Banking to Bankruptcy: Systemic Solutions for Solvency

Recent news items in business dailies of India have carried two important messages. The first is that India inc’s greatest ‘fire sale’ is underway to reduce the colossal levels of debt accumulated by the Indian companies. The second is that the India will soon have as a law, The Insolvency and Bankruptcy Bill 2015, which was passed by the Lok Sabha as well as the Rajya Sabha (the “Law”). The first is validated by speedy developments such as Tata Steel placing its assets on the block, JSP striking a deal with JSW to sell off the former’s power plant and GMR selling off certain stake to Malaysian entity. At the same time, a news item on JSW trying to bid for Tata Steel’s UK assets makes one wonder whether the lessons of leveraged expansion and growth have been fully appreciated.

The development on the Insolvency and Bankruptcy Bill is welcome, in that it provides a more contemporary definition of bankruptcy and insolvency, substitutes several archaic laws by the new single Law, provides a safety net for workers, and creates a board for regulating bankruptcy and insolvency. The government believes that it would restore the balance between the companies and creditors and also strengthen the debt recovery mechanisms. As per expectations, it will reduce the time to resolve bankruptcy and insolvency issues to as low as one year. It also proposes to set up the Insolvency and Bankruptcy Board of India. It  provides for setting up information utilities to collect information on debtors and serial defaulters, under the aegis of the Board. It is also hoped that the Law will move India up in the global rankings in speed of doing business.

Cart before the horse?

The whole debate on current undeclared bankruptcies and future relief through the Law begs certain basic questions. It is true that free market economy is all about free entry and free exits of companies but it presupposes that all stakeholders including the companies themselves will make their best efforts to establish, manage and grow their businesses. It also presupposes that investors and lenders conduct their due diligence prior to investing in or lending to companies. In other words, a company, even in a free market economy, has no business to fail except for reasons beyond the control of companies, governments and nations. Poor management or ignorance of competitive dynamics could also lead to failure but companies and stakeholders must be agile enough to spot the creeping inefficiencies and take remedial action.

The current excitement on fire sale of the stressed assets well as the Law on bankruptcy and insolvency does not seem to address the root cause of the current malaise; rather it focusses on the unsavoury endpoints. Given the way Indian companies and lenders operate, quite possibly, there could be a flood of applications for declaring bankruptcy and insolvency. The current excitement does not also address why the earlier measures such as corporate debt restructuring (CDR), strategic debt restructuring (SDR), national company law tribunals, debt recovery tribunals, SARFAESI act or asset reconstruction agencies have failed to deliver. Without addressing the root cause for the scale-down of performance concentrating on winding up of companies may rank the country up in the ease of doing business in the eyes of multinational corporations and multilateral funding agencies but may not lead to overall business health.

Root cause

The Governor of Reserve Bank of India has stated that the root causes of bad loans or non-performing assets are many, and all of them cannot be attributed to malfeasance by promoters or mismanagement by executives. He opined that huge delays in land acquisitions and revocation of rights and licenses by governments and courts are two principal causes beyond the control of promoters and managements. The issue probably is not one of assumptions going awry; rather the issue is why the plans are not updated to reflect changes. More fundamentally, the plans as drawn up originally tend to be highly optimistic, in terms of investments, lead times, costs and prices with a view to satisfy banks and obtain funding. When the environmental changes superimpose further unanticipated delays and changes, the compounded impact would be extremely high.

Imperfect business plans, failure to course-correct the plans, lack of flexible repayment options in line with realistic business growth, and lenders’ anxiety to have early paybacks, together, constitute the root cause for bad loans to creep in at the first instance. What comes up in late stages as a CDR or SDR plan would actually be the right one that should have been operating in the first place. Also, the multiplicity of lenders with every lender trying to get some share of the loan portfolio without really going into the fundamentals is another cause. What normally is done at the endpoint, like establishing a joint lenders forum, electing a lead banker, having strong bank nominee on boards and having third party review of plans, should be done at the very beginning of a firm’s journey on debt path. Rather than set up an insolvency board, the need is for setting up solvency boards which objectively analyse the business plans at the beginning.

Systemic solutions for solvency

Businesses are fundamentally set up to grow and be profitable. At the very least they must aim to be solvent. Attempting to be solvent is not a conservative and defeatist approach; rather it attempts to correct distortions that could arise in the mad scramble for scale, scope and market share gains. The following principles of solvency are useful to consider in structuring and evaluating debt proposals.

Sector prudence

Debt to equity ratio is still the critical ratio that determines the net operational profitability, along with operational performance. It is understood that certain sectors, such as power, ports, construction and other infrastructure areas which are not attractive to retail investors and certain categories of equity investors, require long term debt. Higher debt allocation to such sectors from the banking system is an economic imperative. That said, the economy cannot sustain a situation wherein debt equity ratios of 7 to 1 and above are freely allowed. It is time that independent institutions like National Institute of Bank Management conduct research and come up with prudential debt-equity norms for all industrial and business sectors, and provide guidance to banks as well as clients. These norms may be revised each year based on performance of portfolio companies.

Strategic perspectives

It is not sufficient for banks and companies to be guided just by prudential norms. There could be an opportunity cost to the firm (and the economy) of not putting up a project because of funding gap. It could be a global generic market entry for a pharmaceutical firm or an import substitution project for high speed rail coaches. It is important that the strategic perspective is understood and funding support provided. Such incremental funding over and above prudential norms should be provided through term loans and working capital loans bearing a special nomenclature of strategic term loans and strategic working capital, and structured with appropriate moratorium and back-ending of interest rates. These should have a narrower tenor of 3 to 5 years, and reviewed half yearly. These instruments would be, in a way, anticipatory strategic debt instruments.   

Locational variations

Locational perspectives are especially important in certain categories of projects. There should be a ranking of ease of doing business for different industries in different states, and credit risk accordingly assessed. While this may ruffle some feathers, in the long run there would be a virtuous impact on the business climate. The need for such rating is clear given the differential levels of incentives as well as hurdles faced by different companies in different regions, especially in the fields of metals and mining as well as road and port development. Many times locational hurdles are related to certain genuine concerns related to environmental impact of projects; bank financing may, therefore, be made conditional on independent environmental analysis prior to full scale credit release.

