Slow, quick, slow


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REALITY can be changed only if we look it squarely in the face and recognise it for what it is. And the reality about the Indian economy is as follows. This year is likely to see the slowest growth of India’s gross domestic product (or GDP) since the crisis year of 1991-92 – the most credible forecast so far is about 4.5%. And as a consequence, the last five years (1997-2002) will have had an average annual growth rate that is no better than that in the 1980s – about 5.6% (compared to 6.7% in the 1992-97 period).

Even this reduced rate of growth is illusory. To understand one reason why, consider a scenario where Bajaj Auto was not able to sell its two-wheelers and, in order to bail it out, the government set up a scheme by which it bought up all the scooters that Bajaj couldn’t sell to its regular customers. The government then set up special warehouses, at public cost, to store the scooters. And when those warehouses were full, began parking the scooters it bought on roadsides, in school playgrounds, wherever it could find space. And on the strength of these government purchases and stockpiling, if Bajaj recorded a 10% growth in sales, would you take that number seriously, or would you consider it a fudge?

Well, there’s news for you. Take a look at Indian agriculture. For the last three years, Indian farmers have not been able to sell vast quantities of their foodgrains in the regular open market. And the government has stepped in to buy the surplus grain. Food stocks have as a result climbed from 20 million tonnes to 60 million tonnes in three years, and will probably get to 75-80 million tonnes by next summer. And 100 million tonnes a year later, because the government is now buying about 30 million tonnes of grain in a year, and managing to sell no more than 10 million at even heavily subsidised rates that barely cover the cost of storage and transport, i.e. the administrative cost of the operation. If such government buying and stockpiling shores up agricultural growth, is that real growth, or a fudge? If you’re short of an answer, just replace foodgrain with scooters, and the picture becomes clear.



Not convinced? Take a look at the bank credit figures. Foodgrains (which are a sub-set of agriculture) account for about 20% of India’s GDP. In comparison, industry accounts for 25% of GDP, and services for about 50%. But in sharp deviation from these GDP components, the first half of 2001 saw fresh food credit given out by banks climbing to about three times as much as total non-food credit. Naturally so, since industry is not stockpiling its end-produce the way the government is adding to its grain stocks.

And don’t be under the illusion that this is productive credit. Because, try as it might, the government is unable to get rid of the stock. It has offered price discounts, and yet more discounts. It has offered the grain as cattle feed in export markets. And when some of the grain wasn’t good enough for even cattle, the government has simply dumped the grain in the sea. One expert says that, hidden in the government’s grain mountain, is wheat and rice that is up to 24 years old. It doesn’t take too much intelligence to guess that agricultural growth that is fed and funded in this fashion isn’t really growth at all. Correcting for this, the growth rates for the current year and for the past couple of years would drop further.

It isn’t just agriculture that is on hormonal injections. The flourishing ‘services’ sector is, too. For, in 1997, the Gujral government accepted in part the generous recommendations of the Pay Commission. In part, because the pay hikes were to be matched by a drop in the numbers employed by the government. But that hasn’t happened, of course. Then, the government went one better than the Pay Commission and extended generous payouts to those on government pensions. And, to a man, the state governments felt obliged to follow suit. The result is that the value of government services (measured by what you pay for them, i.e. what you pay government servants) increased dramatically almost overnight. Over three years or so we added, through this financial legerdemain, about half of one percentage point to GDP growth.

Take away the hormonal injections, and what are we left with? Perhaps GDP growth that is about one percentage point less than what the government’s statisticians tell us. In other words, we are now an economy that has been growing at a ‘core rate’ of barely 4.5% a year, not just in this past year but for three or four years now.



That would be a shock to many readers, used as we have become to tales of how a reforming Indian economy is onto a new growth path of 6% and more, and how we are now going to aim still higher in the new decade. A shock, yes, but not a crisis. Not in a year when the three major economies of the world are all simultaneously in recession – the first time this has happened in more than a quarter of a century. Not when oil prices have been so high. And not when most of the Tigers of East Asia would be happy today to register even 4% growth.

