and banking, oil and gas, mining, for example), all the rest are probably free of licensing and investment controls but are still anemic in growth for various reasons. Secondly, free market economy does not by itself guarantee non-cartelization nor does it by itself prevent exploitative economics (real estate, for example). There must be an oversight role for the governments, particularly in a huge democracy like India where the disparities in wealth, education and health are three of the most galling pain points.     

At a conceptual level, the governments must move from being licensors to regulators. Regulation commonly is seen as taking care of customer interests through good business practices including pricing. Truly effective regulation goes deeper, with an approach and guidance that ensures quality, innovation and competitiveness. Each of this is an important parameter that must be defining in its essence. National regulatory bodies should have expertise to monitor how various industrial and business sectors are performing in terms of the three parameters and periodically issue guidelines, rules and regulations to course-correct the erring or sub-optimized industries. Regulators, who will be industry specific need to matrix with three pan-industry commissions on each of the three parameters mentioned above; quality, innovation and competitiveness. Three national expert commissions can be conceptualized as discussed below.

Three national missions

Quality, of the product and process, is the key to make India global manufacturing hub. From a situation where the quality standards are derived from the developed world, India must be able to set global quality standards. Looks unbelievable? In the 1950s, setting global quality standards appeared infeasible for Japan and in the 1970s for Korea. Yet, today Japan and Korea lead in quality. Why not, therefore, India? If the Indian industry and talent pool is seen to deliver quality, India would automatically become a global manufacturing hub. For that, the existing base must be developed to reach and set higher standards of quality. A National Quality Mission would be well in order.

Innovation, of the product and process, is the engine of growth. Innovation leads to new products and processes as well as continuous improvement in existing ones. Innovation is commonly seen as a result of research. However, innovation, as with quality, is a matter of mindset. An inventive mindset is required to foster innovation as much as laboratories are required to convert ideation into innovation. For a resource scarce country like India, innovation lies in doing more with less; for example, more crop per drop. The ability to identify sources, uses and forms of innovation is a characteristic of successful nations such as Japan and Korea. India requires a continuous scan of product and process landscape to drive innovation; a National Innovation Mission would help.   

Many times, competition is misconstrued as competitiveness. Competition is simply presence of more players in the industry, which it is hoped will lead to each firm excelling over one another offering improved products or services to customers (it is a hope, not a given!) . Competitiveness, on the other hand, is the ability of a company to excel over the others in the industry in terms of products or services to the customers (it is a demonstrated competency, not a hope!). Mere competition, however high it is, does not guarantee competitiveness; in fact, excessive fragmentation affects viability. Indian airline industry and domestic pharmaceutical industry are examples. Competitiveness builds on quality and innovation with management and leadership processes that assure business growth and sustainability. A National Competitiveness Mission would identify appropriate technical and managerial perspectives.

Three national objectives

There are three beliefs that inhibit the genuine embedding of the three principles of quality, innovation and competitiveness in emerging economies, and these need to be countered by the three expert missions. The first is a sense of false correlation between the product level and quality level. It may be presumed, for example, that a Mercedes Benz E series car is one of higher quality than a lower end popular car. Such thinking leads manufacturers and consumers equate specifications with quality, which is not necessarily right. Each product needs to be designed, manufactured and delivered with a purpose in mind, and quality represents fitness for the purpose as expressed through specifications. The functionality, design principles and quality levels form a total ecosystem, which must be continuously elevated. Whatever be the level of product, the level of quality cannot be compromised. A smart phone and a feature phone are both bound by respective quality parameters as would a blacktopped road and concrete road would need to be. The National Quality Mission would need to embed Quality as a national mindset.    

The second is a belief in generational lag, in products and processes, and in social and industrial infrastructure, almost as if it is a matter of destiny for emerging economies. Domestic governments and consumers as well as foreign investors and corporations believe that the latest technologies must first get embedded in the advanced countries before they can be offered, developed or manufactured in an emerging nation. As a result of this belief, which is driven by technological protectionism of innovating countries and the economic weakness of follower countries, emerging nations tend to be in a perpetual catch-up game in respect of innovation. The National Innovation Mission must continuously explore where, why and how India should leapfrog in innovation rather than be just content with followership.

The third is a belief that competitiveness is a firm level concept, and government has only fiscal policies to improve or reduce competitiveness. As Porter’s study on comparative advantage of nations showed (Michael E Porter, The Competitive Advantage of Nations), certain nations tend to become good, and internationally competitive, in certain industries or businesses relative to others. Governments in India, Centre and States, can integrate infrastructure developmental initiatives with industrial development initiatives as well as social development initiatives to generate competitive advantage at firm level and comparative advantage at national level. The freight corridors that are being developed with Japanese investment could be combined with Indo-Japanese industrial clusters and social communities that provide free flow of technologies and goods and services between India and Japan. The same could be accomplished in multiple manners with multiple nations, in diverse product lines. The National Competitiveness Mission must analyze and integrate the several public, private initiatives to generate national comparative advantage.