Startup perspectives

Banks are now being encouraged to fund startups. While a special financial institution, MUDRA, has been established, the case of startup financing is not one of a uniform financial prescription. Some startups which are technology oriented require funds for experimentation, laboratory analysis or licensing while some which are application oriented require funds for beta testing of products etc., In some cases, it could be better to fund the incubators and research parks, and let them undertake the task of allocating financial support to their constituent ventures. Extending the philosophy further, bank finance may be made available to special vehicles such as alternative investment funds etc., which can have a cascading and ripple effect on more startups.

  

Turnaround options

If in spite of the best possible diligence and management, ventures turn bad, they should be addressed through the endgame mechanisms. The endpoint, of course is the insolvency and bankruptcy which hopefully will be addressed efficiently and effectively by the new Law. Prior to that, the options of CDR and SDR must still exist and be effectively deployed. However, unlike leaving all the reins in the very same promoters and managements, CDR and SDR must be mandatorily accompanied by high quality turnaround plans developed by truly independent agencies, infusion of fresh professional talent and restructuring of boards. All of these measures, including technology and business development as per turnaround plans, would cost significant additional money but are worthy of inclusion in the CDRs and SDRs. Banks must appreciate that not all turnarounds can be achieved just by cost compression!

As this blog post brings out, maintaining solvency is far more important to the economy than solving insolvency. At the core of India Inc’s deemed insolvency riddle are two fundamental reasons: a propensity to bank oneself (through overwhelming debt) to bankruptcy, and secondly, a reluctance to take objective and competent professional help (before it is too late) to turn things around. Hopefully, there will be a better appreciation of these two factors, by the banks as well as companies, going forward.

Posted by Dr CB Rao on May 12, 2016  

       

    

Public Sector in India: Diamonds are Forever!

India celebrated Public Sector Day on April 11, 2016. This blog post pays a tribute to the role played by the public sector in India, and discusses a few directions for an even greater role in future.

In India’s post-independence industrial development, evolution of government owned industrial enterprises, commonly called Public Sector Undertakings (PSUs), has been a major high point. While PSUs are generally maligned for the governmental ownership and control as well as the rather bureaucratic approaches of the PSUs themselves, the criticism is misplaced. Anyone who is privy to the huge problem of non-performing assets (NPAs) in the Indian private enterprise sector would agree that performance of enterprises has little to do with the ownership structure, private or public, but probably more to do with a host of factors related to comparative advantage of nations and firms, firm level competitive strategy and, more importantly ownership by leadership. While PSUs comprise central and state governmental ownership profiles, central PSUs are considered to a greater degree in this blog post. Departmental undertakings like Indian Railways as well as public sector banking and financial institutions are not considered either.

In order to differentiate the central government undertakings from the other government owned entities, this blog post refers to them as Central Public Sector Enterprises (CPSEs). The idea of setting up CPSEs was mooted by the visionary planners of young Independent India, notably Pandit Jawaharlal Nehru, the first Prime Minister and P C Mahalanobis, leading statistician and member of the Indian Planning Commission. Over the last several decades, CPSEs have grown to play a stellar role in many technology and capital intensive sectors of India’s industrial economy such as steel, oil and gas, capital goods, power, metals and mining, shipping, aviation, design and engineering, refineries, defence equipment and so on. In several domains, CPSEs remain as leaders to date, despite opening up of all the sectors of the Indian economy to private and foreign participation from 1992. Although used in a different context, the CPSEs have been instrumental in aspiring for and achieving “commanding heights” of India’s Industrial economy.

Navratna concept

CPSEs come under the administrative ambit of the Ministry of Heavy Industries and Public Enterprises. In the early years, emphasis was on organizational and administrative enablers like Standing Conference of Public Enterprises (SCOPE), Public Enterprises Selection Board (PSEB) and dedicated department like Department of Public Enterprises (DPE). While the public sector is criticised for governmental controls, successive governments have also been trying to provide autonomy linked to scale and stature of the CPSEs. The concept was initially started in 1997 as Navratna (Nine Diamonds) system (Navratnas have a mystique and positive significance in Indian mythology), acknowledging the stature of nine large high-performing CPSEs. The Navratna concept over the years was expanded both ways, adding Maharatna and Miniratna status to the both sides of spectrum. Each CPSE was expected to have a Memorandum of Understanding (MoU) with the Ministry based on which performance would be assessed.

CPSEs with an average annual turnover of more than Rs 25,000 crore (USD 3.8 billion), an average annual net worth of more than Rs 15,000 crore (USD 2.3 billion) and an annual net profit of more than Rs 5,000 crore (USD 770 million) over the last three years along with listing on stock exchanges and significant global presence/international operations qualified to be Maharatnas (Great Diamonds). CPSEs which had ‘excellent’ or ‘very good’ rating in the MoU system over the last five years and had achieved a composite score of 60 or above in the six selected parameters of net profit to net worth, manpower cost to total cost of production/services, profit before depreciation, interest and taxes to capital employed, profit before interest and taxes to turnover, earnings per share, and inter-sectoral performance were granted Navratna status. CPSEs which made profits in the last three years continuously and had positive net worth were considered for grant of Miniratna status. Presently, there are 7 Maharatna, 17 Navratna and 73 Miniratna CPSEs. These Ratnas span every conceivable segment of core industry and infrastructure operations, and bring global stature to India’s industrial capabilities. While the core of Navratna concept was financial autonomy in terms of investments, it also became a benchmark for CPSEs to develop and accomplish performance goals.

Shining in the dark

The relevance of CPSEs to India was that they singularly shone during the dark nights of India’s industrial weakness. The 7 Maharatnas, BHEL, Coal India, GAIL, IOC, NTPC, ONGC and SAIL are leaders in capital goods, coal mining, gas exploration and distribution, oil refining, thermal power, oil exploration and steel.  The 17 Navratnas are leaders in defence electronics (BEL), oil refining (BPCL and HPCL), defence aeronautics (HAL), design and engineering (EIL), telecommunications (MTNL), metals, minerals and mining (NALCO, NMDC, RINL, NLC), construction (NBCC), oil (OIL), power (PFC, PGC, REC), logistics (CCI) and shipping (SCI). The 71 other CPSEs which are Miniratnas are in similar and allied domains, with some being in direct consumer and retail services as well (for example, IRCTC). While the preponderant presence in core sectors of the economy is a hallmark of the CPSEs, it has been a natural evolution as well given that private sector had neither the resources nor the inclination to go on such long haul and politically sensitive sectors.

