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India's Near Term: In Debate with TN Ninan
13 Mar 2014

In Brief:

  • For the first time in 20 years, India will see two successive years of sub 5% growth. 2014-15 will, at best, see growth at 6% - way below the country's (now diminished) growth potential of 7%.
  • The two green shoots - agriculture and exports - may not see a further upswing in the near term; the former on account of recent, unseasonal rainfall and the latter due to the Rupee's appreciation on the back of rising FII inflows since January 2014.
  • The currency risk remains massive - should India's next government be unstable/unpalatable to investors, FII outflows can de-stabilise the currency and volatility can return in full measure. The RBI is regrettably not focusing enough on this and on shoring up its Foreign Exchange reserves.
  • India had banked on a few game-changers to raise its rate of growth, e.g. infrastructure investment in mega projects such as the Delhi-Mumbai industrial corridor; Aadhar to fuel direct pass-through of subsidies and opening up credit availability. Unfortunately, none of these is close to realising potential.
  • All hopes are then justifiably on India's next government to aid growth in the medium, if not in the immediate, term. Estimates suggest a clear win for the BJP-led NDA; perhaps, even a majority, given the pattern of vote shares and seats respectively. Confidence in the BJP rests justifiably on UP and Bihar, contributing 20% of total seats in the Lok Sabha, and where the opposition is weak and fragmented.
  • Prospects for a Third Front are dim; the infighting within state-level political parties is simply too intense for a cohesive shot at the elections. Despite Arvind Kejriwal's political genius and his very real appeal in the metro cities, the Aam Aadmi Party too is unlikely to make a dent beyond 15-20 seats, as it has simply not enough girth on the ground in the country.
  • The Congress itself is in a period of serious - perhaps permanent - decline, a reality it needs to confront and introspect over deeply; potentially possible if it sits in the Opposition for one term.
  • Speed will be of the essence for any new government, with immediate needed focus on recapitalising the over-stressed banking sector (and the infusion, in the medium term, of more private capital); on the clearance of infrastructure projects, most stuck on account of land acquisition and/or lack of interest in the private sector due to its own over-leverage on one hand and unfavourable policies on the other. Reforms in tax, labour and agriculture will have to medium-term agenda items.
  • Too little is known of Mr Modi's economic agenda but his rationale of 'not too much government' is heartening, although it may well need to be the opposite to begin with. Should he become India's next Prime Minister, his ability to operate a strong PMO will be central to success, to getting Ministries to work together for tangible outcome. One will have to wait to see which camp of advisors he will finally lean towards - the market oriented economists or the hard-liners that would recommend impracticalities such as a banking transaction tax or a river linking system.


Factoring in the likely GDPnumbers for 2013-14, India will - for the first time in a quarter-century - have had two successive years of sub-5% growth.Rarely has itseen a slowdown of such length and depth, and nor is there likely to be quick up-tick from here. Based on its still-high 30%+ savings and investment rates, the economy's potential growth ratecurrently lies in the 7% range - down from 8-9%a few years ago - but far higher than today's levels.The system is therefore nowunder-performing, and couldreturn to 7% growth in 2-3 years' time, provided that certain constraints are removed. In the coming year, though, it is unlikely to exceed 6%. Quite simply, this is because the macro-economic correction that India needs is not yet complete. Inflation is still well above the RBI's 'comfort level'. Given that interest rates on savings are now lower than inflation, the RBI will be keen to have real interest rates move back into positive territory - which makes a nominal rate-cut anytime soon very unlikely. Meanwhile, the fiscal deficit may have been brought down, but only through an accounting sleight of hand. Over Rs 50,000 crores of due expenditure has been moved to the next fiscal. The underlying fiscal pressures are intense, and the Finance Minister's 4.1% deficit target for this year is optimistic, especially also since it is based on a hard-to-believe 19% rise in government revenues.