Challenges as opportunities

Modiji has exhorted to minimize imports and maximize exports. India imports 80 percent of its crude requirements. India also imports gold, and most of the sophisticated plant and machinery for a wide range of industries. It may therefore look impossible to minimize imports. However, if value added export platform is adopted as the basis, all imports can be exported as value added products; for example, gold as ornaments, and even crude as diesel and petrol, at least to the neighboring nations. Sophisticated plant and machinery may be assembled at site with local content rather than imported as complete built units. This, in turn, requires confidence that the Indian industry is at its pinnacle on quality, innovation and competitiveness.

Skill, Scale and Speed have helped China achieve exactly this, as Shri Narendra Modi aptly observed. China’s acquired expertise in telecom gear, smart phones, fermentation and bullet trains are striking examples. For India to be up to speed on this platform, governments and industries should backward integrate to the fullest extent, in a complete sense. There is certainly utility in indigenously producing new generation products even if in imported equipment, compared to import of the products. However, the full utility accrues when the equipment is also indigenously produced. India, a nation of 1.3 billion people, has now global scale demand levels for a range of products and, therefore, for plant & machinery for such products. It requires holistic planning and execution to recalibrate India on a global scale. The paradigm of industry specific national regulators, and quality, innovation and competitiveness specific national missions have the potential to help translate all of the Prime Minister’s powerful principles into national wealth with social equity.

Posted by Dr CB Rao on August 17, 2014

Expectation – Speculation and Real – Unreal Inflation: The Gross – Subtlety Conundrums of Indian Economic and Industrial Policies

The Reserve Bank of India (RBI) has refused to adopt a soft money policy once again, though the Indian GDP growth rate has decelerated to 4.5 percent, and despite cries for affordable money to fuel growth. Raghuram Rajan, the dapper Governor of RBI has stated that inflation is a greater concern than anything else. As students of economy know, inflation erodes the purchasing power and leads to a spiral of wages chasing prices. Inflation affects the export competitiveness of Indian products, and erodes India’s claim to global cost competitiveness. A major component of the Indian inflation scenario has been the high food inflation. This has hit the vulnerable sections of the Indian society, especially the daily wage earners, who are affected by only a partial inflation-indexing of annual salaries and lack of inflation-indexing of the daily wages.

The squeeze on real living conditions is contrasted sharply by the huge increase that has happened in the prices of real estate. Recent papers, for example, have been flooded with advertisements for apartments and villas that claim price tags of Rs 10 crore plus for downtown apartments and Rs 3 crore plus for apartments and villas in outlying suburbs, even in a conservative city like Chennai. The saga of galloping real estate prices against a backdrop of unsold housing stock is frustrating and enigmatic. There is no doubt that there is a huge element of speculation in the rapid increases of certain asset classes such as real estate and gold in India. Speculation, however, appears to be a larger cultural phenomenon, given the rapid fluctuations that occur in the Indian stock market and the fanciful nature of fancied stocks, euphemistically referred to as momentum stocks.

Banking on banks

Indian governments have conventionally treated inflation through fiscal policies, more specifically banking policies. Increase of interest and deposit rates on one hand, and mopping up of or release of liquidity into and from the banking system have been the specific tools.  Deployment of these tools has led to alternate cycles of high growth and low growth, accompanied by low inflation and high inflation in the better times. The current situation, however, seems to be a more disparate combination of high growth and low inflation, set in a cultural background of speculative trends. Classic banking solutions are unlikely to provide the required solution.  The other way of looking at this is in terms of demand-supply equation; the more goods and services are generated, the greater will be the price competitiveness leading to greater demand fulfillment with lower prices. As discussed earlier, the conundrum in India is one of more products and services at higher prices.    

In India, the banking sector has played an enormous role, incomparable in any other country, of supporting the industry across a broad spectrum, playing a variety of roles. The banks have been the angel investors of sorts to set up, and support, micro and small enterprises. They have been lenders of first resort for medium scale enterprises unable to or unwilling to obtain private equity investments. They have been bank-rolling large enterprises in their expansion, diversification and globalization plans. And most importantly, they have been hugely risk-friendly in supporting gigantic infrastructure projects. Without the banking system, especially the national and nationalized banking system, industrial growth in India would not have been what it has been. Yet, the banking system has got in return been a specter of bad debts, non-performing assets and delinquent or defaulting accounts. It is a moot point if this high level of bad returns is due to the gross insufficiency of risk capital for the industry on one hand and the expedient dependence of the industry on the interest bearing loans on the other or due to a combination of poor industrial management, loose loan monitoring or high interest rate regime.