While it may be easy to say today that government has no business to be in the business of industry, the contributions of the CPSEs to India’s equitable economic development cannot be overemphasized. A CPSE like HUDCO brought in a much needed revolution in the financing of affordable housing and housing refinance on a massive scale while another CPSE like Rural Electrification Corporation gave the much needed thrust for electrification of villages. Both the tasks would not have been accomplished on the scale and affordability parameters as done by these two entities. Engineers India, IRCON. PDIL, MECON, Railtel, RITES, EPIL, TCIL and such other corporations developed India’s engineering and design capabilities as a national competitive advantage. More recently, Indian Renewable Energy Development Agency has stood out as a contemporary example of CPSEs continuing to chart into sunrise territories. While not a subject of this blog post, the public sector banking system has contributed to socio-economic development in a manner that a pure private sector banking system would have been hard put to deliver.

Polishing the diamonds

CPSEs thus promoted, and continue to promote, self-reliance in vital sectors of the economy.  The above does not mean that the best has been achieved in respect of CPSEs. Like diamonds, Maharatnas, Navratnas and Miniratnas also require polishing. The polishing of diamonds is indeed an expert job; so is polishing of CPSEs. Ideally, the leadership of CPSEs is the ideal instrument to hone the capabilities of CPSEs. More fundamentally, the MoU system may be overhauled to incorporate challenging global benchmarks and creative corporate and functional strategies to enable the Ratnas shine better. Each of the 7 Maharatnas and 17 Navratnas have, for example, the potential to be amongst Fortune 500 list of global firms. The 73 Miniratnas can be niche, boutique firms on standalone basis or become Navratnas through collaboration and/or consolidation.  The requisite scaling can be built up through more of ‘Make in India’ on one hand and ‘Grow in Globe’ on the other.

The external affairs initiatives launched by the NDA government as well as the new global stature for India and domestic growth passion, both assiduously promoted by Prime Minister Narendra Modi should be diligently followed up by the CPSEs. Given the resources at their command, the opportunities that can be explored and exploited by the CPSEs in India and abroad could be virtually limitless. A onetime global consulting study in respect of these 24 companies would be a really worthwhile investment to develop and execute such a domestic and global initiative. Some of these could involve expansion within India as well as globalization of operations, besides domestic and global joint ventures. As a first step, special efforts must be laid on having visionary leaders at the helm as well as creation of chief strategy officer posts in CPSEs with challenging ‘sky-is-the limit’ growth mandates.   

Stake dilution, value accretion

The emphasis of the CPSEs, public, economists and the governments with reference to the CPSEs seems to be only on disinvestment, and monetising the value for the government and help in the process of reining in the fiscal deficit. While this is also mandated by minimum public shareholding norms and, in some cases, straightforward privatisation goals, the ideal route for the CPSEs would be to issue additional shares to bring in public and foreign equity. This would certainly strengthen the capital structure of CPSEs and let them pursue higher scale with enhanced technological capabilities. The government should appreciate that stake dilution as per the existing methodology tends to be a constant overhang on the stock market price for the CPSEs, thus limiting capital raising at the rich valuations they deserve. It is time that the full market capitalization potential of CPSEs is understood and realized. Alongside such a new funding approach, individual CPSEs should relentlessly pursue operational excellence and value creation initiatives.

As contrasted with realization from stake sale, enhanced annual dividends from operations would be a recurring source of income from the CPSEs for the central government. This requires adoption of strategies and techniques of competitive advantage by the CPSEs. Notwithstanding the natural monopoly provided by certain segments (for example, metals, minerals and mining) and the advantage provided by scale and longevity, all CPSEs must plan and perform as if they operate in highly competitive domains. A firm such as BHEL must seek to beat L&T in market capitalization and there should be no reason why Shipping Corporation should accept a lower EPS than say, a GE Shipping. A study of successful and profitable private sector and public sector players in India and abroad could point to the exciting opportunities that await the CPSEs. The central government should start taking its ownership of CPSEs as a perpetual value enhancing asset that would pay increasing dividends, not only to state exchequer but also to the larger economy!

Posted by Dr CB Rao on April 13, 2016

     

India’s Growth Potential: Sky is the Limit but Stock is the Ceiling?

A few intriguing data sets speak volumes about the growth potential of India, a huge nation of 125 crore (1.25 billion) people. The first is that in 2014-15, airlines in India carried 823 crore passengers which is nearly 100 times more than 871 lakh passengers carried by the Indian railways. This is counterintuitive given that huge sections of the population cannot afford air travel where typical fares are 50 to 100 times more than rail fares, depending on the type of airline and class of travel. This indicates that it is becoming impossible to secure reserved travel on the railways with short lead times even as more people are realizing the time value of money. The question then is whether billions of dollars should be poured into the aviation sector or creating a pan-India network of superfast bullet trains (or possibly on both).

The second is that India has 100 crore telecom subscribers but only 27 crore Internet subscribers.  Less than 50 percent of the households own a television while over 63 percent have telephones. Only 67 percent of households have access to electricity. Given the seamless connectivity that drives communication and entertainment, a completely energized household network may lead to a completely connected and re-wired nation. Less than 50 percent of the households have access to tap water or toilet facilities. Less than 50 percent of the households qualify as per modern building safety standards. For similar population, China has more than 3 times of households than India. These statistics are only a few among a variety of statistics that demonstrate the tremendous growth potential that awaits India.