The fact is that, even at a fairly modest 4.5% GDP growth, India remains among the dozen fastest growing economies in the world. Among those doing better are China, Russia and half a dozen breakaway states from the Soviet Union, and Egypt. Indeed, since exports have been falling, and these account for close to 10% of GDP, 4.5% GDP this year growth is quite creditable – as defensive government spokesmen have been pointing out.

But don’t get lulled into complacency. For there is a crisis. In fact, three crises. Apart from the one in agriculture, there are crises also in manufacturing and in financial services.



The more obvious crisis points this past year were in financial services. In the summer, the Unit Trust of India was back in the headlines for all the wrong reasons. It had gone bust again and needed help. Then came news about the Industrial Finance Corporation of India, which defaulted on its payment obligations and had to run to the government for bailout No. 2. And in the wake of that came further reports that even the Industrial Credit and Investment Corporation of India (ICICI) had, what has been euphemistically called, an assetliability mismatch.

In other words, it didn’t have ready cash to meet its payment obligations. Result: ICICI began asking key customers to pre-pay loans and hawking its assets in an effort to raise the cash. Meanwhile, the mother of all the financial institutions, Industrial Development Bank of India, is heading for serious trouble too. Between them, these four organizations handle close to Rs 300,000 crore worth of financial assets. No one yet knows what is the size of the hole in their books, but it is going to be substantial.

That’s not all, of course. Because there are also the commercial banks. It’s been known for more than four years now that three government-owned banks are in trouble – UCO Bank, United Bank of India and Indian Bank. Now it is believed that five other banks are also in trouble, bringing the number of problem cases to eight out of a total of 27 public sector banks. The government has already re-capitalised some of the troubled banks, more than once, but the problem has not been licked and the banks need still more funds – as does IDBI, if it is to meet its capital adequacy requirements.

The government now says it has no more money to give them, so the only way out would be to go to the market and raise funds from the investing public. But having seen the fate of institutions like IDBI and IFCI, which now have share values that are barely a tenth of the prices at which the public invested, it can be safely forecast that investors will be wary.



There seems to be no escape from doing the obvious: asking the banks to straighten out their act. The price for failure is already being borne by anyone who is a bank customer, because credit would be one to two percentage points cheaper than it is just now, if the banks did not have such high establishment and operating costs, and such large provisions to make. The real rate of interest (i.e. the nominal rate minus the rate of inflation) for most bank customers in India is over 8%, which is very high by any standards. Cheaper credit would allow more customers to finance acquisitions through debt (thus generating additional demand) and allow companies to expand operations (i.e. facilitating investment). But with profit margins squeezed, the cost of money is a clear deterrent to faster growth.

Which explains why the best companies are now bypassing the banks and accessing the wholesale debt market directly. If 10-year government bonds are available at 8% and less, companies with strong balance sheets can easily access funds at 9%. They see no reason, therefore, to borrow bank money at 10 and 11% interest. The result is that the banks are now experiencing what the state electricity boards and the railways have already seen happen: their best customers are deserting them, and they are left with a less and less attractive customer profile, thus adding to the crisis of Indian banking.



The electricity boards lost out because they were fleecing industry to finance free power being given to farmers. Till it reached the point where power from the grid was no cheaper for industry than self-generated power from in-house generating sets. Similarly, the railways have been over-charging their freight customers in order to subsidise passengers, to the point where those wanting to move cargo find it cheaper to use the road, and bypass rail altogether. Industry has been everyone’s milch-cow for financing politically driven decisions on pricing public sector services, and industry has slowly been going on strike.

But that’s a digression. Returning to the problems of the financial sector, it would be fair to acknowledge that the problems in India’s financial sector are much less serious than in economies like Japan’s or half a dozen East Asian countries. The non-performing assets in India’s banks are said to be only 2.5% of GDP (Rs 50,000 crore), and by the standards of many emerging market economies, that is close to respectable.

