China Research

In the fiscal year ended March 2013, the Indian economy turned out its weakest economic growth in a long while. The provisional estimates released at the end of May 2013, reported that the economy grew by 5.0 per cent, terribly weak compared to even the crisis year 2008-09, when India managed to close the year with 6.7 per cent growth. An economy of more than 1.2 billion people, the majority of who are poor by any global benchmark and where tens of millions of youngsters are coming out of school and college each year in search for jobs and livelihoods, depressed growth is very bad news. The average annual rate of growth for the eight year period from 2003/04 to 2010/11 was 8.6 per cent. The average over the 20-year period 1992/93 to 2010/11 was 7.0 per cent.

In the two years immediately following the crisis year, namely in 2009/10 and 2010/11, the Indian economy grew by 8.6 and 9.3 per cent respectively. So why did growth slump to 6.2 per cent in 2011/12 and to 5.0 per cent in 2012/13? And what is the near-term outlook and prognosis for growth? Is a revival possible in 2013/14? These are questions that hang like a heavy cloud over both policy makers and economic analysts. For the magnitude of the slump in the second half of 2011/12 to 5.5 per cent was surprising, as was the persistence of slow growth in 2012/13.

Broadly the answer to the question of why the slump happened appears to lie in three separate elements. (1) The first is that the vigour of the recovery from the crisis year was underestimated in the preliminary estimates of economic growth. This led to some delay in adjusting the fiscal and monetary stimulus that had been rolled out to counteract the effects of the crisis in 2008/2009, which in turn allowed inflation to be pushed up to unacceptably high levels. This in conjunction with rising world commodity prices undermined profitability. The impact was compounded by a significant depreciation of the national currency. Companies saw their operating margins decline, and corporate profit growth was weak. (2) Plans for equity infusion had been deferred by many companies as the crisis unfolded. They had kept capital flowing into projects by taking on more leverage than originally envisaged. The shortage of equity has however persisted into present times. This combined with declining profitability has stretched balance sheets painfully. Hardly a condition that is favourable to business expansion and investment. (3) Beginning earlier, but becoming more painful since 2010, projects started to face numerous problems in securing clearances from administrative departments to carry forward their projects. These difficulties were complicated in the context of judicial decisions and guidance in some cases. All of this also had adverse impact on the quality of banking assets, as banks play a big role in funding projects in India.

Aside from soaring inflation, the deterioration of macro-economic conditions stemming from deterioration in fiscal conditions and the external payments situation, together with contentious domestic political climate and high level of rhetoric negatively impacted economic conditions. Compounding this was the malaise in the global economy. The generally depressed state of global business sentiment was reflected in weak business confidence within India.

In many ways this was a perfect storm. So many unrelated problems came together in a short span of a few years. The hubris that unfortunately arose from the successful negotiation of the global economic crisis certainly prepared the ground for a high-impact letdown.

Where do we stand today? The fiscal trajectory has been corrected. Politically difficult decisions in rationalization of fuel prices, re-prioritization of expenditures and some other steps to boost revenue, has seen the fiscal deficit undergo strong correction and in the current year 2013/14 will stick to target. Long-standing decision on permitting foreign direct investment into certain areas and other reforms did not come cheap. An important partner in the ruling coalition left the government in September 2012, and another went in early 2013. However, the government has persisted in the right direction and overall macroeconomic policy has undergone the necessary stabilization.

Important re-jigging of the way clearances are given to projects has been undertaken and a higher powered committee of the Cabinet has facilitated the clearance of a large number of large investment projects. The government is energetically pursuing every opportunity to push for the execution of investment and asset creation in the public sector and to encourage private business to expand and invest. Over time, possibly in the second half of 2013/14, these measures should result in renewed investment activity.

Notwithstanding the sharp decline in growth, investment and savings rates remains favourable. Gross domestic capital formation in 2011/12 and 2012/13 were at 35.5 per cent of GDP in both years. This was lower than what it had been in 2007/08 (38.0 per cent) and in 2010/11 (37.0 per cent), but are still reasonably high. On the basis of historical relationships in India between investment and growth, this level is capable of generating 7 to 8 per cent rates of growth. The proportion of GDP going to create fixed assets (fixed investment rate) was about 30 per cent in both 2011/12 and 2012/13. The domestic savings rate for 2011/12 was nearly 31 per cent and probably close to that in 2012/13. In short, the domestic investment and savings rate are still at levels that can produce much stronger growth than has been evident in both of the two previous fiscal years.

That it has not, is in part, on account of the delays that has inflicted projects in India on account of clearances, fuel availability and other delays. For example, there is at the moment, more than 10,000 megawatts of thermal power plant capacity that is wholly or largely idle on account of non-availability of natural gas and coal. Likewise there are many projects that have got delayed in their path to completion, even as billions of dollars of capital has been invested in them. It is the belief of government that actively pursuing reform in policy and administration and facilitating the completion of such projects, the invested capital will be able to generate considerable incremental current output, that is, economic growth. It is not as if there is no market in India for incremental supply. Indeed the converse is true. The shortage of infrastructure services – electricity, roads and the like – seriously constrain output in India.

The positive developments that have materialized in India over the past year are: (1) Stabilization of a range of macro policies; (2) Restoration of the trajectory towards fiscal consolidation; (3) A decline of wholesale price inflation from double digit levels to about 5 per cent, which is within our comfort zone. Manufacturing output remains depressed as also measures of business confidence. However, there is a strong possibility that hard numbers will begin to show improvements in coming months and that there will be some degree of recovery in the second half of the year, which in turn should lay the foundation for a stronger and more broad-based economic recovery in 2014.
June 4, 2013

 

 

 

 

Saumitra Chaudhuri
Member, Planning Commission & Member Advisory Council to the Prime Minister and the Government of India

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India is a promising emerging market for the world today. The world output is expected to grow at around 3.5% in 2012 where the major contributors are likely to be emerging economies like India and China. Indian and Chinese economic growth rates in the past five years inspired investor’s world over to consider them as the next investment destination. Despite, the low growth rates of 6.5% last year in India and lower growth rate projection of 5.5% in 2012 in India and about 8% in China, the future seems to be hopeful yet challenging for both these countries.