Enigmatic story  

Any set of numbers relating to India that we may take or any comparison with China or a developed nation clearly outlines the development gap that needs to be bridged viewed in one perspective, and the huge potential that can be achieved if the gap were to be bridged in another perspective.  Much as the Internet and Electronic Commerce are the new waves of growth, India needs to bridge huge gaps in physical infrastructure if the total population needs to be served equitably. This huge need and potential for huge infrastructure contrasts sharply with the travails all the core industries, from steel to cement and from capital goods to power sector, are facing. Unfulfilled demand, therefore, is one aspect but finding sustainable ways to prime all the sectors of the economy for capacity building and fulfilling growth is the other vital aspect.

Import of 2 to 3 million tonnes of steel from China is enough to threaten the Indian steel industry and unnerve the investors in the sector. Similar is the case with the automobile sector which has emerged only now from a multi-year downturn, perhaps the longest trough in its cyclical history. Sugar industry has been facing unviability for years, impacting the farmers. With a highly sensitive and volatile stock market, hyper-anxious investors, uneasy bankers worried about asset quality, and cash-constrained industry, there seems to be very little new choice than continued incrementalism in India’s growth journey, even if the growth rate were to move from 6 to 7 percent to 10 to 12 percent. The hope that foreign direct investment (FDI) would provide the much needed investment is true more in terms of creating jobs rather than transforming India’s industry and infrastructure.

Stock is the ceiling   

While for India sky is the limit for the growth story it looks as if it is the stock market that sets the ceiling. Stock markets are the platforms that can enable companies raise funds based on performance and potential. The Indian stock markets are, however, caught in a vortex of unpredictable foreign portfolio investments and unceasing quest of investors chasing quick returns. With the tendency of promoters limiting public issues to opportune premium pricing moments, the stock markets are more of platforms for reinvesting money in limited stocks rather than attracting new capital for new ventures on a continuing basis. Increasingly, the risk-return game is being played by angel investing and private equity funds in momentum sectors rather than in long term physical structures.

The Government has tried to alleviate the situation by having a mix of stock financing and bond financing for public sector and utility projects. Without bond financing backed by sovereign guarantees certain vital corporations like Rural Electrification Corporation and Power Finance Corporation may not have achieved the current level of capital formation. Nor would have development institutions such as IDBI and SIDBI expanded their capital access in their growth phases. Majority of public and private sector corporations are, however, hamstrung for funds and have to proceed carefully with an eye on a volatile stock market even if sky is the limit for India’s growth. Policy makers as well as market investors have to make a serious choice in terms of generating investments for India’s growth.

Faith, rather than return

India’s growth story can be fulfilled only by investments that are driven by long term faith rather than short term returns. It is difficult to imagine that bullet trains, metro rails or expressways and even steel plants, power utilities or cement works can be established by investments that seek a payback in 5 or 10 years. They cannot also be attracted by providing adjunct corridor lands as incentives for commercialization. India’s growth story can be executed only with faith, an unwavering faith that there is so much growth potential in the country that no investment, as long as it is properly planned and executed, can go wrong. The fact that the Government is able to unlock its huge investments, made several decades ago, in public sector undertakings by marginal stake sales nowadays is proof that value built over the years in right projects would pay back over course of time.

The question for investors is how soon is soon enough and how late is not too late. There are no standard answers to these; pension funds may have a preference for guaranteed even if low belated returns while private equity may continue to bat for quick returns despite very relevant nationalistic and patriotic concerns. In India, nationalized banks and development financial institutions have traditionally played a leading role in funding long gestation projects. However, they do not seem to be as active in this area nowadays as they should be due to the stressed asset situation. The debate is skewed by a compelling need for banks to conform to Basel norms. The one worry in this crucial area of public policy is a lack of proper debate on what constitutes a performing asset and non-performing asset, and the management and governance considerations thereof.

Investing in faith

There is clearly a lack of alignment between policy makers, promoters, managements, banks, financial institutions, private equity investors and general investors on what constitutes the fair gestation period for a fair return in different sectors. There is also lack of alignment on which types of investments are appropriate for which sectors. Rather than focus on just one or two topics, institutions such as NITI AAYOG, CII, ASSOCHAM and FICCI, should develop holistic white papers. The author would like to postulate that private and foreign investments should focus on areas that are market and export intensive, create employment and place greater purchasing power in the hands of general public. These investors should focus on investments that provide a fair return in 5 to 10 years.

The Governments should concentrate on building infrastructure and infrastructure enabling projects which can pay a return only in the medium and long term, say from 10 to 30 years. The fair return would accrue at a faster pace if appropriate user charges which the markets can bear (for example, utility rates, toll charges) are possible. Such higher charges would be feasible if the private and foreign investments spur employment and help society with greater purchasing power. The overall policy would thus have a target well-balanced investment portfolio, with all the investment segments work synergistically. This policy would rest on sound economic fundamentals when the economic structure of each industry is well researched and well-articulated.

Participation

Stocks and investments through/for stock markets are just one, albeit powerful, form of generating investments. These are not, however, the right ones for aiming at sky-high investments. As the stock pricing history of certain long lead infrastructure firms in the high days of their public offerings and subsequent euphoric days indicates, such stock prices are fuelled by unrealistic anticipations and tend to fall as rapidly as they rise. Efforts to rely on stock market mechanisms for investment-intensive and long gestation projects could create artificial bubbles too, at grave risk to investors, especially the retail investors. A healthy bond market with sufficient incentives in terms of sovereign guaranteed, tax-free returns could be an alternative platform for public participation. With more focused investment participation driven by sound socio-economic logic, India can achieve multifaceted growth in diverse areas.

Public sector banks and financial institutions would continue to be powerful drivers for enabling infrastructure funding. As the Government is now planning, major contributions from the Government to ensure capital adequacy would be a worthwhile investment to strengthen these institutions and channelize investments into projects of faith through these important institutions. One cannot imagine, for example, the huge enrolment for the Prime Minister’s Jan Dhan Yojna without the drive and structure of public sector banks. Voluntary and mandatory participations from companies under the Corporate Social Responsibility programmes are also making a difference, but could make an even more impactful contribution if they are focussed on few initiatives such as Swachh Bharat Abhiyan and Education for Underprivileged.

