India’s Investment Conundrum

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The Economic Survey released by the ministry of finance every year before the budget is by far the best document on the ‘real’ state of the Indian economy. The latest Economic Survey released in late January, discusses the poor state of investment in India in great detail.

The investment to gross domestic product (GDP) ratio (a measure what part of the overall economy does investment form) peaked in 2007 at 35.6%. It has been falling ever since and in 2017, it had stood at 26.4%. No other country in the world has gone through such a huge investment bust, during the same period, the Survey suggests.

Further, the Survey remains pessimistic about whether India will be able to bounce back from here. For one, India’s investment slowdown is not yet over. As the Survey puts it: “Cross -country evidence indicates a notable absence of automatic bounce-backs from investment slowdowns. The deeper the slowdown, the slower and shallower the recovery.”

Evidence from other countries which have gone through a similar investment slowdown seems to suggest that a full recovery rarely happens. Further, a fall in private investment accounts for a bulk of the investment decline. This is something that can be seen from the fact that new projects announcement in the period of three months ending December 2017, came in at a 13-year low (as per data from Centre for Monitoring Indian Economy).

A fall in the investment to GDP ratio also suggests that enough jobs and employment opportunities are not be created. A recent estimate made by the Centre for Monitoring Indian Economy suggests that in 2017, two million jobs were created for 11.5 million Indians who joined the labour force during the year.

With sufficient jobs and employment opportunities not going around, it has impacted the earning capacity of many Indians, especially, the one million Indians entering the workforce every month.

Ultimately, enough jobs and employment opportunities not being created has translated itself into a lack of growth on the consumer demand front. This can be seen in the capacity utilisation of manufacturing firms which has varied between 70-72% for a while now. This lack of consumer demand has finally translated into falling corporate profits, over the last decade.

Take a look at Figure 1.

Figure 1:
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Source: Economic Survey 2017-2018.

Figure 1 plots the corporate profits as a proportion of the GDP since 2008. The Indian profits are represented by the blue line, which has gone down. As the Economic Survey points out: “India’s current corporate earnings/GDP ratio has been sliding… falling to just 3½ percent.” Indian corporate profits have halved since 2008. This is a clear impact of a falling investment to GDP ratio.

Of course, no relationship in economics can be totally linear.

A falling investment rate leads to fewer jobs and employment opportunities, in turn leading to lower consumer demand and lower corporate profits.

Lower consumer demand obviously has a negative impact on the investment rate, which again has an impact on jobs, employment opportunities and corporates profits. And so the cycle works.

John Maynard Keynes, in the aftermath of the Great Depression of 1929, had suggested that when the private sector is not investing, the government needs to step in, up the ante, spend money and create consumer demand.

One of the best sectors to invest in, in order to create demand is housing. The sector has many forward and backward linkages, which can have a huge multiplier effect. As the finance minister Arun Jaitley said in his budget speech: “Under Prime Minister Awas Scheme Rural, 51 lakhs houses in year 2017-18 and 51 lakh houses during 2018-19 which is more than one crore houses will be constructed exclusively in rural areas. In urban areas the assistance has been sanctioned to construct 37 lakh houses.” A few months back, the government had announced a huge road building programme as well.

These programmes will definitely help. But the government can only do so much, given the fact that India’s investment to GDP ratio has been falling for more than a decade. The government doesn’t have access to an unlimited amount of money, and the private sector needs to start investing if the investment rate has to revive.

The private sector won’t do so, at least not immediately, because of a lack of consumer demand and also because it is just coming out of a huge borrowing binge. The government can only facilitate this situation by pushing through ease of doing business at every level.

As Jaitley said in his speech: “To carry the business reforms for ease of doing business deeper and in every State of India, the Government of India has identified 372 specific business reform actions.” These reforms need to be quickly implemented, if there has to be any hope of breaking India’s investment conundrum.

The column originally appeared in Daily News and Analysis on February 13, 2018.