The worry is that the 2.5% is probably a severe underestimate, and the actual size of the NPA problem is probably much greater. In part, this reflects the poor credit appraisal abilities of India’s public sector banks, and in part the growing problems of India’s manufacturing sector, and the fact that many companies to whom both the banks and the financial institutions have lent large sums of money, now face tougher times and viability questions.

That brings up the third crisis, which concerns India’s manufacturing sector. If truth be told, large parts of India’s manufacturing base are not competitive and not viable in an open economy. Sure, some would argue for some protection as the logical policy response. But it is protectionism that has generated such unviable, hothouse industry and what we need now is a manufacturing sector that can stand on its own feet, without government-lent crutches. Without that, manufacturing will not be able to export, or retain satisfied domestic customers.



Nothing explains the loss of confidence that has been suffered by Indian manufacturers, as clearly as the drying up of investment in manufacturing. The production of capital goods has been falling for some time, denoting a shrinking sector. Then, take a look at the key manufacturing sectors: steel, cement, fertiliser, automobiles, chemicals, petrochemicals, engineering goods. Try and recall the last time anyone set up significant new capacity in any of these sectors. To some extent, this reflects the excess capacities that got installed in the heady days of optimism, in the mid-1990s; and to some extent it reflects the more intense price competition (and protectionism) that characterises international markets, as in the case of steel.

But if you want examples of hopeless lack of competitiveness, you can look at any of several sectors. Take fertiliser, where the Indian farmer pays roughly the same prices as are quoted in international markets, even as the government pays out massive subsidies to the fertiliser producers, some of whom have a cost of production that is twice as high as the ruling market prices. If you wanted an efficient fertiliser sector that could function without subsidies and still offer the Indian farmer international prices, close to half of all the manufacturers would simply have to shut shop.

That’s true of steel as well. The Steel Authority of India has only one or two profitable plants; many private plants too are unviable at today’s prices. Haldia Petrochemicals is already a troubled giant, as is Mangalore Refineries. Virtually everyone in the car industry is losing money, barring Maruti Udyog and maybe one other company.



The manufacturers say they can’t function effectively, given the state of India’s transport infrastructure (rail, roads, ports), the hopeless power situation, the cost of finance, the inflexibilities of the labour market, and the regressive nature of the customs tariff structure (in many cases, inputs still attract a higher duty than the finished product!). The regrettable story of India’s reforms is that progress on most of these fronts has been slow and very patchy.

If we were to leave manufacturing in its present hobbled state, accept that the government has not found a solution to the problems of the financial institutions and banks, and recognise that agricultural growth has been steroidal in character, then GDP growth can accelerate only if the services sector does well. Services already account for close to half of total GDP, and consist of government services (providing external security, internal law and order, etc), transport, communications, financial services, trade, and personal services (e.g. medical, legal).

Of these, we’ve seen that the financial sector is very troubled indeed. We’ll return to transport in a moment, but suffice it to say that as of today the sector is still mostly unreformed. Government services should, if anything, be downsized. In any case all governments are now impecunious, so don’t expect much growth from there. Retail trading has seen very slow change, and personal services are difficult to measure.



Telecommunications have been a bright spot so far: basic telephone services have been growing at 20% every year (5 to 6 million new phones annually, getting to 35 million by March), and mobile phone services even faster (2.5 million more this year, which will end at close to a 6 million total). But two riders are in order.

First, many new telecom services have proved to be failures. The vast majority of internet service providers have shut shop, and the paging business has proved a non-starter. The promise of broadband, once considered so exciting, has been belied after it became clear that customers don’t exist in sufficient numbers to justify the investment. Even in basic telephony, private enterprise has got off to a very slow start. The one bright spot has been mobile services, which have done very well.

But this is one sector where future growth should continue to be rapid. For one thing, the birth of competition has seen a crashing of long-distance call charges. The advent of internet telephony by April will make long-distance calls even cheaper. Private investment in basic telephony is expected to gather speed. All this will help increase telephone use and telephone density. The official goal of getting to 90 million phones in another five years may well be realised, as competition intensifies and the consumer gets more choice in all aspects of telephony.