Posted by Dr CB Rao on August 16, 2015

  

The Seeds that Become Trees: A New Logic for India’s Industrial Forestry

There are many sayings that demonstrate the power of small seeds that could grow into massive trees. After all, nature is all about free fall of seeds in fertile lands turning into bountiful forests, duly aided by rain and shine. In a nation’s life too, industrial and economic growth tends to be based on seeds of innovation and manufacture. A few ideological moves (eg., heavy engineering thrust) or a few individual initiatives (eg., Sanjay Gandhi’s small car passion) could turn out to be major transformational revolutions years later. The drivers of development are simple and straightforward in many cases; however, only perceptive administrations at least register them while the perceptive and proactive administrations lead such transformations. Very few economies of the world are blessed with these twin capabilities; the vast majority of others need not despair, however. Not being in the forefront of revolutionary changes in the past does not mean that the country cannot be a leader in future, provided that the nation has learnt from the past as to how to visualize and develop the future!

India, despite its hoary history, had to take the bow of modern industrialization only from the time of its independence in August 1947. Indian administration’s cognitive skills, including those related to conceptualization and analysis of industrial development, have started evolving in the 1950s and started laying the developmental pathways for industrial development from the 1960s. All through the period, there have been opportunities to witness and interpret as well as absorb and implement how other nations pursued their growth. India followed a mixed economy model, and achieved mixed results until a crisis of sorts stared at the economy in the 1990s. This period of liberalization was a period of enlightenment for economic and industrial planning. That said, it cannot be denied that some of the important foundations were laid prior to liberalization while far more could have been done after liberalization. Whether a nation merely views such transformational movements as products of time or leads such transformations proactively is a resultant of many factors. This blog post reviews five ‘seed to tree’ developments in India to examine if some lessons can be read out of them.

Engineering of the 1960s

For the global industrial economy, the 1960s represented the heydays of modernization and expansion of traditional industries that represented the bulwark of a developed economy. A technologically resurgent Japan brought in new efficiencies to industries such as steel, automobiles and capital goods, and also laid the foundations of a globally networked production-consumption structure, which is based more on competitiveness than on national origin. For India, that period had coincided with the goal of self-reliance for some of the industries in the list such as steel, medium commercial vehicles and capital goods became a preferred choice, albeit with a heavy dependence on imports from countries such as Russia, UK and Germany. Unfortunately, the socialistic dogma of the Pandit Jawaharlal Nehru government served to shut out the development of other important growth engines such as automobiles and white goods.

The 1960s were notable for two concepts of indigenous development – that new cities and economies could be built around new industries, and that more industries meant more economic power to States in India’s federal development paradigm. Cities such as Bhilai, Rourkela, Bokaro, Jamshedpur, Dhanbad and Durgapur stand testimony to the first concept. The now flourishing steel plants in far-flung Southern cities such as Visakhapatnam and Salem stand as living examples of the struggles by the States to get such steel plants. Youngsters were offered only three core engineering educational streams such as mechanical, electrical and civil at that stage, keeping in view such perspectives. But, that was also the time when in other developed countries of USA, Europe and Japan transistor radios  and other electronics devices began to be manufactured in billions. Even as India built a solid traditional engineering infrastructure, the emerging electronics age got ignored by the country.  

   

Electronics of the 1970s

The 1970s were verily the electronics age of computers, audio-video devices, home appliances and a host of electronics systems that provided better accuracy and repeatability to traditional capital goods. The 1970s also saw the emergence of software coding, from the punched card readers to machine languages to FORTRAN and such other languages for man-machine interface. The Indian ministers and bureaucrats probably knew that they were wrong in giving the global electronics revolution a miss in terms of indigenization but did little to correct.  When IIT Madras imported IBM 1401 mainframe computer in 1974 to support development of indigenous technologies, C Subramaniam, the learned Union Minister for Industrial Development remarked that imports of such sophisticated technologies was probably not the best way to develop the indigenous industry. In fact, the governments of that time allowed the free import of second hand or aged equipment to promote industrialization (import of Innocenti scooter plant to set up Scooters India in Lucknow was one example!).  

If China has, over the years, become the great manufacturing workshop of the world and the preferred manufacturing outsourcing destination, the seeds of that industrial amazon were sown in the late1970s, when the concepts of market economy were first embraced in the late 1970s, and the foundations of mass consumer electronics industry began to be laid. While India started to introduce electronics and telecommunications as well as other diversified engineering courses, the country saw the flight of technical talent to USA and Europe which offered the new-age electro-mechanical and mechatronic industrial development. Continuing the inward looking traditional industrial policies, the socialistic ideologues and governments of the 1970s began to add computers, consumer electronics and home appliances to the list of “luxury goods” that only automobiles represented till then! Full four decades later, even in 2015, the country is still not sure of being an electronics-driven industrial powerhouse like China has been from the 1980s. 

  

Automobiles of the 1980s

Amidst the lag of India’s industrial and economic competitiveness, something that was absolutely maverick happened in the 1980s – the establishment of Maruti Suzuki India Limited in 1981 by the Government of India in 50:50 joint venture partnership with Suzuki Motor Corporation of Japan! Maruti Suzuki verily ushered in an automobile revolution in India with an unprecedented influx of new passenger car models and light commercial vehicles, mostly with Japanese technologies and their subsequent indigenization. This has led to the creation of four Detroits in India, one in the traditionally automobile oriented Chennai region, the second in the Northern Gurgaon region where Maruti Suzuki established itself, the third in the Western Pune region and now in the North-Western Sanand region. There were, of course, large two-wheeler facilities in Pune, Aurangabad and certain other parts of the country but the role of the automobile industry of the 1980s in starting a new manufacturing revolution in India cannot be minimized.

With a production level close to 22 million vehicles per year, India is one of the largest producers of automobiles in the world. In terms of two-wheelers, India is globally the largest with an output of 17 million vehicles. India is also the only large and structured player globally in the unique and ubiquitous three wheeler segment with an output of one million vehicles per annum. In cars (and utility vehicles) also, India is no longer a trailing country. From a meagre production of 30,000 till the late 1970s, India now clocks an output of 3.2 million! Commercial vehicles are also highly diversified and expanded with an annual output of one million. Performance on the export front has, however, been less than desirable. The only notable bright spot on the automotive export front has been the export of two million two wheelers, constituting about 12 percent of the total two wheeler output while all others have had insignificant (low single digit percentage) export levels.