While it is possible that a decisive new government will help lift the mood,severalbottlenecksweigh against a sharp recovery in the near term.For one, there is currently no room for anyreal macro stimulus, either fiscal or monetary, to drive up growth in the short term. For another, projections, even for farm output this year are subdued - partly owing to heavy, unseasonal rainfall in recent weeks. This will put a damper onagricultural growth. Meanwhile, India's recent export recovery and narrowing current account deficit (CAD) owe much to a weak Rupee. However, with FII inflows resuming in strength, and the Rupee climbing as a result, exporters may soon find their margins being eroded. Moreover, there is a real danger that if the election resultsare 'bad' from a business perspective, money will flow out again, destabilising the currency with it. Worryingly, too,the RBI is not working to shore up its foreign exchange reserves, as it should, to prepare for such a scenario. Nor is it doing much to hold the Rupee down - which is necessary for export growth to sustain. Finally, some of the main'game changers' the UPA has worked on- the Delhi-Mumbai industrial corridor; the Aadhar project and its linkages to direct payments of subsidies - are taking time to get off the ground. While they will eventually bear fruit, their near-term impact on growth is limited.


Investors plainly favour a BJP-led government at the Centre, and the markets may be right to be forecasting - as they clearly are right now - a big win for the NDA. In looking at the pre-poll surveys, however, there are two factors to consider: the percentage of the vote likely to go to each party, and what that means in terms of Lok Sabha seats. Translating from one to the other is not an exact science, and hinges on several factors. First, at the individual constituency level, is whether a contest is a straight two-way fight, or instead, one involving several players. In the latter, a candidate winning even a small vote-share can come out ahead of the pack. The second, and in this case, more important, factor is the size of the 'swing' in favour of or against the major parties.

Today, the major polls (leaving aside scepticism on their reliability) are giving the NDA between 33-36% of the vote - the highest of any party since the 1991 elections. This represents a massive, 13% positive swing from the 2009 numbers, when the BJP got 18% and its allies another 2-3%, for a total of 20-21%.Meanwhile, the Congress's vote share has not declined on quite the same scale, falling from 29% in 2009 to 25-26%. What accounts for this huge gap is that the smaller parties are being squeezed out of the picture. This seems to be a repeat of what happened in Chhattisgarh and Madhya Pradesh three months ago, where the Congress either held on to or even improved its vote-share, but still managed to lose - mainly because the BJP snatched away support from other players. Should the BJP manage to retainsuch a high vote-share, the current estimatesof its seat count could prove to be grossly low, and the NDA could get a clear majority on its own. Supporting this is the fact that in Bihar and UP - which alone account for 20% of the seats in the house - the regional players are weak and fragmented. In a four-way vote split in these states, the BJP could potentially walk away with half the seats. Meanwhile, in the three major states the BJP either won or retained a few months ago, it remains strong. The onecaveat to this view is that the BJP still has serious work ahead of it: its candidates are just being announced, and it remains to be seen how voters react to their specific candidates.

A possible alternative to the NDA is a Third Front government, but this can become feasible only if regional parties can cobble together at least 170 seats and then get the Congress' backing. It is, however, hard to see this happening, for the simple reason that many regional players vehemently oppose each other. In UP, the SP and BSP cannot work together, and neither, in Tamil Nadu, can the DMK and AIADMK. In Andhra Pradesh the TDP and the YSR Congress are at loggerheads, and in Bihar, it is the JD(U) versus the RJD. Meanwhile, expectations of the Aam Admi Party (AAP) having a huge impact on the results are exaggerated - at least this time around. So far, the AAP has nothad the chance to spread beyond Delhi and Haryana. It is currently testing the waters in Punjab, UP and Gujarat, but is not yet in a position to mount aserious campaign countrywide. At most, it might get 20 seats this time. However, in the longer run, the AAP and the BJP are competing for the same voter segment - the lowermiddle classes and the 'neo middle class' - and AAP's leadership has been able to latch on to issues that truly bother people. Arvind Kejriwal has demonstrated political genius by turning disadvantages into advantage, holding on to the public's attention, and its sympathy. He is fearless, and willing to take his opponents head on. It is possible that he develops into a heavyweight in the political arena a few years on.