Expectation and speculation

It is perfectly natural and logical for the industry and bankers to have mutual expectations. However, if expectations are not based on solid forecasts, and if results are not reviewed against expectations, any transactional relationship moves into a zone of speculation. Speculation, as can be appreciated, is the act of forming opinions about what has happened or what might happen without knowing all the facts. Speculation is nothing but guesswork without a basis of facts; speculation is also engaging in a physical or financial transaction in the hope of a profit; the more usurious the hope of profit is the more speculative the transaction becomes. Expectation, on the other hand, is a belief that an outcome will happen because it is likely. Expectation is based on refined human capabilities of logic and rationality while speculation is based on primal human characteristics of greed or fear. It is important that economic and industrial management of India is based on sound expectations and not on shaky speculations.

It is perfectly logical for the experts and laymen to expect that the RBI will raise or lower interest rates, or tighten or liberalize liquidity each time the monetary policy is announced. It is, however, pure speculation (pardon the oxymoron!) if the stock market investors and operators indulge in massive selloffs or buyouts in anticipation of, or within minutes of, any particular movement in policy. It is important that all stakeholders base their judgments and actions on expectations, and eschew any preemptive or presumptive judgments and actions that are built on speculations. It is, therefore, commendable that Raghuram Rajan has been forthright in setting expectations on inflation and growth, and not fueling speculative trends.  He discourages the widely held notion that low interest rates magically lead to high growth rates and advocates that the best way to promote growth is keeping inflation low. He is very clear, rightly so, that there is no tradeoff between inflation and growth.  That said, India faces a threat from two hues of inflation, which hopefully will be addressed by authorities with similar objectivity and candor.

Real and unreal inflation  

In any society, there cannot be a perfect match of demand and supply or of factors of consumption and factors of production. It is this mismatch that primes the drive for growth (potential demand outstripping physical supply) or leads the quest for competitiveness (physical demand lagging potential supply). The virtuous economic management seeks to develop and utilize factors of consumption and production to balance demand and supply at continuously increasing levels. The not so virtuous economic management seeks to tolerate inflation and curb consumption in times of short-supply of products and services. While this is a natural economic characteristic, proactive economic management and industrial management require that growth and competitiveness are always pursued as twin sides of the same coin. Clarity in fiscal and monetary policies set the stage for this. An integral part of this approach is the accessibility for continuously improving factors of production such as technology, talent and investments.

The economic mismatch generates real inflation as discussed above, but can be managed with emphasis on factors of production and other instruments of economic policy. However, it is the unreal inflation that tends to be a more dangerous scourge for the economy. Unreal inflation occurs when prices rule high, in some cases usuriously high, even when products and services remain unsold. The state of real estate mentioned in the beginning of this blog post (threefold increases in real estate prices when more than two-thirds of housing stock is remaining unsold, as an example) is an example of unreal inflation. There could be several other examples such as luxury hotel rooms being pricey despite low occupancy, luxury brands commanding unearthly prices  or leading smart phones costing more than computers despite increased competition and lower per manufacturer sales. The unreal inflation is a fight between firms with erstwhile monopolies and deep pockets and the new generation resource constrained firms with follow-on products. In the unequal tussle, more often than not, the economy and society tend to be squeezed in and lose out.

Philosophical issues

The discussion on inflation and speculation as well as on real and unreal inflation brings forth several philosophical issues and guideposts. Firstly, it is clear that there should be a healthy balance between risk capital and borrowed capital in an industry so that each firm optimizes its cost of capital (disregarding for a moment the invisible and long term cost of equity capital). Secondly, the industrial comity, investor community and the banking sector must anchor their transactions around expectations rather than on speculations. Thirdly, the balance between demand and supply on one hand and the factors of consumption and those of supply must be dynamically optimized, with focus on continuous growth and competitiveness. Fourthly, economists and industrialists must learn to differentiate between real inflation (which is inescapable but can be managed cyclically) and unreal inflation (which is irretrievably erosive and needs to be rooted out). Fifthly, and most importantly, economic and industrial policies require a culture of trust, transparency, forthrightness, logic and rationality amongst all the stakeholders that consider growth and competitiveness as two sides of an integrated economic and industrial strategy.

Posted by Dr CB Rao on February 2, 2014