Vivek Kaul
Before taking over as the governor of the Reserve Bank of India(RBI), Raghuram Rajan was the Chief Economic Advisor to the Ministry of Finance. As the Chief Economic Advisor, Rajan authored the Economic Survey, which was released before the budget presented in February 2013.
In this survey there was a detailed discussion on the fascination Indians have for gold. The survey came to the conclusion that Indians were buying gold to protect themselves against the high consumer price inflation prevailing for the last few years. It also said that there were no financial instruments in which Indians could invest ]in order to protect their purchasing power. Hence, they ended up buying gold.
“The overarching motive underlying the gold rush is high inflation and the lack of financial instruments available to the average citizen, especially in the rural areas,” wrote Rajan. “The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion, offering new products such as inflation indexed bonds, and improving saver access to financial products are all of paramount importance,” he added.
The survey was released in February 2013. At that point of time India was dealing with high gold imports which were putting pressure on the rupee. India produces almost no gold of its own. Hence, all the gold that is consumed in this country needs to be imported. Every time, gold is imported, the importer needs to sell rupees in order to buy dollars, which he uses to pay for gold. As more gold is bought more rupees are sold to buy dollars to pay for gold. This puts pressure on the value of the rupee against the dollar.
In fact, on April 30, 2013, one dollar was worth Rs 53.81. By August 28, 2013, one dollar was worth Rs 68.83. The rupee rapidly lost value against the dollar.
Raghuram Rajan took over as the governor of the RBI on September 4, 2013, and very soon inflation indexed bonds for retail investors were launched. This was in line with what Rajan had written in the Economic Survey released in February 2013.
These bonds offer an interest rate of 1.5% over and above the rate of inflation measured through the consumer price index. So, if the inflation measured through the consumer price index is 10%, like it currently is, then the rate of interest offered on these bonds would be 11.5%.
This is higher than what any bank fixed deposit is offering at this point of time. But the trouble with these bonds is that the rate of interest will keep varying with the rate of inflation. And if the rate of inflation falls then the rate of interest on offer will fall as well.
In case of fixed deposits that is not the case. If an individual puts money in a five year fixed deposit
offering an interest of 9% right now, he will continue to get an interest of 9%, even if the inflation falls from the current 10% to let us say around 6%. In that case, the interest on the inflation indexed bonds will fall to 7.5% (6% inflation + 1.5%).
This uncertainty has been one of the reasons why these bonds haven’t really taken off among investors. As a report in the Daily News and Analysis(DNA) points out “A check at few private and public sector banks revealed that they haven’t seen a significant interest from consumers for this product.” In fact, in a bid to ensure that more people invest in these bonds, the RBI recently extended the deadline to invest in these bonds to March 31, 2014, from an earlier date of December 31, 2013.
These bonds are being sold through banks. For a bank, inflation indexed bonds are a direct competition with fixed deposits and, hence, any bank is unlikely to encourage people to invest in inflation indexed bonds on its own.
Unless, the bank is offered a high commission to do so. Insurance companies offer banks high commissions to sell investment plans masquerading as insurance. And that is what most banks are interested in selling these days. As the report in the DNA referred to earlier points out “Bankers also agreed that they are not marketing the products aggressively. This is not surprising considering that they have not been incentivised enough. RBI pays a nominal amount to banks for the sale of IIBs, this is way lower than the 1-5% that is paid by insurance companies as commission, explain bankers. Not surprisingly then, Ulips[unit linked insurance plans] and other life insurance products are offered as the top investment options by relationship managers in all banks.”
Given this lack of commission on inflation indexed bonds, it is unlikely that banks will ever get around to selling them to their customers. The new pension scheme(NPS) is an example of another excellent product which is there in the market, but practically no bank pushes it because they barely make any commission on it.
Hence, if the inflation indexed bonds are to take off, then the commissions that are offered by insurance companies on investment plans masquerading as insurance, need to be brought down further. The question is whether the government will get around to doing this?