To set itself apart from its predecessor, anynew government will need to quickly and decisively prove its managerial effectiveness - or risk losing the confidence of investors.Unlike the UPA, it will have no room to simply sit on decisions, but instead, it will have to let its actions speak louder than words. The current regime has taken a number ofoverdue steps in recent months - and these will have some impact in the coming year or two - but much, much more is needed. Many highway projects are stuck because of disputes over contracts, land acquisitions, or because of cost-related issues. 20,000 kilometres worth of road projects are lying untouched, with no contractors willing to make bids for them. In the power sector, fuel shortages and the new gas-pricing policyare coming in the way of generation. Meanwhile, major companies across sectors are deep in debt, while their ability to raise fresh equity is severely hampered. Banks, for their part, have huge stocks of NPAs and restructured assets, and urgently need recapitalising. However, the amounts the government is offering are a pittance comparedto what is needed. One of the most difficult issues for the new government, therefore, will be whether and how to bring more private capital into the banking system.

In terms of the reforms agenda, tax reform is a low-hanging fruit, but it will be tricky to push through the 'biggie' in that arena - the GST. Even if the NDA enjoys a majority in the lower house, it will need the Congress' support for the bill to find passage in the Rajya Sabha - and it is unclear whether that will happen.Labour reforms will be tricky, but with enough political backing, possible. Growing in the 3.5-4% range, agriculture has been a success story in recent years, but much needs to be done in terms of improving the diversity of output, strengthening supply chains, and so on. (Agricultural reforms, by raising productivity and therefore wages, are also linked to poverty reduction). The manufacturing sector, meanwhile, is being hampered by infrastructural shortages. Highways are a big area of concern, but fortunately, new linkages are beingbuilt with ports, and the railway system is being made more efficient. In terms of electricity, peak-power shortages have come down from an average of 12-13% a few years ago, to 4% this year - though partly, this is because of slackening demand. Going forward, India has invested heavily in new capacity in recent years, and if the gas-pricing and coal-supply issues can be sorted out, there should be adequate power supplies to keep industry going.

Assuming that Narendra Modi comes to power, it is not fully clear what his economic agenda will be. However, hehas spelt out a broad approach:moving away from subsidies and towardsmarket pricing; getting industry and infrastructure moving on a priority basis; and tackling important issues as they come up. At the very least, Mr Modi genuinely believes, if not in minimal government, that the state cannot and should not do everything. Hopefully, therefore, he will restrict the scope of government in many areas, and will be as reform-oriented as expected. Information on the economic agenda of a Modi-led government is however still not clear. One concern is that he currently has too many different advisors - some with outlandish policy ideas, such as a banking transactions tax - and it remains to be seen whether the other group - market-leaning economists- will hold greater sway, and therefore push reforms. Another concern is whether he will be able to run a strong Prime Minister's Office (PMO), and therefore push measures that his party opposes. If instead, the PMO is weak and requires support from different quarters, the prospect for reforms will grow dimmer.On this count, Mr Modi's centralised, dominating style offers hope of a strong PMO.


On the poor quality of India's 'soft infrastructure' - its education and healthcare systems:

A lot of money has gone into these sectors in recent years, and in quantityterms, the school-attendance numbers have risen sharply. In the last five years, for instance, the number of secondary school students has virtually doubled. Moreover, the primary-education system has been broad-based, and private schools and NGOs are taking up the slack wherever required. In Mumbai, for instance, NGOs run schooling programmes out of public facilities, at 40% of the cost of public schooling. However, the quality of education - as measured by test scores - remains poor, and most students are learning very little. This poses a grave danger to society: millions of children who come out of secondary school will want white-collar jobs instead of going back to farming, or taking up menial jobs. With not enough jobs being created on the one hand, and the quality of education so poor on the other, many will simply not be able to land the type of jobs they want - and this can create serious social unrest. The healthcare sector is even worse off, with inadequate public infrastructure, and services accessible only to the relatively well-off.