India is a young nation that promises much more than what is evident in the through international lens of statistical barometers. It is presently going through the legislative reform process for making it a more accountable and transparent nation to its people through introduction of several pending bills. Adaptive to the global developments, the country has advanced its governance structure in a reformative manner that is approachable by the common man by means of e-governance.

The right to information act has empowered the common man. Further, the introduction of Value Added Tax, Direct Tax Code and e-filing has enhanced the transparency into the system, bringing it closer to the international standards. The government incentives like the NREGA scheme and national policy for manufacturing or schemes for social sector development and infrastructure development schemes is likely to give boost to the economic growth. Fiscal measures taken by the government are made keeping in mind their commitment to the fiscal responsibility and management bill.

Serious credit crunch
India despite such fiscal measures is unable to achieve its potential levels of growth in industry, agriculture and services sector. They need the necessary credit impetus to grow. Credit flows are needed in each sector to enhance the investment multiplier promising higher growth rates. Indian banks have been resilient to the global financial crisis but today face serious liquidity crunch. The central bank of India while reviewing the third quarter’s economic situation has identified that inflation rates are high for the given low economic growth rates, high current account deficits and high fiscal deficits. Given the challenges the bank has decided to keep the CRR (Cash Reserve Ratio) to 4.75% and SLR (Statutory Liquidity Ratio) to 23% so as to induct liquidity in the Indian market.

Lately, the chairman of one of the largest PSU banks in India, SBI, has demanded that CRR requirement may be scraped providing greater liquidity to the banks. It is difficult to believe that such a demand could be made by the country’s largest public sector undertaking (PSU) bank. CRR is an essential liquidity maintained by the central bank that acts as a bulwark for the financial system. Removing the CRR requirement would put the banking sector into great danger. Banks need to monitor their investment and act in a more socially responsible manner especially the PSU banks. There is a need for the banks to participate in the economic development process by initiating and encouraging investment in areas with long gestation periods or less than market benchmark returns.

The Reserve Bank of India alone cannot do much to improve the situation. The banks need to adopt a socially responsible role by making credit available at low cost. The agriculture, industry and services sector is unable to achieve its full potential due to lack of low cost credit. The actions of the Reserve Bank of India with respect to CRR and SLR are less likely to yield results given the deregulated state of banking in India. Banking priorities presently are not aligned with the economic development priorities especially when PSU banks take pride in declaring their profits over their declaring their contribution to the economic growth through credit disbursal. Unfortunately, the government units are not defining their performance through their contribution to the social benefits which is an area less researched in the world.

Disinvestment and deregulation are good for a country as long the directed flows do not cause market imperfections or inefficiencies of oligopoly or monopoly causing a dead weight loss to the economy. It is a myth to believe that monopoly and inefficiencies only arise in government sector. They may develop well in private markets as well, to reduce such inefficiencies it is needed that government may introduce competitive market structures and monitor them carefully.

Regulations in the Indian banking sector were dropped primarily with the belief that the competition in the sector would enhance the consumer’s position. However, despite the deregulations and entry of new players, the market continues to be supply driven rather than being demand driven. Banks have become large conglomerates with forward and backward linkages. Banking is the need for all economic transactions today but has the country provided for a sufficient competitive market structures that that support credit growth.

Necessary policy improvements
India is one country that has a large set up of informal financial markets that still continues to support the economy. To achieve a higher growth potential it is needed that markets may be made more competitive, regulations more stringent, contracts enforceable and government set ups more accountable. To aid this it is needed that there is consolidated effort of fiscal and monetary policies to support economic events. Political and economic will to align sectorial growth rates with economic development priorities.

How do we do it all? The government needs to bring back its disinvestment agenda to reduce its fiscal deficits with proposed conversions of retained earnings into equity shares. Plug all leakages of savings that go into unproductive investments like speculative investment in real estate or investment in gold or foreign currency. Tap the flow of income even the smallest by making banking a habit.

Demonitise the economy, it will reduce black money and ills of the parallel economy! Make transactions accountable by necessitating the use of income tax number known as the PAN number even in the smallest transaction! Direct the flow of saving to banking channels by removing the KYC norm on small balance account holders with low or no banking transactions!

A mere deregulation in diesel prices or reduction in subsidies would not help much in the fiscal position of the government. It would be better to concentrate on the economic issues rather than industry specific issue or specific transfer payments. Tax evasions need to be controlled. Tax incentives to motivate investments need to be given. Government needs to control cost and time overruns in infrastructure and other projects that increase government expenditure and inflation. Banks need to be reminded of their main business of lending and must not play with the public money by investing or speculating in the stock market. Legal systems need to promise foreign and domestic investors protection for their investment and manpower. Imports of unproductive resources like gold need to be reduced or curtailed. Make governance more easy and accessible through e-grievance addressal cells.

The potential
India with its young population size, highly qualified manpower, rich political base, progressive outlook and rich natural resources needs more unity and coherence in its economic growth and development story. One sector alone cannot push the growth rates. Agriculture needs another green revolution. Industry needs a fresh line of credit and services needs newer and higher grounds of performances to develop. Further, a future recovery in the world economy will bring greater hope for India as trade and investment ties would improve.

 

 

 

 

Yamini Agarwal
Professor and Vice Chairman (Academics)
Indian Institute of Finance (IIF), Delhi

 

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