While commissions offered by insurance companies have fallen over the years, but they still remain higher than the commissions offered on almost all other financial products. This ensures that banks and other financial firms are interested in only selling insurance.
The government is unlikely to cut commissions any further given that it needs the Life Insurance Corporation(LIC) of India to help finance its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends. . A large portion of the money raised by LIC is used to buy government bonds. This helps the government finance its fiscal deficit easily.
The government also uses LIC to bailout its disinvestment programme. The government sells shares in public sector enterprises to help finance the fiscal deficit. On several occasions, stock market investors do not want to invest in these shares. On such occasions, LIC is directed to pick up these shares.
Hence, the government needs LIC to finance its fiscal deficit. The LIC needs to keep selling more and more insurance policies. And for that to happen, it needs to keep offering a high rate of commission to its agents all over the country.
This is the major reason why Raghuram Rajan’s grand plan of getting Indians to invest in inflation indexed bonds instead of gold, will not take off. It will take off only when insurance commissions are brought in line with commissions on offer on other financial products, so that banks and investment advisers are interested in selling a product that is best for their customer rather than the product which offers the highest commission. And that will happen only when the fiscal deficit is under some sort of control.
The article was published on www.firstpost.com on January 6, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Month: January 2014
Dos and Don'ts of Managing a Crisis
Thomas DeLong
A crisis can destroy an organization if the organization does not respond appropriately. During a crisis or a low growth environment, organizations fall apart, unless they have a few leaders who have the courage to be transparent and set an example. The irony, though, is that I see over and over again that companies and leaders are not honest with their employees. We don’t talk. We don’t give feedback. And we simply don’t have the courage to have an honest conversation.
The typical behaviour during a crisis is to blame other people for all of our problems rather than looking for our contribution to the problems. I think this is true all over the world. This is because of the dilemma that we have. Leaders allow their insecurities to build. They don’t share the challenges they’re facing, nor do they sit down and sort out their disagreements. They go around blaming each other, which does nothing but create more dishonesty between them.
So what can companies and leaders do about this? Number one: Set clear goals and include your management in those conversations as opposed to being autocratic. The second thing is to execute the goals that you set and hold those people accountable for it. In too many organisations I see people being held accountable without ever being specifically told what they are responsible for. The third thing is to communicate more and become less secretive. Leaders need to have conversations when problems are small instead of waiting for them to become too large. They should have an open door policy for managers who report to them in an effort to prevent this type of build-up. It is very important to for leaders to take more feedback when times are tough, not less. It is about asking questions rather than having all the answers.
Take the case of Harsh Mariwala of Marico. He used to hold quarterly meetings with his leadership team in which they had conversations with each other around what each person could do to be better. It is important to conduct this sort of meeting as a group so that the group becomes more supportive and does not fall apart. Mariwala is a role model for the kind of transparency that we should have in organizations. These organizations are the ones that will leverage the crisis and not only learn from it, but get to a very different place in a positive way.
Phil Daniels, a psychology professor I had in graduate school, taught us about a feedback mechanism which he used to call the SKS form. It was a very simple process where we would ask others what we should start (S), keep (K), and stop (S) doing. The form is designed to be sharp and clear. People have to express themselves in three bullet points under each subhead. I have introduced this system of evaluation in universities as well as in appraisals on Wall Street. It helps leaders anchor themselves in reality and stop having any illusions and living in a fantasy world.
In times of low growth, leaders are not feeling the best about themselves and wouldn’t want to solicit feedback. Typically they would have enough excuses ready not to take feedback. This leads to a situation where leaders start believing that there is no real need to learn what views other people in the organization have at that point in time. Nor do they get around to asking for help when they need it. The SKS form breaks that kind of thinking. I believe even negative feedback can be satisfying. It is rarely as bad as we expect it to be and it tells us very clearly exactly where we are and what we need to work on. Once a leader is armed with clarity, he or she can work more effectively with a greater sense of purpose.