The Republic at 69 and the next seven decades

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India has been independent for more than 70 years and a republic for 68 years. Between 1950, the year, the country became a republic and 1991, the year, the government initiated economic reforms, the economic size of the country became five times.

By 2014, the economic size of the country was 4.2 times of what it was in 1991. I am forced to stop this comparison at 2014 because India adopted a new GDP series in January 2015 and the GDP data in that series is available only from 2011-2012 onwards.
The differentiating point between pre and post 1991 eras, is that the economic growth has been faster post 1991. There is no denying that this economic growth has had huge benefits.

At the same time, it has created its own set of problems as well. In 1990, as per the World Inequality Report 2018, the top 10 % of India’s population earned around 34 % of the national income. By 2016, this had jumped to 55 %. This rise in inequality has happened because the upper echelons of the society have benefitted more from the economic reforms of 1991.

As can be seen from Figure 1, India along with Brazil, have the highest concentration of wealth in the world, after the Middle East. In purchasing power terms, the per capita income of Brazil is 2.3 times that of India.

Figure 1:
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Source: World Inequality Report 2018.

Inequality is not the only reason to worry about on the economic front. For years, the story of India’s demographic dividend has been sold to the world. Demographic dividend is a period of few decades in the lifecycle of a nation where it’s workforce increases at a faster pace than its overall population. As these individuals enter the workforce, find jobs, earn and spend money, the economy grows at a faster pace and pulls out many people out of poverty.

At least that is how things are supposed to work in theory. Around a million Indians are joining the workforce every month. This is expected to continue for the next decade and a half. The trouble is that there aren’t enough jobs going around. A recent estimate made by the Centre for Monitoring Indian Economy suggests that in 2017, two million jobs were created for 11.5 millions Indians who joined the labour force during the year.

There are other data points also which suggest a lack of jobs. The investment to gross domestic product ratio has been falling for a while now. The capacity utilisation rate of manufacturing firms has stagnated between 70 and 72%. If existing capacities are not being used, there is no reason for firms to expand and create jobs.

Labour intensive export sectors like apparels, gems and jewellery, leather, agriculture etc., have remained flat, over the last few years. Real estate and construction, two sectors which have tremendous potential to create jobs which cater to India’s cheap and largely unskilled labour, are down in the dumps.

For many, agriculture is no longer economically feasible. A discussion paper recently published by NITI Aayog suggests that agriculture contributes 39% of rural economic output, while employing 64 % of the workforce. For agriculture to be economically feasible nearly 8.4 crore individuals need to be moved out of it. This unfeasibility of agriculture has also resulted in landowning castes across the country, wanting reservation in government jobs.

The education scenario continues to be depressing. Children are going to school but aren’t really learning. The latest Annual Status of Education Report (ASER) states: “For the past twelve years, ASER findings have consistently pointed… that many children in elementary school need urgent support for acquiring foundational skills like reading and basic arithmetic.” Given this, even when firms have jobs, they cannot find people with the necessary skillset.

The trouble is that skilling is not happening at the scale that it needs to. The different ministries in the government had accepted a target of training 99,35,470 individuals in 2016-2017. Of this, only 19,58,723 or around less than one-fifth had been trained up to December 2016. It isn’t fair to blame the government for this, given the huge scale required. This needs a total overhauling of our education system with a huge focus on vocational studies.

Further, the Indian firms start small and continue to remain small. Labour laws remain the major culprit on this front. The state of Jammu and Kashmir has 260 labour laws. Other estimates suggest that India has around 200 labour laws in total. A very serious effort is needed at the government’s level to improve, the ease of doing business.

All in all, the scenario that prevails for India’s demographic dividend, is very bleak. And it is this demographic dividend which is expected to take us forward for the next seven decades.

The column originally appeared in the Daily News and Analysis, on January 26, 2018.

It’s Surprising That More People Aren’t’ Moving to Urban India

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Filmstar and member of parliament, Hema Malini, blamed the recent Kamala Mills fire tragedy, on India’s population and migrants. She was quoted in a Zee News report as saying: “The population is so high. When Mumbai ends, another city should begin. But the city keeps extending. Uncontrollable… The administration has allowed every migrant to live in the city. However, looking at the wide population in the city, the authorities should have brought in some restrictions here to control the population.”

