Indian Economic Woes: Clouds in Passing or Storm in Offing?

Business analysts and economic experts, who not so long ago convinced themselves and the rest of the world that India would soon be an economic superpower, are now busy overturning their hypothesis. The global chill that started with the hint by America’s Federal Reserve in May of this year that it would soon start reducing its vast purchases of treasury bonds (thus signaling the end of ultra-cheap money) has shaken up the Indian economy more than any other emerging market economy.  The responses of the Indian government to a speedily depreciating Rupee, be it curbs on consumption of gold or restrictions on overseas investments by Indians and Indian entities, have only led to concerns  about the fickleness of foreign investments and potential capital controls reminding one of the 1991 balance-of-payments crisis.  

There is no doubt that Indian economy and the Indian business are a victim of global economic travails marked by years of flat growth in the US and near-bankruptcies in certain European countries. However, Indian governance has also been a victim of its complacency that followed the confidence with which it handled the 2008 global meltdown, especially in terms of the robustness of the banking system. Lack of expansion in manufacturing output and increase in exports together with stalling of infrastructure projects on one hand and high inflation together with spiraling imports of gold and oil have resulted in a burgeoning current account deficit (CAD) that needs greater  (rather than lower foreign capital as now) flow of foreign capital. The Economist (August 24^th-30^th 2013) estimates that India needs to attract USD 250 billion of foreign investment next year to support management of CAD and debt servicing, more than any other vulnerable emerging economy.

External prescriptions

External experts attribute the current state in India to the slackened pace of reforms and the obstacles to growth such as power shortages and labor issues affecting industrial productivity, red tape and graft affecting governance, and bad debts and subsidies affecting capital efficiency.  The external prescription is on familiar lines; complete the full float of the Rupee even if it breaks the viability of a few firms and industries, remove all subsidies, fuel and food, even if it affects vulnerable sections of the society, remove sector caps on foreign direct investments even if it affects domestic competitiveness, and stress-test and recapitalize banks and financial institutions even if it means that some such institutions have to break up or such capital injection would widen the deficit.

External experts would also suggest breaking of public monopolies, in coal, power, metals and capital goods, for example and encourage private enterprise in all sectors of the economy including agriculture and retail, and aerospace and defense, for example.  They would also suggest sweeping tax reforms, including GST, to unify and simplify tax regime across the country. The other focus would be on easier exits, including liberalized labor laws. While some, if not all, of the external prescriptions do have economic logic, all of them may not be easily introduced or extended in India. Economic policy has to be not a mere global replica but more importantly a socially sensitive platform. Each country would need to evolve its own economic prescription that meets the country’s social needs.

Indian perspectives

Experts are prone to downplaying the continuing scourge of poverty in India, in the context of the islands of prosperity that are getting built up. They believe that it is not hunger that is the issue but it is nutrition that is the issue in India. They believe that rather than grains which provide calories, which according to them are available in villages, children need nutrients, including proteins, fibers and vitamins. Apparently, this is a misplaced perspective of economic journalism that traverses India in air-conditioned comfort. In reality, both hunger and nutrition continue to be the central issues in India. And the only way in which both the issues can be tackled is through inclusive growth that enables a minimum wage level that enables a reasonable quality of life supported by an accessible and affordable educational and healthcare infrastructure. Neither GM foods nor packaged foods, which would be an outcome of privatization and globalization of agriculture, would meet the superior delivery of inclusive employment.

The other critical issue for India relates to the millions of young people who will enter the employable age group over the next several issues. Apart from the fact that there must be millions of jobs that need to be generated through enhanced economic and industrial activity, there is also a responsibility on the educational institutions and young people for the job seekers to be truly employable. It is enigmatic that each year thousands of seats in various engineering colleges go unfilled even as Indian industry struggles to keep updating the skill levels of its young entrants. There are mismatches between economic needs and job creation, job requirements and skill availability, and skill requirements and educational opportunities. A holistic paradigm is required to expand and upgrade educational infrastructure while expanding and diversifying industrial infrastructure.

Inclusive growth

The incomes in rural areas are made in part by traditional agricultural activities and in part by incomes earned through work in industrial and urban areas. Potential farm workers are not getting displaced in the modern India by industries replacing agriculture but by the workers themselves going in search of more assured wages as migrant labor elsewhere. Clearly, this needs to be reversed by insulating agriculture from the vagaries of nature and uncertainties of earnings, and reestablishing its economic attractiveness. Each rural economy needs to be made self-sufficient by a three tier strategy. The first component must focus on modernizing agriculture through better harvest technologies and implements. The second component must focus on creating cooperatives that take agricultural produce to food processing sector and other consumption points, and eventually engage in value addition themselves, like Amul so successfully did. The third component must focus on developing the infrastructure of roads, electricity, water and sanitation and educational institutions in the rural areas.