The final point is, do employees have faith in the management? If I look at my boss, do I say to myself that I have faith in this person? Is this person spending time and mentoring me? Am I growing and developing because of this person? Typically what happens in tough times is that leaders are too busy trying to achieve their numbers. So they think they don’t have the time to mentor, and instead try to outsource the activity to someone else. This is when the whole culture starts to break down.
Many leaders do not realize the importance of mentoring, especially in times of crisis. In such times, young professionals who work in an organization start to see themselves as free agents, and jump jobs as soon as the first good offer comes along. Still others leave to maintain a work-life balance. Employees regularly complain that leaders do not spend time mentoring them, and leaders don’t think they should spend time and energy mentoring people who are going to leave anyway.
In an economic downturn leaders and managers simply focus on the bottom-line and they forget about human capital issues because they don’t have the time to deal with them. They ignore their own culture. They become path driven, which is important, but they forget the human dimension. One of the first things that happens is that employees are laid off. This occurs because too many leaders are not aware of the culture of the organization or the implications of letting people go. They are myopic and short-sighted. More often than not it’s the lower and middle levels of the organization that have to bear the brunt of these firings. As individuals rise through an organization and become leaders, they intuitively, without knowing it, protect themselves.
But any transformation has to take place at all levels. It isn’t about letting go of the individuals at the lowest level on the rung. It is about making changes throughout. All that firing does is create cynicism and frustration throughout the organization. Leaders who remain protect their own security.
It doesn’t need to happen that way. I am writing a Harvard Business School case right now about the pharmaceutical company, Novartis. They wanted to do better in the US market. They knew that they had to re-envision their strategy. At the same time, they looked at their structure and how they were going to organise the business differently. They had to rethink what their capabilities were.
They did a very effective job in managing business, strategy and creating new systems, all simultaneously. One of the side effects was a reduction in force. However, because everything was done in a very systematic, thoughtful manner Novartis was able to engage those who stayed in a dramatic way. They built greater trust because of the way in which they went about the transformation. If the only variable that you change is the number of employees, there is going to be a problem.
For me, the head of human resources in an organization is the CEO. A CEO is responsible for human capital. But too many human resource departments are seen as law enforcement as opposed to being partners to the CEO. Too often HR departments are seen as spies for the leaders rather than as strategic partners. If HR is only used to police and help reduce the number of employees there will be no trust whatsoever with the HR department.
To conclude, here are a few tips about what employees should do in a low growth or recessionary environment. Number one: They need to have their own personal agenda or goals. Number two: They need to set up systematic communication with their managers, whether it is feedback or two way communication. Number three: They need to know what their capabilities are. Number four: They need to decide whether they are putting the company first or putting their own personal well-being first. I think the final point is that, at the end of the day, individuals are responsible for their own careers.
The article originally appeared in the Business Today edition dated January 19, 2014
As told to Vivek Kaul
(Thomas J. DeLong is the Philip J. Stomberg Professor of Management Practice in the Organizational Behavior area at the Harvard Business School. Before joining the Harvard Faculty, DeLong was Chief Development Officer and Managing Director of Morgan Stanley Group, Inc., where he was responsible for the firm’s human capital and focused on issues of organizational strategy and organizational change. He is also the author of Flying Without a Net: Turn Fear of Change into Fuel for Success (Harvard Business School Press, 2011), which centers on the challenges of helping talented professionals who are resistant to change.)
Blend Offence and Defence
Ranjay Gulati
In the middle of the 2008 recession I spoke to the leadership team of a large company and asked them how many of their units were facing budget cuts?
So they all laughed nervously and raised their hands. I then asked how many of them had seen their budgets increase? And they laughed again and this time no one raised their hands.
I then asked them if this situation was good or bad? They did not understand my question and responded with a puzzled look. I said, let me explain.