The other bright spot in the services sector is computer software exports and IT-related services like call centres. Everyone is familiar with the Nasscom-Mckinsey forecast that software exports would reach $50 billion by 2008. Things seemed on course till a year ago, as exports were growing by more than 50% annually. But this year’s growth is likely to be down to 25%, and from the resultant base of $8 billion in 2002, it is difficult to see a vault to $50 billion in six years, signifying as it does an annual growth rate of more than 35%. The logic of large numbers must surely point to slowing growth rates over time, and therefore a more modest number than $50 billion by 2008. But even if the current year’s 25% growth were to be sustained over six years, the number would climb to $30 billion by 2008, making software India’s single largest item of export.



It is important to see that number in context. India’s total commodity exports this year are not likely to be much more than $40 billion (up from $18 billion a decade ago, giving us an annual growth rate of barely 8%). And the country would be doing a very good job if that number were to continue growing at the same rate, reaching $65 billion at the end of six years. At that point, software would account for close to 30% (65+30+others=100) of total foreign exchange earnings, compared to less than 5% a decade ago.

By that time, it would also, paradoxically, have become a serious threat to Indian manufacturing. To understand why, note that India has historically been deficient in energy, and imported oil. Over many years, if not decades, India’s non-oil trade has been broadly in balance. Thus, India has had not a trade deficit (fluctuating between one and 2% of GDP) as much as an oil deficit. However, software now promises to compensate for that, insomuch as it will at some point equal the bill for India’s oil imports. This year, software exports will pay for 50% of the oil bill of about $15 billion. Five years from now, it could be 100%.



If India has no deficit on the total package of goods and services in which it trades, and if it continues to be a net importer of capital by attracting foreign investment and large remittances from non-residents, then one of two things must happen. Either we will have to create a deficit by opening up much more to imports, spelling more trouble for manufacturing. Or, the excess of dollars flowing into the system will push down the dollar and push up the rupee, so that the rupee will begin appreciating against the dollar.

A third option would be for the Reserve Bank to buy up the onrush of dollars and add to the country’s foreign exchange reserves. But this would mean pumping an equivalent value in rupees back into the system, creating a liquidity surge and threatening either price stability or an import surge, or both.

All three options spell trouble for mainstream industrial manufacturers. Their domestic markets will be threatened by the increasing competition that will come through an appreciating rupee (making imports cheaper) or lowered tariff walls. And the appreciating rupee will also price them out of export markets, since most commodity exporters have thin margins on their exports. What this means is that, even as software powers ahead, the deficiencies that bedevil India’s manufacturing sector will have to be tackled in double-quick time. Time, then, to look at how much and how quickly the systemic constraints are being addressed.

One success story concerns the country’s ports. At the major ports, container operations have been privatised and handed over to companies like P&O. There is a dramatic difference, therefore, in the cargo handling efficiencies in the privatised corners of the Jawaharlal Nehru Port (Nhava-Sheva), Tuticorin and the Madras port. More privatisation is planned, at Kochi for instance. Some of these ports now claim efficiency levels, in terms of ship turnaround time that match international standards. With the private sector having set up some minor ports, and with private jetties handling some bulk cargo, India’s port capacity for the first time matches its cargo requirements. But further improvements are possible, since the reform is still patchy, and many ports are hopelessly over manned.

Ditto for roads. The work on the golden quadrilateral (Delhi-Mumbai-Chennai-Kolkata) will be done in another couple of years, and will reduce road haulage time to half their current levels – even more if many states abolish their octroi regimes (responsible as they are for both delays and corruption). The typical haulage time of one week between Delhi and Mumbai could then be reduced to a couple of days.



The north-south and east-west highways, plus the spurs to all the major ports, will take till 2007 to complete, and should for the first time give India a road backbone that matches international standards. If road haulage time drops dramatically, and port turnaround time is nothing to complain about, it will open up new export opportunities for many because of the saving of both time and cost.

