India: The Siege Within

satyajit dasSatyajit Das  

India seems never to be able to fulfil its economic potential. The nation seems to be trapped in an Alice in Wonderland world where “the rule is, jam tomorrow and jam yesterday-but never jam today”.
India Shining…
India’s GDP rose by 43% between 2007 and 2012, slightly less that China which increased by 56% but much faster than developed economies which grew only 2%.
Economists rushed to out do each other in spruiking the India story. Forecasts of growth rates of 8.5% per annum or even higher became commonplace. Morgan Stanley, the US investment bank, predicted that India’s growth would reach 9-10%, outpacing China’s “pedestrian” 8% within three to five years.
In a report titled India: Better Off Than Most Others, Macquarie Capital, argued that India’s traditional weaknesses -low exports, a predominantly state-owned financial system lightly integrated to foreign markets, sluggish export growth because of bureaucracy and the large domestic agricultural sector producing only for domestic consumption- were now strengths underpinning growth.
Indian leaders moved between international forums, basking in their new found status and power. Indian businessman made trophy purchases of business overseas, usually financed by debt. At the World Economic Forum at Davos, representatives of the Indian government and business announced that India could grow in its sleep.
India’s economic hubris was exemplified by a marketing slogan, first popularised by the then-ruling Bharatiya Janata Party (“BJP”) for the 2004 Indian general elections – “India Shining”. After years without a good news story, the Indian media focused on the nation’s “greatnesses”, relying on extraneous facts. The fact that the market capitalization of State Bank of India surpassed that of Citigroup was cheered. The press celebrated the first Indian edition of Harper’s Bazaar which featured a crystal-studded cover, the introduction by Rolls-Royce of its new Phantom Coupe in India and the opening of a new BMW showroom in Delhi. More recently, the nation has found solace in its venture to send an unmanned spacecraft to Mars!
But in recent times, the unsound economic basis of India’s growth has increasingly been revealed. In late 2011, the government’s 12th five-year plan forecast growth of 9% between 2012 and 2017. By late 2013, India’s economic growth had slowed below 5% , high by the standards of developed countries but well below the levels required to maintain economic momentum and improve the living standards of its citizens.
Elements of the India Shining story remain intact –the demographics of a youthful population, the large domestic demand base and the high savings rate. Increasingly, India’s problems – poor public finances, weak international position, structurally flawed businesses, poor infrastructure, corruption and political atrophy- threaten to overwhelm its future prospects.
Instead of membership of the prestigious BRICS (Brazil, Russia, India, China, South Africa), the nation has become attained membership of the BIITS (Brazil, India, Indonesia, Thailand, South Africa), the acronym for the most vulnerable emerging economies.
Public Troubles
In recent years, India has consistently run a public sector deficit of 9-10% of GDP, including the state governments and off-balance-sheet items.
Confronted with the global financial crisis and the additional complication of a poor monsoon, India implemented successive aggressive stimulus packages from 2008 onwards to restore growth. The predictable result was a huge increase in the central government’s fiscal deficit.In fact, between April and October 2013, the government has already touched 84.4% of the annual fiscal deficit target of Rs 5,42,499 crore or 4.8% of the GDP. Interestingly, the finance minister P Chidambaram has reiterated time and again that the target set at the beginning of the year is a “red line” which will not be crossed.
It is unlikely that the government will be able to meet its budget deficit target, other than by adopting some cosmetic measures such as postponing the recognition of expenditure. In effect, it may delay payment of a portion of subsidies to the various oil marketing companies for the under-recoveries they face while selling diesel, cooking gas and kerosene at a subsidised price. At the same time, the Food Corporation of India will also not be immediately compensated for selling food grains at a subsidised price.
Indian government’s debt is around 70% of GDP. As the debt is denominated in rupees and sold domestically, India faces no immediate financing difficulty. Instead, the government’s heavy borrowing requirements crowds out private business.
Indian banks are significant purchasers of government bonds. The banks, generally majority state owned, are also forced to lend to Indian state enterprises and also politically well connected promoters. This limits the supply of credit to Indian businesses that are sometimes forced to borrow overseas, exposing them to currency risk. Given India’s deteriorating external position, the foreign debt is becoming increasingly problematic.
Foreign Troubles
Swiss bank Credit Suisse in its August 2013 report House of Debt -Revisited analysts estimated that the gross debt of ten Indian corporate groups for 2012-2013 stood at Rs 6,31,024.7 crore, having risen by 15% year on year. In fact, the interest coverage ratio of these groups stands at a low 1.4. The report drew attention to the fact that a significant proportion of corporate loans, estimated at 40-70%, are denominated in foreign currency, meaning thatthe sharp depreciation in the rupee will have added to the debt burden.
In an environment of booming stock markets between 2005 and 2008, foreign currency convertible bonds (FCBs) provided companies with low cost debt. However, the toxic combination of falls in share prices and a fall in the value of the rupee (in which the shares are denominated) means that the FCBs will not convert and need to be repaid. The repayment in foreign currency will crystallise large currency losses. In addition, refinancing the FCBs will result in much higher borrowing costs, which will significantly affect the profitability of Indian corporations.
Bank Troubles
Slowing growth, tighter credit and other economic problems have increased corporate defaults to the highest level in 10 years resulting in bad loans. Non performing loans are now above 3.6% of bank assets, a sharp increase over the last year.
The real level of bad debts is probably higher, because of the significant number of “restructured” loans, which many suspect are merely non-performing loans which have been extended with more generous terms to avoid formal recognition as bad debts.
The problem is greatest for government owned banks, which constitute 75% of the banking system. The bad loans are concentrated in sectors such as power, aviation, infrastructure, real estate and telecommunications.
The common element is that these industries are characterised by government involvement and which have suffered from erratic government policy or wholesale interference. In electricity, state owned utilities have accumulated losses of $14 billion, in part because low government mandated rates dictated by political considerations do not cover the cost of generation.
While many Indian companies are financially sound, with strong earnings and healthy balance-sheets, there are significant levels of loans to politically sponsored “promoters”, who are over indebted and have limited access to new capital without a willingness to dilute down the backers stakes, which is often not acceptable except in extremis.
The pressures are likely to increase over time as the economic slowdown bites.
The Indian government has already moved to recapitalise state owned banks to ensure their capital position. In the process, the budget deficit and the government borrowing requirements have come under increasing pressure.
We have no Infrastructure Today
India is plagued by inadequate infrastructure. In critical sectors like power, transport and utilities, there are significant shortages. Poor investment and slow government decision making has hindered development.
Political pressure to keep utility costs low has impeded investment. In the electricity sector, state-owned utilities that purchase power from producers and sell to residential users have incurred large losses. State governments are unwilling to raise retail consumer rates despite increases in the price that power producers charge the utilities.
Electricity generators cannot obtain sufficient coal from the state-owned mining monopoly Coal India, which has been unable to increase production to match the demands of new power plants. Some electricity producers have been forced to invest overseas to assure access to coal.
Increasingly, the structural problems and poor history of projects has made foreign investors cautious, creating a shortage of foreign capital for investment in infrastructure.
While its workforce is young and growing, there is a shortage of skills. In a dysfunctional public education system 40% of students do not complete school. The workforce is 40% illiterate. India’s overall adult literacy rate is 66% compared to 93% for China.
Some universities, especially the 16 Indian Institutes of Technology, are world class. But their limited capacity means that are significant shortages. Some estimates forecast a shortage of 200,000 engineers, 400,000 other graduates and 150,000 vocationally trained workers, such as builders, electricians and plumbers, in the coming years. In contrast, there are 60-100 million underemployed or surplus low skilled workers in agriculture.
Political Atrophy
Political paralysis is a major impediment to economic development. Successive governments of every political persuasion have failed to undertake meaningful reforms, necessary to foster growth, employment and development.
Required changes in land and property laws have not been made. Problems in acquiring land are a factor in 70% of delayed infrastructure projects. Reform of tax laws, including introduction of a direct sales tax correcting cumbersome difference between individual states, have not been completed. Changes to mining and mineral development regulations to allow proper, environmentally controlled exploitation of India’s mineral wealth have not been made.
Other crucial areas remains unaddressed – rationalising unwieldy and economically distorted subsidies, implementing economic pricing of utilities, promoting foreign investment in key sectors or reforming agriculture, especially the wasteful and inefficient logistics system for transporting produce to market. Reform of labour markets and privatisation of key sectors has not been progressed.
The lack of progress on reforms remains a barrier to international investment.
Corruption remains a problem. As current RBI Governor Raghuram Rajan told a business audience a few years ago “too many people have gotten too rich based on their proximity to the government”.
The current governing Congress led coalition and the BJP led opposition are weak, both crippled by corruption scandals. All parties are dominated by political monarchies or by geriatric politicians who cannot or will not embrace change.
India’s fabled democracy is increasingly ossified, where a complete inability to make hard decisions or undertake reforms makes government futile if profitable for some.