Software of the 1990s

Even as automobiles began representing the new hardware of Indian industry from the 1980s, software emerged as the first driver of India’s global competitiveness. The 1980s saw maturing of Tata Consultancy Services from punching to coding, and the founding of India’s future software industry bellwether, Infosys. This phase represented the start of another type of migration of talent within India, from manufacturing to software! With the foundations laid in the 1980s, in the 1990s, software came to be associated with a larger canvas of information technology (IT), emphatically transforming the way the world looked at India and IT. The sector also established that India’s global delivery model could provide leadership not merely in terms of talent cost advantage but more in terms of seamless turnaround of systems development and transactions. IT has also laid the foundations of a new youthful middle class society that began embracing consumer economy and driving products and services typical of such economy.   

India’s IT sector has been notable for a massive investment in in-house training and development, in terms of more up to date coding skills and multi-country linguistic and cultural approaches. The industry has perfected a model of twin recruitment and development engines driving scale and globalization.  After its global success, the IT industry has been trying to move up the value system by offering consultancy services and also through vertical specializations. These are, however, logical steps and do not constitute any strategic redefinition. A major failing of the Indian IT sector has been in terms of its disinclination towards strong inorganic growth and diffidence towards developing its own product platforms. It has taken a Sikka to try to add a strong product direction to Infosys. Not many IT majors, however, seem inclined to commit resources for product investments. The future of the IT industry is as strong as ever but probably below the potential.  

Internet of the 2000s

The Internet has done wonders for globalization and communication. The Internet of People connects people and organizations across the globe through a host of devices such as computers, tablets and smart phones, connected by a telecommunications backbone. Many things that are done physically, from retailing to movie screening, began to be conducted by remote management through the Internet, in an increasing measure. After digital book publishing and reading, electronic commerce and mobile wallets have become the new platforms. This has resulted in a huge shift in how business is conducted in various fields, and the future potential. IRCTC, the eTicketing platform of Indian Railways logs between 0.5 to 1.0 million tickets per day which is still a fraction of 22 million passengers moving on any day over the Indian railway network. There could be an explosion of the Internet of People in India with better and universal broadband and wifi connectivity, lowering of tariffs for data transmission and availability of additional spectrum.

It is now getting evident that the next revolution in the Internet could be more profound. The Internet of Things could connect devices and environments in multiple ways, revolutionizing how people live on a day to day basis. Healthcare, travel, home life, retailing are all set to become more real time and inclusive. RFIDs, sensors, scanners, software, analytics, processors and telecommunications would determine if product and industrial structures would undergo a metamorphosis. Unfortunately, the greater the input of technological change the greater is also the level of waste. For example, as opposed to replacing normal electric bulbs or refrigerators after their useful life, technologically connected appliances may seek replacement every year as new technology arrives. The e-waste generated by smart phones and tablets is indicative of the waste that could occur across all product categories in the Internet of Things.

Indigenous seeds

The choice of just five sectors as above to describe India’s industrial development of the last decade is by no means comprehensive (for example, pharmaceuticals was not covered!) but is certainly illustrative. The seeds of India’s industrial development have been from trees that have grown elsewhere. Even in respect of IT where India has become a global leader, not a single computer language or operating system has been developed in India (may have been developed elsewhere partially with Indian talent, however). The transhipped seeds, and in some cases the transplanted trees themselves, grew in the eager markets of India. Over the last several decades, there have been gallant efforts to indigenize design and manufacture; yet even the new NDA government’s current manufacturing paradigm of ‘Make in India’ seems to require overseas seeds. The past experience suggests that financial investments, technologies, equipment and components come in bundles each with a cycle of cautious investment, domestic consumption, limited exports and capital repatriation with a very specific time span in mind. Every time industrial renewal is desired, the cycle of imported seeds et al repeats itself.

With the Modi government firmly committed to a policy of India’s economic growth equating with India’s self-respect, a different seeding programme for industrial and economic growth is required. India now has the option of staging the next manufacturing revolution following the previous model or improving upon it to make it a self-perpetuating cycle of indigenous development. For this to happen, a new genre of seeds is required. The past industrial revolutions were hamstrung by limited scientific and technological educational streams which came into existence only after the development of physical industrial infrastructure. This has resulted in talent bottlenecks and skill gaps. A bolder India must create educational disciplines far in advance of the sighting of new industrial infrastructure. If necessary, to cut the developmental times short, the vast Indian diaspora which is enthralled by the prospect of a new India must be encouraged to come on two to three year sabbatical to seed their talents in Indian industry, research laboratories and educational institutions. More importantly, ‘Make in India’ paradigm must be supplemented by ‘Research in India’ and ‘Design in India’ paradigms. And, as the costly lesson of missing the electronics revolution shows, no sunrise sector should be ignored by India in this phase.

Posted by Dr CB Rao on April 14, 2015           

Beyond Microeconomics and Macroeconomics: The Need for Indian Social Economics

Economics has been a fascinating social science that has accompanied the industrial revolutions. The first formal organization of economic thought, albeit in a political setting, is attributed to Adam Smith (1776) for his book “An Enquiry into the Nature and Causes of the Wealth of Nations”. Alfred Marshall’s text book “Principles of Economics” (1890) laid the foundation to the microeconomic branch of economics. The adverse economics of the Great Depression of the 1930s spurred the development of macroeconomic thought. John Maynard Keynes’ book “The General Theory of Employment, Interest and Money’ provided new perspectives of macroeconomic thought. Over the years, almost every aspect of human endeavour got its own economics perspectives; from industrial economics to welfare economics, for example. Microeconomics and macroeconomics, however, continue to be the more dominant streams of economics to date.