Of course, migration and population, had nothing to do with the Kamala Mills fire. It had everything to do with the collapse of governance that Mumbai (or for that matter most Indian cities) has seen over the years.

Having said that migration is a huge issue that many Indian cities are facing. In fact, as a recent discussion paper titled Changing Structure of Rural Economy of India Implications for Employment and Growth, authored by Ramesh Chand, SK Srivastava and Jaspal Singh, and published by the NITI Aayog, points out: “As per the 2011 Census, 68.8 per cent of country‟s population and 72.4 per cent of workforce resided in rural areas. However, steady transition to urbanization over the years is leading to the decline in the rural share in population, workforce and GDP of the country. Between 2001 and 2011, India‟s urban population increased by 31.8 per cent as compared to 12.18 per cent increase in the rural population. Over fifty per cent of the increase in urban population during this period was attributed to the rural-urban migration and re-classification of rural settlements into urban.”

The question is why is this happening. The answer is fairly straightforward. Agriculture, as a profession, is not as remunerative as it used to be. The average size of the land farmed by an Indian farmer has fallen over the decades and in 2010-2011, the last time the agriculture census was carried out, stood at 1.16 hectares. In 1970-1971 it had stood at 2.82 hectares. This has happened as land has been divided across generations. This fall in farm size has made farming in many parts of the country, an unviable activity, leading to the size of agriculture as a part of the economy becoming smaller and smaller, without a similar fall in the number of people who continue to be dependent on it.

In fact, the situation could have only got worse since 2010-2011, as farm sizes would have shrunk further. Further, there are states like Kerala and Bihar, where the farm sizes are smaller than the average 1.16 hectares across India.

The NITI Aayog discussion paper points out that in 2011-2012, agriculture contributed 39.2 per cent of the rural economic output, while employing 64.1 per cent of the rural workforce. In 2004-2005, agriculture had contributed 38.9 per cent of rural economic output, while employing 72.6 per cent of the rural workforce.

What this basically means is that between 2004 and 2012, many rural workers essentially moved away from agriculture to other areas. Many would have migrated to cities for better opportunities as well.

What it also shows is that way too many people continue to remain dependent on agriculture. The sector has what economists refer to as huge disguised unemployment. If we look at the national level, agriculture contributes around 12 per cent of the gross domestic product (a measure of economic output), while employing 47 per cent of the workforce.

This clearly means that those working in agriculture are worse off than those not working in agriculture. In fact, the NITI Aayog discussion paper points out that the average urban worker made around 8.3 times the money an average agricultural worker does. The average urban worker makes 3.7 times the money an average cultivator does.
Given this, huge difference in income, it is not surprising that people want to migrate from villages to cities. Another data point that adds to this trend is the fact that only around half of the rural workforce looking for a job all through the year, is able to find one. In urban India, this is more than 80 per cent.

Given this, many people need to be moved from agriculture into other activities. The NITI Aayog discussion paper points out: “To match employment share with output share of agriculture another 84 million agricultural workers are required to quit agriculture and join more productive non-farm sectors. This amounts to about 70 per cent increase in the non-farm jobs in rural areas.”

What all these factors come together to tell us is that it is surprising that more people not moving to urban areas from rural areas, given the huge difference of income between rural and urban workers and the fact that there is a huge disguised unemployment in agriculture. Given the limitation of data (with the Census only being carried out once every 10 years), we will come to know the real situation only once the next census is carried out in 2021. But seeing how things are currently, it is safe to say that more people will move from rural to urban areas, than was the case in the past.

The column originally appeared in Daily News and Analysis on January 7, 2018.

No shortcuts to solving India’s job crisis

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In the recent past, India’s jobs crisis has come to the fore. There is no specific reason for it, given that India has had a jobs crisis for a while now, with the media discovering it only recently.