Improved road haulage will only heighten the competition for the railways, which have been slow to respond to the rapidly changing environment for the movement of goods. Various reform measures have been suggested (by the Rakesh Mohan committee, for instance), but the railway managers want to persist with their old ways. It might need a state of imminent collapse to prod them into action and change. Well, that stage is not very far away – at the most, a couple of years.



Meanwhile, progress on the airports and airlines has been slow. Private investment in the airlines was hemmed in by impractical rules, till everyone lost interest. And now that the market has dried up, the government wants to be more liberal in its policy (ditto with the policy on direct-to-home broadcasting, for instance). The leasing of airports to private parties has also made slow progress. And the privatisation of Indian Airlines and Air-India has come a cropper. What this means is that a severe constraint on business travel (and on tourist arrivals) will stay for some time to come.

The far more intractable and infinitely more serious problem, though, has been power. The last decade’s attempts at reform have got nowhere so far. Private investment in power generation has been extremely modest, and most of the global power majors have given up on India and left its shores. The experiments with privatising power distribution have served only to highlight the rot in the system (imagine a situation where the boards have massive investments in capital equipment, but no register of the physical assets they own, and no accounts finalised for years!). And though a few chief ministers have dared to raise power tariffs to farmers, this is still seen as a huge political liability.

In Punjab, which has its assembly elections due soon, the Congress is debating whether to offer free power to farmers, as part of its manifesto, because this is a position already adopted by the Akalis. In truth, though, the boards would probably not be required to raise tariffs if they could eliminate large-scale power theft, under-billing and non-collection of billed amounts. Among all the infrastructure areas, power remains the one area with the least amount of progress, and the most ground left to cover.

That leaves the issue of the labour market. Though the finance minister promised reform in February, successive labour ministers have stalled action. Fortunately, however, court rulings on labour disputes have become more realistic and the trade unions have begun to recognise the reality of the marketplace. The law may not have changed, but market reality has. That isn’t enough, though. A much freer labour market, mandated by law, is required in order to give employment a boost.



The other knotty issue is ending the reservation of some 800 items for manufacture by only small-scale industry, though large-scale industry in other countries can export those products into India. This too remains a political hot potato, for reasons that may have more to do with local funding of politicians at state and district level, than with vote banks.

With so much ground left uncovered, it will take an optimist to forecast industrial revival to the point where manufacturing growth (no more than 5% over the past four years) accelerates to 8% and more. Similarly, the problems bedevilling agriculture are so sweeping that corrective steps like switching to new crops in order to get away from the over-emphasis on grain, will take a lot of time and effort. And in services, perhaps the biggest issue to be addressed is the reform and downsizing of government, and the improvement of governance. Simultaneously, as the government withdraws from substantial areas of economic activity and creates space for the private sector, new institutional mechanisms required to ensure the orderly functioning of markets, must be put in place.



Among the new crop of regulators, it is one of the relatively older ones (the Securities and Exchange Board of India) that has done very well in reforming the stock markets. The transformation here is scarcely believable. But the record of some of the other regulators (telecom, for instance, or electricity) isn’t anything to write home about yet. More regulators are planned (for hydrocarbons), and it looks as though some ministries have seized on the regulatory mechanism as a ruse for retaining arbitrary control over markets. Old habits die hard.

The question that threads its way through all these issues is whether the government, cobbled together by an untidy coalition, has the sense of purpose and willpower to address the many problems that cry out for attention. On the record of the past three years, the best that can be hoped for is that we will continue to muddle through. That translates into a GDP growth rate of between 5 and 6% in the next quinquennium, no more. That isn’t bad going, by our modest standards, but it isn’t going to be enough to absorb the 8 million who enter the employment market every year; it isn’t going to be enough to ensure that the eastern half of the country grows fast enough to keep a lid on social pressures. And it isn’t enough to ensure that the curse of absolute poverty will be abolished in another couple of decades. Those are sobering thoughts. But then, it could have been worse too.