Insecure India
In the title of his 1990 book A Million Mutinies, writer V.S. Naipaul pithily captured India’s internal political disputes. Today, about a third to a half of India is affected by the Naxalites, a violent Maoist insurgency which has been active for over the 50 years.
The threat of religious conflict between Hindus and Muslims is ever present. The Chief Minister of Gujarat, a likely candidate for future Prime Minister, remains under a cloud for his alleged involvement in sectarian violence.
Ongoing border disputes with Pakistan and China and the instability of AfPak (Afghanistan and Pakistan), which will be compounded by the US withdrawal, dictates large defence expenditure diverting resources away from other parts of the economy. This is compounded by regional competition with China for influence requiring the capability to project military power into the Indian Ocean and also South East Asia.
The Great Pretender
In the 1980s, Indian sociologist Ashis Nandy observed that “in India the choice could never be between chaos and stability, but between manageable and unmanageable chaos”. Today, a deteriorating global environment, deep-seated structural problems and lack of crucial reforms exacerbated by corruption, threatens to make condition unmanageable, more quickly than most assume.
Indian leaders have been urging businesses and investors to “trust them”. But the country and its elite seems unable to face the truth and undertake fundamental long term changes.

The column originally appeared in the Business Today, edition dated January 6, 2014

Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)

(As told to Vivek Kaul)