If you are not increasing your spending in any domain at this time then it means you are not sowing the seeds for future expansion. You are not going after anything. Instead, what you are doing is falling into the trap most businesses fall into when the going gets tough, which is to simply play defence and cut back across the board with the intention that we must live to fight another day. All this is in the face of evidence that perhaps the best time to leap frog competition is when markets are down and not up. And yet, we back away precisely at the time when we should not be doing so. The point I was trying to make was that the thought that they should be going after markets or attacking competition, just hadn’t crossed their minds.
Then I took a step further and asked them, who is in charge of budget cuts at this time? And everyone pointed to the finance function. I said if finance is responsible for the allocation of scarce resources, a question to ponder is what do they know about customers and markets and what customers want or don’t want? Furthermore, the preferred approach for budget cuts was the proverbial cheese slicer approach where each unit was impacted equally. In doing so, they were now allocating their limited resources with limited knowledge of customers or markets.
If we look at this example very objectively, there is something terribly wrong here. The company was not attacking their market in an environment where everyone else was not doing so either. And the person/division of the company that was cutting back had no idea what the customers wanted.
I think the realisation here is that in a low growth and turbulent environment most companies go into pure defence, where the entire focus is on how do we survive and wait to fight another day. The only thing the companies can think about is cutting back on costs. But does this really work?
I along with my Nitin Nohria (of the Harvard Business School) and Franz Wohlgezogen (of the Kellog School of Management) wrote a piece titled Roaring Out of Recession for the Harvard Business Review, which was published in 2010.
In this piece we looked at corporate performance during the past three global recessions: the 1980 crisis (which lasted from 1980 to 1982), the 1990 slowdown (1990 to 1991), and the 2000 bust (2000 to 2002). We looked at 4,700 public companies and studied their performance in three periods: the three years before a recession, the three years after, and the recession years themselves.
And the results were rather interesting, which went against conventional wisdom. Companies that focus on cutting costs and cut costs faster than competition don’t necessarily flourish when the recession gets over. In fact, we found that only 21% of such companies did better than competition when times got better.
An excellent example of this is Sony, which announced a cost reduction target of $2.6 billion in December 2008. The company planned to close several factories, fire employees and delay investments into newer technologies, as a part of the plan.
This strategy was similar to the one followed by the company during the 2000 downturn, when the company cut its workforce by 11%, its R&D expenditures by 12%, and its capital expenditures by 23%, over a two year period. This helped the company increase its profit margins briefly, but sales tumbled.
While Sony managed to boost its profits briefly, it has struggled to retain momentum since then. It has tried developing new products like electronic book readers, but these markets have been taken over by swifter rivals like Amazon.
The trouble with concentrating totally on cost cutting during a recessionary or a low growth environment is that managers approach every decision from a lens of minimising costs. The other thing that happens is that those responsible for resource allocation decisions frequently have no idea of either the customers or the various markets the company operates in, and prefer to make across the board cost cuts. This leads to the company paying no attention to initiatives which might lead to future growth.
Also, it is worth remembering that there is a collective paradox here: when everyone is playing defence, what should you be doing?
But pure offence does not work either. Being overly aggressive during a recession, and ignoring early warning signs like customers clamouring for lower prices, is not viable either. In fact, we found in our research that such firms stand only a 26% chance of becoming leaders after the downturn has ended.
An excellent example of a company that became a victim of being too aggressive in a recession is Hewlett-Packard. At the height of the recession that followed the dotcom bust in 2000, the company under the leadership of Carly Fiorina, drew up an ambitious change agenda. As Fiorina put it “In blackjack, you double down when you have an increasing probability of winning. We’re going to double down.”
Among other things, the company bought Compaq for $25 billion, spent $200 million on corporate branding and also went about spending $1 billion on expanding the availability of information technology in developing countries. These initiatives strained the organisation and spread its resources too thin. After the recession ended, and growth returned, the company couldn’t match the profitability levels of its competitors like IBM or Dell.
So pure offence does not work and neither does pure defence. What works is being able to selectively blend both. The key is how do you learn to play defence and offence at the same time. What you do is you say that I am going to cut back more than I need to do in some areas and I am going to expand in some areas. The trick is to learn how to spend more by spending less.