An integrated rural development strategy will by itself reduce the pressures on urban settlements. That said, an integrated urban settlement strategy is also equally required. This would potentially require expansion of skills to cater to a wide range of industrial and economic activities. Factory production needs to be supplemented by several supportive activities such as logistics, distribution, sales, service, wholesaling, retailing, safety management, employee centricity and customer connectivity in the overall. Policies of industrial parks and SEZs are now independent of civic and connectivity development strategies. Making industrial and civil development interlinked and simultaneous is a much needed change that needs to be implemented. The loss of productivity that is experienced because of the lag in non-industrial development is enormous. The paradigm needs to be changed from focused industrialization to broader socio-economic development.    

Capital imports or product exports?

To a large extent in the urban inclusion strategy and to a smaller and important extent in the rural inclusion strategy require three inputs capital, technology and skills. If the points discussed above are taken note of the skills gaps would be addressed. That would leave capital and technology to be addressed. The external prescriptions, supported by a section of Indian policy makers and analysts, require that India should depend increasingly on overseas capital and technology. The policy preoccupation in the current situation seems to be on getting more foreign direct investments as a panacea. While foreign investments, especially in equity route, are welcome and would be effective to address external economic stability, the real impetus would arise from product push into the export space. What has been the export mantra of the 1970s and 1980s must be revived to lead a new export wave from out of India. That would ensure that the country is not disparately dependent on foreign investments which may come with their own conditions, and in layered preferences amongst various economies.

The need to focus on product exports is relevant because foreign investments would flow in only when products made out of India are quality-compliant and cost-competitive, and are produced in a safe and efficient manner. India has established a major industrial and retailing infrastructure and rather than re-discover the wheel, it would make eminent economic logic to build upon it to achieve higher levels of performance. It would be appropriate to import technologies and pay royalties rather than import capital, whether through equity or debt, and have long term service obligations. In other words, foreign capital must flow into India on its own merits of producing export-worthy products or to participate in a slice of the huge Indian market. Policies that enhance product competitiveness must be given priority over policies that are aimed at attracting foreign capital only by opening up of the caps of overseas investments in certain sectors. The former would automatically enable the latter, and would be quicker.

There are indeed clouds over the Indian economic landscape. Whether these are passing monsoon clouds or gathering storm clouds depends on our own policy prescriptions, and the level of customization to the Indian context.

Posted by Dr CB Rao on August 25, 2013               

Indian Economy 2013-18: Expectation Economics or Execution Economics?

Over the last twelve months, India has seen its growth rate halve, from 10 percent to 5 percent, and industrial output contract to as low as 2 percent. Current Account Deficit has widened, Rupee has lost as much as 10 percent in a span of just 10 weeks, with a further 10 percent slide forecast over the next 10 weeks. Foreign direct investments (FDI) have stalled while the Foreign Institutional Investors (FIIs) have pulled out billions from the Indian stock markets. Inflation has been persistent even with liquidity getting squeezed. India, Inc has been reporting lower profits, and in some cases lower revenues too. Some of the aura surrounding India as the potentially the third largest economic power is getting eroded.

Certain industrial sectors are particularly relevant for reading the strength of the Indian economy. Realty, power, capital goods, metals, and oil & gas sectors have fared poorly over the last five years, with the stock market indices relating to the sectors plummeting by 90, 70, 67, 60 and 37 percent respectively. Important sectors such as consumer goods, banking and technology have remained flat. The only sectors that have recorded growth are FMCG, healthcare, automobiles and IT at 182, 103, 80 and 70 percent. Within these, automobiles and information technology have seen fluctuating fortunes in the last three years.  Recent physical numbers of performance indicate a clear deceleration in these sectors while IT’s performance is linked to dollar appreciation vis-à-vis Rupee.

Lagging economics

The laws of industrial and consumer economics typically operate with a lag. The high performance of domestic consumption oriented sectors does not necessarily reflect long term sustainability of domestic demand and consumption. On the other hand, the languishing of realty, capital goods, power, shipping, metals, oil, gas and other infrastructure sectors indicates that sustainable investments are not being made to support a healthy long term supply and consumption profile in the Indian economy. Simultaneously, the inability to keep continuously developing newer bases of competitive manufacture such as electronics, semiconductors, solar panels and systems, telecom gear etc., limits the country from continuously generating domestic investments and drawing foreign investments. China’s massive thrust on infrastructure has been well accompanied by competitive manufacture of all industrial and consumer goods.

The macroeconomic balance of any economy is governed by the positive trade balance, flow of foreign investments, domestic savings and investments, and current account balance.  Looking back, we can identify post-liberalization of 1992, two distinctive five year cycles: 2003-08 and 2008-12 which saw Indian economy climb up to new tracks, despite the striking global liquidity and bankruptcy crisis in 2008. These cycles were marked by high rates of growth, increasing foreign investments, high inflation in parts, high fiscal deficits, steady increases in manufacturing output and volatility in infrastructure development with some highs and lows. One would expect the Rupee-Dollar parity to exhibit volatility under the circumstances over the ten year period; but it did not. The exchange rate (Rupee to Dollar) remained steady at about Rs 45.6 during the ten year period. Some underlying contradictions did exist which are now coming to the fore.