Comment: There is currently a huge trust deficit in the outside world towards India. This holds not just for MNCs - whose head offices are holding back on new investments in the country - but also for regulators. The US and Canadian authorities, for instance, are extremely upset with the Indian system. Not realising just how whimsical the Income-Tax Department truly is, they feel that their companies are being targeted, and they are even thinking of retaliation. This is worrisome, because India is so dependent on outside investments, especially in IT and pharmaceuticals, and the damage could be severe if such steps are taken. That said, the Indian bureaucracy truly is at fault: nowhere in the world do bureaucrats behave with less courtesy or professionalism; instead of talking with industry, they talk down to it.

Response: The Indian system truly isimmune to others' opinions - and it is remarkably obtuse as to how the rest of the world sees it. Many countries, for instance, have moved to resolve their transfer-pricing issues, but India continues to take a crude, hammer-and-tongs approach to the subject. To add to the problem, India is probably the only country where not only are the laws complicated to begin with, but they are also interpreted very strictly. Elsewhere, it may be one or the other, but not both. There have been many sensible suggestions for administrative reforms that can be easily implemented to make the system far more effective. Almost inexplicably, there has been no forward movement on this in the last decade.

On the inflation-growth trade-off:

There is no automatic trade-off between inflation and growth. Growth can be either inflationary, as in India, or non-inflationary, like in China. It all depends on how the macro-economy is being managed. In India's case, mismanagement boils down to having one of the world's highest fiscal deficits, and loose money policies. (Allowing a 23-24% credit growth rate for years is asking for trouble.)To add to the pressures, global commodity prices have been high, the Rupee has been falling, and a weak Rupee makes high global fuel prices worse. Agriculture wages have risen sharply, as have procurement prices for farm products (at 15-17% a year). Rising incomes also means more spending on higher-value food, including meat, vegetables and fruits - and this has driven up prices, fuelling a serious wage-price spiral.

Comment: Corruption has become so widespread and moral values have fallen so low, that it would hard for the next government - irrespective of who comes to power - to do much about this.

Response: It is important to look at institutional problemsseparately from moralissues, and it is possible to address one while ignoring the other. Singapore was not always as 'clean' as it is today, and the Hong Kong police used to be highly corrupt, until better systems were put in place. In India,it is themachinery of the tax administration itself that is corrupt, and it is in fixing that, notindividual tax officers that the solution lies. Used well, digital information networks can also help to expand the income-tax net, and this can eventually help clean up things. When there is an intent to change things, anything is possible.

The contents of this paper are based on discussions of IMA's CEO and CFO Forums in Delhi and ChennaiwithTN Ninan, Chairman and Editorial Director of the Business Standard, in March2014. The views expressed may not be those of IMA India. Please visit www.ima-india.comto view current papers and our full archive of content in the IMA members' Knowledge Centre.

This article is tagged under the following categories:
Subject: @Economy   |  Category: Macroeconomy
Subject: @Economy   |  Category: Economic policy   |  Subcategory: Monetary policy
Subject: @Economy   |  Category: Economic policy   |  Subcategory: Fiscal and tax policy
Subject: @Economy   |  Category: Economic policy   |  Subcategory: Industrial policy
Subject: @Economy   |  Category: Infrastructure and industry   |  Subcategory: Industry sectors
Subject: @Economy   |  Category: Infrastructure and industry   |  Subcategory: Infrastructure
Subject: @Economy   |  Category: Agriculture and rural
Subject: @Economy   |  Category: Markets   |  Subcategory: Capital markets
Subject: @Economy   |  Category: Markets   |  Subcategory: Currency markets
Subject: @Business   |  Category: Business Trends   |  Subcategory: Business Confidence
Subject: @Politics and Geo-Politics   |  Category: Domestic politics   |  Subcategory: Domestic policymaking
Subject: @Politics and Geo-Politics   |  Category: Domestic politics   |  Subcategory: Political Parties / Elections
Subject: @Politics and Geo-Politics   |  Category: Domestic politics   |  Subcategory: Sub-national politics
Subject: @Politics and Geo-Politics   |  Category: Domestic politics   |  Subcategory: Governance
Subject: @Society and Environment   |  Category: Public services

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