What I am proposing is a zero budget answer. In order to spend more you have to spend less. Before you can spend more you have to figure out what are the things that you are doing that do not add any value to the customer. And you will be amazed how many inefficiencies actually pop up. Taking a disciplined approach to resource allocation that is informed by a deep understanding of what customers value or not become the key to success. Cost cutting has to be done in a disciplined methodical way because its remarkable how many things organisations do that are not value adding to customers. So that is the starting point.
But politically it is very challenging to do this in an organisation. Are you going to tell three people that I am cutting back your budget and then tell one person that I am increasing your budget? Instead many organizations prefer an egalitarian way, where we want to share the pain equally. Everybody gets to cut back on their budgets equally.
A deeper issue that holds back organizations from leveraging such opportunities is their inability to truly engage with their customers and markets. Something that should be the foundation of every business of being customer centric doesn’t materialize very easily. And the problem isn’t usually the lack of market knowledge. Its usually embedded in the organization itself. The devil here is inside and not outside the organization! Most large organisations are built around production and distribution. You organise around product to make sure that you are intensely focused on developing and selling outstanding products. You organise around geography to be able to effectively distribute those products. And you add into this mix your functional organization that is created to be efficient and build deep expertise within key functions. But somewhere in this whole equation the customer gets lost. The bureaucratic morass here impedes are abilty to operate in concert to take on difficult markets.
Very few companies master the skill of playing offence and defence and doing so in a way that is centreed around their customers. In our research we found that only 9% of all companies came out of a recession stronger than before. These chosen few outperformed industry rivals by at least 10% in terms of sales and profits.
These select few companies re-examined almost every aspect of their business model. They looked at how they have configured supply chains and structured/reduced their operating costs on a permanent basis. This ensured that when demand came back again, their profits grew faster than their competitors. Also, money that was saved in one area was invested in another area.
A good example of this is Staples, an American office supply chain store , and how it withstood the 2000 recession. It closed down many underperforming facilities but at the same time increased its work force by 10%, in order to support the high product categories and services it introduced. The company also contained its operating costs and came out of the recession much stronger and more profitable.
The sales of the company more than doubled from $7.1 billion in 1997 to $14.6 billion in 2003. In comparison, the sales of Office Depot, another office supply company, went up by about 50% from $8.7 billion to $13.4 billion, during the same period. In fact, Staples was 30% more profitable than Office Depot in the period of three years that followed the recession.
To conclude, I would say you never want to waste a good recession. But the only way you don’t waste a good recession is if you realise that you need to use this to leapfrog everybody else. Getting ahead of competition during an up market is much harder. If you are wasting a recession you are wasting an opportunity.
Ranjay Gulati is the Jaime and Josefina Chua Tiampo Professor, the Unit Head of the Organizational Behavior Unit, and the Chair of the Advanced Management Program at Harvard Business School. He is also the author of Reorganize for Resilience: Putting Customers at the Center of Your Organization (Harvard Business Press, 2009)
The column originally appeared in the Business Today edition dated January 19, 2014
(As told to Vivek Kaul)
India: The Siege Within
Satyajit 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)
Why equality is better for all
Tim Harford
Inequality is become a hot topic – but what’s really going on? Let’s start with looking at rich countries. The figures vary depending on who is measuring, and when, but France’s Gini coefficient is around 33 per cent, Finland’s 27 per cent, and it was 34 per cent in the UK and 45 per cent in the US. To put this in perspective, a Gini of 0 implies total equality of incomes; a Gini of 100 per cent means that one person has all the dough.
Then let’s move to Brazil, China and India – often lumped together, especially by European and American analysts, but of course they are hugely different in many ways.
Brazil is a notoriously unequal society, so one might expect it to have a very high Gini coefficient. The CIA’s World Factbook reported that the Gini coefficient for Brazil was 61 per cent in 1998 – the sort of extreme inequality that we might expect, given the country’s reputation.