Expectation economics

Reviewing the past decade of 2003-12, one may wonder whether the macroeconomic stability of India was a result of a peculiar phenomenon of expectation economics, globally as well as locally. The last decade, for example, has been an era when the mighty economies of the world, USA, Japan and Europe, and their respective mighty currencies Dollar, Euro and Yen became structurally weak. This was also the period when the concept of BRICS economies (including India) came to the fore as the drivers of a future global economy. There was also a well deserved all-round admiration for the way India managed its banking and liquidity system in sharp contrast to the meltdown in the USA and Europe. Huge expectations had built up as a consequence that India would be the future market for industrial and consumption growth.

It was, therefore, not unnatural that what should have been an intrinsically weak Rupee for the reasons adduced in the previous section above maintained its parity as a stable currency. However, the moment the economies of other nations started perking up and the expectations of India started turning tepid, the fault lines in the Indian economy have begun to show up in recent times, as discussed in the opening paragraphs. The lessons are clear that while India has all the right ingredients for becoming an economic superpower such as its large 1.3 billion population, growing middle class, youthful demographics, increasing literacy and reducing poverty, there must be a growth oriented macro and micro economic regime to harness the resources.

Incremental economics

When macro-economic and micro-economic fundamentals are under threat, incremental measures would hardly suffice. Discouraging consumption of gold (through increase of duties), tightening of domestic liquidity (through bank liquidity ratio controls), curbing conspicuous consumption (through taxing of luxury goods), facilitating foreign investments (through relaxation of certain FDI caps) and buffering against hard landing (through subsidy and security options) can at best be palliative measures. They do not address the basic infirmities or weaknesses of the macroeconomic situation (for example, balance of payments, short term and long term debt and microeconomic situation (for example, industrial costs, prices, output and consumption).

The perils of incremental economics are that governments end up undertaking corrective measures too little and too late. As a result, problems become crises. The near bankruptcy India faced in 1991 is an example of delayed transformational moves. While everyone considers 1992 as the year of inflexion in terms of transformational economic liberalization in India, there can be no denying that India has been taking partial measures of liberalization even from the 1980s but they were just not enough. A large complex economy like India needs transformational economics when faced with problems that could turn into crises; it is true now as much as it was in 1990s. India traditionally had a strong consensus for weak reforms. In the context of the several years of liberalization further dramatic liberalization policy changes as in China could be a challenge for India.

Competitiveness economics

India has its contradictions; fundamentally the people want to grow and prosper but at the same time, people are patient and tolerant of low or even no growth. The larger base of population, at the base and the middle of the economic pyramid, is less knowledgeable about the benefits of further liberalization versus any other way of economic management. In fact, there continue to be many misconceptions about liberalization which is equated to the opening of the Indian economy to “foreign domination”. As long as Indian polity is fractured it is unlikely that total liberalization as a concept will have open advocates.  It is critical that the importance of competitiveness, as opposed to liberalization per se, is taken up as the primary economic concept. The purpose of liberalization, after all, is competitiveness.

India must focus on sector competitiveness as a panacea for economic ills. For example, if India becomes a global leader in design and manufacture of jewels for global markets and becomes a net foreign exchange earner, it would probably not make a difference even if the country imports gold and diamonds. The same would apply to other sectors as well; if import of certain technologies makes India globally competitive it is a path worth taking. Competitiveness, however, requires an enlightened mindset on the part of employers and employees. The best intentions can go awry if competitiveness is equated only with shop floor productivity as painfully brought out by the unfortunate incidents at Maruti Manesar plant. Competitiveness must create new jobs, enable better living conditions and ensure greater prosperity for all stakeholders.

Execution economics

Competitiveness is a function of design as well as execution. The Indian Finance Minister is on record that China’s execution capabilities are indeed enviable. Timely and rightful execution of policies and strategies, whether liberalized or not, adds more to competitiveness than a perfect liberalization policy or strategy. In formulating policies, the end point of economic growth with social equity cannot be lost sight off. It matters less whether bullet trains are set up in India with indigenous technology or imported technology and domestic or foreign investments, or a combination thereof compared to whether the bullet trains would be set up at all. Not ensuring exceptional connectivity with such transformative transport option that is also capable of generating several thousands of new jobs is poor execution economics, and denies the country the benefit of competitiveness economics.

The above is not to imply any preferential statements in favor or against dependence on foreign capital and technology flows vis-à-vis self-reliance through domestic investments and indigenous technologies. Amongst the Asian Tigers, Singapore has succeeded immensely based on the former while Korea became a leader based on the latter. For a large country such as India with several natural resources and intrinsic capabilities, the Korean model of development of its own fast-follower and pioneering technologies as the foundation for creating globally competitive industrial superstructure is probably more relevant. Korea represents an impressive model of execution economics. India would have much to gain if investments are directed into the infrastructure sectors which have seen de-growth and competitiveness is enabled through technological competencies and execution promptitude.

Posted by Dr CB Rao on August 10, 2013