Microeconomics deals with the economic behaviour of individual markets, firms, entities and individuals, focusing on matters such as, but not limited to, production, cost, scale and efficiency; supply, demand and equilibrium; scarcities, surpluses and elasticity of demand and supply, costs and prices, and theories of firm and industrial organization. Macroeconomics deals with the issues of economy from the top, focusing on matters such as national income and output; jobs and unemployment; price inflation and deflation; savings, investment and consumption. Flow of money and business cycles as well as economic growth, international trade and international finance are some of the other considerations. It studies the impact of monetary policy and fiscal policy.  Monetary policy is implemented by the central banks to control the liquidity in the economic system to ensure economic stability. Fiscal policy relates to the use by the governments of revenues and expenditures, along with savings and taxes to influence economic growth.

Indian scenario

India, ever since its independence in 1947, has been following established economic theories to drive economic growth. The socialistic pattern of development curtailed free market economics until 1991 but the macroeconomic liberalization thereafter gave a new upward drift to the Indian economy. Regardless of the economic system, monetary policy followed by the Reserve Bank of India and announced in its periodic policy reviews, and the fiscal policy followed by the Central government and effected through the annual union budgets influenced the investment and consumption patterns of the society. The sensitivity of the markets to banking liquidity and interest rates and to tax and allocation policies has been only increasing with years. In addition, budget times have also become important periods for economic reforms and policy stimulation measures, including export-import policies, industrial development policies and poverty alleviation programmes.

India has been home to some of the sharpest economic brains. Amartya Sen, Amit Mitra, Arvind Panagariya, Ashok Desai, Bibek Debroy, Bimal Jalan, C Rangarajan, D R Gadgil, D Subbarao,  I G Patel, J C Kumarappa, Jagdish Bhagwati, Jairam Ramesh, Kaushik Basu, Manmohan Singh, Montek Singh Ahluwalia, Nanabhoy Palkhiwala, Omkar Goswami, P C Mahalanobis, Raghuram Rajan, Subramanian Swamy, V K R V Rao, Y K Alagh and Y V Reddy are some of the well-known names. Several political leaders including Jawaharlal Nehru, the first Prime Minister of independent India, and several finance ministers from C D Deshmukh and T T Krishnamachari of the yesteryears to P Chidambaram and Arun Jaitley of current years have been economically savvy leaders. Mahatma Gandhi, the father of the nation, had articulated his own brand of Gandhian economics targeted at economic self-sufficiency and growth of cottage and small industries which is relevant even today.

Intriguing India

Although the phrase “Incredible India” has been coined only a few years ago, India has always been incredible. The scientific and technical thought that went into the centuries old Indian heritage of Ayurveda, Yoga, Astronomy, Architecture (especially temple and palace architecture) was indeed phenomenal. Post-independence too, India demonstrated rare pluck to construct its own massive dams, build its own heavy industry, establish its own banks and financial institutions, develop its own educational infrastructure and creates its own aerospace infrastructure. India may not have gained global competitiveness but the country certainly acquired the capability for self-sufficiency that is rare amongst the emerging markets. In all this, adoption of micro and macroeconomics to an Indian context, in a somewhat serendipitous manner, played a role.  India’s development may have lagged behind its true potential but a base has certainly been laid for more accelerated development if right constructs are developed and relied upon.

At the same time, India has indeed been an intriguingly bipolar country characterized, for example, by paradoxes such as massive educational level but meagre skill level, strong penchant for growth but constraints all the way, vibrant democratic culture but strong vestiges of feudalism, and phenomenal wealth generation but continued acceptance of poverty. Economic growth with social equity has been the avowed objective of parties and governments alike but togetherness in fulfilling the growth with equity objective has been missing. The paradox of incredible growth potential constrained by intriguing plurality of thought makes one wonder if India can benefit to the requisite degree only by Western economic thought or would require a distinctly Indian economic constructs that are tailor-made to solve indigenous socio-economic problems without losing the global contexts. Even issues like quantitative stimulus or directed subsidies are not discussed and framed with objective economic thought that addresses India’s issues in a customized manner.

Success factors

India’s success would lie in enhancing agricultural productivity with sustainable crop economics, improving technological innovation with rapid commercialization, developing infrastructural sinews with meaningful capital productivity, expanding manufacturing capacities with global competitiveness, rural and urban renewal with protection of ownership interests, and creation of jobs with minimal migration pains. Economic policies and administrative actions of the successive governments have tried to provide policies and budgets with incentives and subsidies to tackle some of the above needs individually, depending on the political perspectives. Most of these have been based on established macroeconomic and microeconomic approaches which are buffered by Indian socio-economic and cultural compulsions. Given that all of these cumulatively have not helped India reach its full potential, it is time that economic models that specifically address India’s development concerns are created.

India’s socio-economic needs would require an Indian social economics theory (and practice) that addresses the typically Indian issues of (i) agrarian economics, (ii) infrastructure economics, (iii) Make in India economics, (iv) renewal economics, (v) employment economics, (vi) migration economics, and (vii) behavioural economics. The reason for focussing on the first six aspects is fairly obvious; if well-researched and well-modelled economic theory is developed on these aspects, not only better economic policies that stimulate gross domestic product and higher per capita income can be developed but also they can be better implemented with widespread support. These aspects which are independent as well as integrated can together provide better socio-economic development in the country. All of these will, however, need to be supported by a solid understanding of Indian behavioural economics with perspectives that are regional as well as national. The seven branches of Indian social economics are discussed below.

(i)                 Agrarian economics

India, despite decades of industrial development and the recent burgeoning of service economy, is still an agrarian economy. The potential for capacity expansion and productivity in agricultural production and distribution is impacted by crop economics on one hand and irrigation economics on the other. Economic models which assess the impact of crop mix on food grain and commodity self-sufficiency and the impact of dams on year-round crop patterns are required. The microeconomics of India’s debt ridden small farmer are affected by spot prices and distribution margins. While farm subsidies mitigate the burden to some extent, an in-depth study of crop economics for individual and national sustainability is required. Similarly, the economics of dams and reservoirs are also poorly understood. There is no reason why major irrigation projects like Polavaram (in Andhra Pradesh) had to hang fire for decades; economic modelling of irrigation projects could stimulate better allocations or encourage setting up of special purpose vehicles.