But here’s the thing: Brazil’s Gini is now down to 52 per cent. That’s still high but it’s a big fall, a quarter of the way to becoming ultra-egalitarian Finland in just fifteen years. It shows that in the right circumstances inequality can be tackled: Lula da Silva, the Brazilian President from 2003 to 2010, was regarded as a revolutionary firebrand when elected, but turned into a pragmatist who was happy to court international business investment, yet was keen to redistribute some of the rewards of Brazil’s commodity boom.
China is still ostensibly a communist country, but it is rapidly taking over from Brazil as the poster child for income contrasts. The CIA Factbook puts the Gini coefficient there at 48 per cent. That is already higher than the level in the United States, and given that China is still much poorer than the US, such income inequality implies tremendous hardship for poorer families. A more recent study found a Gini coefficient of 61, which if true is pretty serious. No wonder China’s leaders are nervous about social unrest, even though the country is still growing very quickly indeed.
Finally, India. India’s gini coefficient is in the high 30s and seems stable at that level. Notorious examples of glaring inequality, such as Mukesh Ambani’s billion-dollar house, towering at the height of a forty story building over Mumbai, turn out to be the exceptions, not the rule.
Should we conclude that all is well in India, then? Not necessarily. The latest concept in inequality economics is the “inequality possibility frontier”. Here’s a way to think about it: in a pure subsistence society, significant inequality is impossible: if resources are unevenly distributed then people will simply starve. The richer a country gets, the greater the proportion of resources that could, in principle, go to a small number of people – and so the more unequal it could become.
There’s every reason to believe that India’s levels of income inequality, already above European levels, are just foretaste of a winner-take-all society to come.
But Indian policymakers must not panic. Consider the attitude summed up by China’s first great economic reformist, Deng Xiaoping, who took power in 1978 following the end of the Maoist era. One of his much-quoted maxims was ‘Rang yi bu fen ren xian fu qi lai,’ or ‘Let some people get rich first’.
Deng had a point. Economic growth isn’t a steady automatic accretion of wealth – it comes from tearing up old ways of doing things and replacing them with something new. This process of creative destruction is highly likely to create some inequalities in the short term. China’s growth model has been very experimental, loosening different restrictions on different industries in different parts of the country – and in particular creating globalisation-friendly industrial zones on the coast. It is almost inevitable that such experiments, if successful, would produce winners and losers. (If unsuccessful, of course, they produce only losers.) Not everywhere can develop at the same rate.
India is going to have to embrace similar experiments and inevitably, inequality will be the result. What, then, is the right response?
The first is to give some space for Indian business to grow. The World Bank’s “Doing Business” project uses standardised case studies to measure regulatory burdens; it currently rates India 134 out of 189 economies – and slipping down the rankings. Obviously the rule of law is necessary and businesses cannot be entirely untouched by government, but there is clearly tremendous room for improvement in making it simpler and cheaper to set up a legal business, register property or get a construction permit. It can hardly be a surprise that India’s growth industries have been those that were hard even for government officials to imagine existing – and of course if you cannot be imagined you can fly under the radar until you’re big enough to defend yourself.
The second is to focus on primary education to help equip India’s people to take advantage of new economic opportunity. India’s very best universities are legendary. India’s primary and secondary education does not enjoy the same glowing reputation.
The third element is to improve social programmes, to make them as generous as possible within the resources of the Indian state, and – importantly – to target them better. I am no expert on the Indian welfare state but the stories I am told are of waste, duplication, and fraud. This is a triple tragedy: people who desperately need help aren’t getting it; the state is spending money it cannot afford on people who may need no help at all; and the welfare state, which should be a bedrock of any developed economy, is discredited.
I’m fascinated by the possibilities of direct cash transfers. Recent randomised trials of cash handouts to low-income entrepreneurs in Sri Lanka after the 2004 Tsunami, of to poor women in post-conflict Uganda, and even to homeless petty criminals in Liberia, suggest good results. At a bare minimum the money tends to be spent on useful consumption – buying food and clothes rather than alcohol and drugs. In many cases is used to buy investment goods with excellent rates of return. In most cases the most effective welfare program is going to be not free rice or milk, but cash.