As per the OECD Economic Survey on India released earlier this year, close to 30 per cent of India’s youth (individuals in the age group 15-29) are neither employed nor in education or training. Data from the Labour Bureau suggests that only three out of five Indians who are looking for job all through the year, find one. In rural India, only half of the individuals looking for a job all through the year, are able to find one.

Long story short—India has a jobs crisis. And it has been there for a while, despite the media discovering it only recently.

Arvind Panagariya, while he was the Vice-Chairman of the Niti Aayog, was asked on more than a few occasions, on why India had a jobs problem. As late as August 25, 2017, around a week before his term at the Niti Aayog came to an end, he remarked: “The major impediment in job creation is that our entrepreneurs simply do not invest in labour intensive activities.”

It’s not fair to blame just the entrepreneurs. An entrepreneur will go in areas where he sees value and in the process if he ends up creating jobs, then so be it. The bigger question is why have entrepreneurs stayed away from labour intensive activities.
Given India’s population, the country’s natural comparative advantage should have been in large-scale, labour intensive manufacturing. But the sectors like automobiles, engineering goods, pharmaceuticals and software, where we have done well, are both capital and skilled labour intensive.

As far as labour intensive sectors like apparels, food-processing and footwear, are concerned, these sectors haven’t really progressed in India. Let’s take the case of apparels. This is a hugely labour-intensive sector. As per an estimate made in the Economic Survey, the sector creates nearly 24 jobs for every lakh of investment. This is a sector which is 80-fold more labour intensive than automobiles and 240-fold more labour intensive than steel.

Apparel exports grew rapidly in the East Asian economies and pulled them out of poverty. As the Economic Survey points out: “The average annual growth of apparel exports was over 20 per cent, with some close to 50 per cent.” In the Indian case textiles and readymade garments exports have more or less stayed flat between 2013-2014 and 2016-2017.

The question is why? The labour costs in India are similar to that of Bangladesh, but cheaper than that of Indonesia, Vietnam and China. But the logistic costs are the highest in India at $7 per kilometre of road transport (to be able to get the merchandise to the ports from where it can be exported).

The logistic costs in China are at $2.4-2.5 per kilometre. In Bangladesh they are at $3.9 per kilometre. In Vietnam, the logistics costs are the same that as of India, but delivery to the east cost of the United States takes 14 days. It takes anywhere between 21 to 28 days from India.  The turnaround time is greater in case of India.

What does not help is the fact that most Indian apparel firms are very small. As per the Ease of Doing Business—An Enterprise Survey of Indian States close to 85 per cent of the firms employ less than eight workers.

As the Survey points out: “At one extreme, enterprises with less than eight work­ers employ more than four-fifths of the apparel work­force in India and less than 1% in China. At the other extreme, nearly 57% of the workforce in China is in enterprises larger than 200 workers but barely 5% in India. The Chinese apparel industry is highly compet­itive with $187 billion in exports compared with just $18 billion for India in 2014.” Hence, the ability of Indian firms to execute large orders is limited.

The apparels sector, which has the potential to create a huge number of jobs, hasn’t been creating them. Most firms in this sector, start small and continue to remain small. One reason for this lies in the fact that historically, labour intensive sectors in India came under small scale industries up until 2000. Clearly, the historical hangover persists.

As the Enterprise Survey of Indian States points out: “The largest enterpris­es—employing more than 200 people—are mostly concentrated in industries like manufacturing of mo­tor vehicles, trailers, transport equipment, pharma­ceuticals and textiles.”

The question is why do firms in labour intensive sectors start small and continue to remain small. The answer to this question lies in something that Jagdish Bhagwati and Arvind Panagariya wrote in India’s Tryst with Destiny: “The costs due to labour legislations rise progressively in discrete steps at seven, ten, twenty, fifty and 100 workers. As the firm size rises from six regular workers towards 100, at no point between the two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra costs of satisfying these laws.”

The point here is that Pangariya knew why entrepreneurs stayed away from labour intensive sectors. Hence, economists also tend to get rhetorical once they are a part of the government.