(ii)               Infrastructure economics

That India has lagged behind all the developed nations and key emerging economies in infrastructure development is well known. The NDA government has admitted that the public-private collaboration model has not had much impact, and needs redefinition. Most private sector infrastructure firms carry huge levels of debt from public sector banks. The economics of infrastructure development in the Indian context are unique with long lead times and slow returns even after project completion. From the project conceptualization stage through the project appraisal stage the economics of each infrastructure project need to be understood not merely in terms of the internal rate of return for the project but the overall economic uplift because of the multiplier effects of infrastructure projects. The study of infrastructure firms should be a special branch of microeconomics while budgeting of such projects should be a special branch of macroeconomics with appropriate monitory and fiscal policies to support.

(iii)             Make in India economics

With India’s low wage costs, large talent pool, frugal engineering and mass mobilization capabilities, the world should embrace Prime Minister Narendra Modi’s Make in India mantra enthusiastically. There are two caveats: India should evaluate and propose objectively to the investors the sources of economic advantage of Make in India strategy in respect of each industrial activity. Secondly, India should evaluate and propose for itself the role of India’s large domestic market in leading to globally competitive production. Typical economic thought teaches us that high-end niche products subsidize low-end mass products. In the Indian economic milieu, it could be the other way around; India’s bottom of the pyramid can provide huge scale economics which can be leveraged for global products. Tata Motors’ success with JLR is a corporate level economic behaviour of this theorem. There is a need for a more rigorous understanding of the unfolding Make in India economics. 

(iv)             Renewal economics 

India has an enormous need, and hence offers immense potential, for rural and urban renewal. There is no habitat that can be excluded from the renewal paradigm. Yet, renewal is not easy in India. The way the residual government of Andhra Pradesh is scrambling to build a new capital on a zero base as a multibillion dollar venture is proof of the developmental needs. However, as illustrated by the same example, any distributed renewal or new development – urban or rural – has several implications for overrunning current land use and community avocation practices, in spite of such renewal being essential. On the face of it, continuous renewal offers the most economical way of developing habitats in a distributed manner relative to big bang new constructions. Only when the economics of renewal are understood can the overall spatial planning in India, including development of smart cities and smart villages, can be brought to global standards, consistent with the Indian socio-economic imperatives.

(v)               Employment economics

India needs jobs for the democracy to work in a positive manner. The unemployment rates of India varied between 5 and 10 percent historically, and is currently trending at 5. 2 percent. This may be better than the Euro region which is trending at 11.2 percent but is only comparable with US and UK (trending at 5.5 percent) and worse than China and South Korea at 4.1 percent and less. More than gross employment, underemployment and overemployment as well as skill-need gaps are causes for concern. Underemployment is characterized by people performing jobs of lower level than they are capable of (for example, just digging trenches rather than building reservoirs). Overemployment is characterized by more people than required performing the same job (for example, three or more people manning a toll plaza post). Skill gap is characterized by an individual failing to work to a national or international standard (for example, a painter failing to prepare a surface prior to painting). The elimination of underemployment and overemployment and investment for skill development have economic implications that need a uniquely Indian thought.

(vi)             Migration economics

Urbanization is a concomitant of economic development, universally. Migration of people from rural areas to urban areas is also a natural accompanying phenomenon. However, unplanned and under-resourced migration causes urban squalor and triggers urban unrest. India has an additional dimension of people migrating from States of lower per capita income or lower economic activity to other States perceived to be better. The economics of migration with people chasing minimal employment tend to be mirages. Real economics would occur when economic activity moves into regions where people reside, and touch their lives directly. Large scale industrialization or large scale mining of natural resources with necessary caveats is one solution. More importantly, such underdeveloped regions should be stimulated with a small and micro enterprise start-up culture that brings soft economic touch to indigenous evolution and promotes self-sustainability. It must be a form of Gandhian Economics whereby the well-to-do regions and people act as trustees for the underdeveloped regions (be it, Bastar forests, Idukki river bed or Manyam agencies). Migration economics needs to be a uniquely Indian requirement.  

    

(vii)           Behavioural economics

Behavioural economics as is well understood is the study of the impact of psychological, social, emotional and cultural factors on economic decisions made by individuals and institutions, and the consequences for microeconomic and macroeconomic factors like costs, prices, savings and investments. Standard economic theory suggests that as long as individuals understand the economic consequences of their decisions they take decisions that are in their best self-interests. The reality is that individuals (and even institutions) suffer from biases and transient perceptions and do not necessarily have self-control and objectivity. Given the plurality of the Indian society and the lack of insightful literacy for vast sections of population (at all levels of the population pyramid) and the divisive nature of political discourse, economic decisions tend to be inappropriately made or even appropriate decisions tend to get stalled. We have seen earlier that there is a paucity of economic theories that are tuned to India’s indigenous problems. This inadequacy coupled with the vast mosaic of Indian behaviours makes it mandatory that Indian version of behavioural economics is urgently developed.

Indian social economics

The country is in need of an integrated Indian social economics thought which applies all the established disciplines of economics including, in the main, micro and macroeconomics, to develop economic principles that are uniquely relevant to India to enhance capacities, capabilities and effectiveness in the areas of agriculture, infrastructure, manufacturing, renewal, employment, migration and behaviours. These are typically Indian issues on which everyone is agreed in terms of the overarching goal of economic growth with social equity. However, lack of directed and issue-specific economic thought has prevented due progress and fulfilment of potential. India does have its general and applied schools of economics. Every premier college or institution has a department of economics. There are also specialized institutions like Madras School of Economics, National Council for Applied Economic Research (NCAER), Institute for Social and Economic Change and so on.

The established schools and centres, however, have not been focussed on analysing economic issues that need to be specifically addressed in India. Nor has there been an effort to develop economic principles that guide public policy and governance at central and state levels. While several case studies have been conducted, there has been no specific vision to develop an India-specific economic theory. Intellectuals and administrators are more focused on variations in known policy measures and instruments rather than develop India-specific prescriptions. Now that the NDA government is keen to establish new centres of higher education and research and the States are also keen to participate in such higher educational initiatives, it would be appropriate to establish Indian Institutes of Social Economics and Research in the principal geographical regions of the country to develop India-specific economic thought and practice with a board of economists with Indian and indigenous passion.

Posted by Dr CB Rao on March 8, 2015