The question, then, is how to distribute that cash properly in India. Mobile phone networks are starting to make electronic transfers feasible, but a fundamental issue is identifying the correct recipient. It’s encouraging to see India pioneering an ID system for the entire population – a massive social, institutional and technological challenge. I’d like to point to examples elsewhere in the world of this kind of system being used successfully, but the truth is that the scale and ambition of India’s ID program is utterly unprecedented. Well-wishers across the world are watching and hoping that it will work.
Of course, some people ask why inequality matters. Who cares if the super-rich are getting super-richer, as long as the poorest are enjoying some increase in living standards too? I have a degree of sympathy with this view: certainly I am not someone who thinks it’s intrinsically harmful for Mukesh Ambani to get a little bit richer, as long as this is at nobody else’s expense. My priority is poverty rather than inequality itself.
But that said, I don’t think we can dismiss inequality entirely. For one thing, the money now accruing to the richest members of societies across the world is not trivial. The vast majority of income gains in the United States, for instance, have gone to the richest, leaving the majority of Americans suffering very limited growth in their incomes for the last thirty years or so. That’s not to say that the rich “stole” the money – economic growth doesn’t work like that. But it does make the point that the sums involved are very substantial. It’s not just a matter of envy.
There is some research suggesting that inequality has harmful effects on crime, mental health and growth. I don’t find it totally convincing – but one has to consider it a risk. Some intriguing recent research from the IMF suggested that when countries enjoyed episodes of strong growth, those episodes were more likely to end quickly in highly unequal societies. One possible explanation of these tendencies is the political economy of highly unequal states. The more unequal a society, the more resources an oligarchic elite can deploy to seize political control and defend their wealth. Oligarchs don’t like free markets: they like barriers to entry provided by political cover. Even the relatively saintly Bill Gates, who has devoted much of his fortune to economic development, built his billions on the back of his (perfectly legal) monopoly of the Windows system, backed up by global intellectual property law.
Many other plutocrats have less laudable intentions and rather starker ways to maintain their wealth. Look at China. Almost one in ten of China’s richest thousand people sit in the National People’s Congress – a body of almost three thousand lawmakers. Their average net worth is four times the average net worth of the richest politicians in the US Congress, despite the fact that the US itself is a far wealthier nation. Many people worry that the US is subject to too much influence from plutocrats; if that is true then the situation in China looks even worse.
At the very least one must recognise that there’s likely to be some degree of redistribution from the rich to the poor that will improve welfare as a whole.
A final point: inequality isn’t just a case of the super-rich versus the super-poor. It has an impact on the middle classes too, and the way we conduct ourselves. I count myself as middle class and I expect most people reading this article see themselves the same way, so I hope they empathise with my position. The more unequal the society that surrounds us, the higher the stakes: the more we have to invest in giving our children that tiny extra advantage, or to defend ourselves from crime.
We find ourselves devoting disproportionate effort to choosing the perfect neighbourhood, school, or tutor. More equal societies – we look with admiration at Denmark, Finland and Sweden – have lower stakes. Middle class families relax, knowing that any school is likely to be good, and that the gap between the highest achiever and the also-ran is not so very great. The tragedy of inequality for the poor is obvious to all. But inequality is also a prison for the middle classes – we find ourselves trying to run up an escalator that is always, albeit gently, threatening to drag us downwards. No society can be truly prosperous unless people feel a sense that their economic lives are secure. That is something to which India – and every country around the world – should aspire.
(Tim Harford is an economist, journalist and broadcaster. He is the author of “The Undercover Economist Strikes Back” and the million-selling “The Undercover Economist” and a senior columnist at the Financial Times)
This as told to column originally appeared in the Business Today edition dated January 19, 2014
(as told to Vivek Kaul)