To conclude, if the government wants to get labour intensive sectors going, then major labour law reforms are necessary. Along with that the logistics costs need to fall. And that can only happen with an improvement in physical infrastructure. There are no short cuts here, really.

The column originally appeared in DNA on Oct 26th, 2017.

The Bank Ponzi Scheme

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Every six months the Reserve Bank of India (RBI) publishes a document titled the Financial Stability Report . In the December 2011 report, it pointed out that at 55 per cent, loans to the power sector constituted a major part of the lending to the infrastructure sector. It further said that restructured loans in the power sector were on their way up.

Restructured loans are essentially loans where the borrower has been given a moratorium during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased.

This was nearly five and a half years back, and the first time the RBI admitted that there was a problem in the bank lending to the power sector. In the December 2012 report, the RBI said: “There are also early signs of corporate leverage rising among the several industrial groups with large exposure to infrastructure sectors like power.”

When translated into simple English this basically means that many big industrial groups which had taken on loans to finance power projects had borrowed more money than they would be in a position to repay.

In the years to come by, other sectors along with the power sector also became a part of the RBI commentary on loans which were likely not to be repaid in the future. In the June 2013 report, the central bank said: “Within the industrial sector, a few sub-sectors, namely; Iron & Steel, Textile, Infrastructure, Power generation and Telecommunications; have become a cause of concern.”

In the December 2013 report, the RBI said: “There are five sectors, namely, Infrastructure [of which power is a part], Iron & Steel, Textiles, Aviation and Mining which have high level of stressed advances. At system level, these five sectors together contribute around 24 percent of total advances of scheduled commercial banks, and account for around 51 per cent of their total stressed advances.”

Dear Reader, the point I am trying to make here is that the RBI knew about a crisis brewing in the industrial sector as a whole, and power and steel sector in particular, for a while. In fact, in the June 2015 report, the RBI pointed out: “the debt servicing ability of power generation companies [which are a part of the infrastructure sector] in the near term may continue to remain weak given the high leverage and weak cash flows.”

The funny thing is that while the RBI was putting out these warnings, the banks were simply ignoring them and lending more to these sectors. Between July 2014 and July 2015, banks gave out Rs 86,500 crore, or 71.5 per cent, of the Rs. 1,20,900 crore that they had lent to industry to the two most troubled sectors, namely, power and iron and steel.

What was happening here? The banks were giving new loans to the troubled companies who were not in a position to repay their debt. These new loans were being used by companies to pay off their old loans. A perfect Ponzi scheme if ever there was one. If the banks hadn’t given fresh loans, many of the companies in the power and the iron and steel sectors would have defaulted on their loans.

Hence, the banks gave these companies fresh loans in order to ensure that their loans didn’t turn into bad loans, and so, in the process, they managed to kick the can down the road. In the process, the loans outstanding to these companies grew and if they were not in a position to repay their loans 2-3 years back, there is no way they would be in a position to repay their loan now.

Many of these projects, as Raghuram Rajan put it in a November 2014 speech, “were structured up front with too little equity, sometimes borrowed by the promoter from elsewhere. And some promoters find ways to take out the equity as soon as the project gets going, so there really is no cushion when bad times hit.”

The corporates brought in too little of their own money into the project, and banks ended up over lending. Over lending also happened because many promoters in these sectors were basically crony capitalists close to politicians to whom banks couldn’t say no to.

Over and above this, the steel producers had to face falling steel prices as China dumped steel internationally. In case of power producers, plant load factors (actual electricity being produced as a proportion of total capacity) fell. Along with this, the spot prices of electricity also fell. This did not allow these companies to set high tariffs for power, required for them to generate enough money to repay loans.

All these reasons basically led to the Indian banks ending up in a mess, on the loans it gave to power and iron and steel prices.

The RBI has now put 12 stressed loan cases under the Insolvency Bankruptcy Code, in the hope of recovering bad loans from these companies. Not surprisingly, steel companies dominate the list.

The column originally appeared in the Daily News and Analysis on June 23, 2017.