Vivek Kaul
The finance minister P Chidambaram hasn’t crossed the “red line” of achieving a fiscal deficit target of 4.8% of the gross domestic product (GDP), that he had set for the government when he presented the last budget in February 2013. In fact, he has done even better and achieved a fiscal deficit of 4.6% of the GDP.
Fiscal deficit is the difference between what a government earns and what it spends, expressed as a percentage of the GDP. There are essentially three variables that are involved in calculating the number. The amount the government earns. The amount the government spends. These two numbers form the numerator and their difference is then expressed as a percentage of the GDP.
Hence, in order to achieve a targeted fiscal deficit, any of these three numbers can be manipulated. Chidambaram has worked on two of these three fronts to arrive at a fiscal deficit target of 4.6% of the GDP.
Let’s start on the expenditure front. The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government. Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government can at best delay paying subsidies. Hence, when expenditure needs to be cut, it is the asset creating planned expenditure which typically faces the axe and that is not good for the overall economy. If one looks at the numbers that is the direction they point towards.
The planned expenditure target of the government was at Rs 5,55,322 crore. The actual planned expenditure has come in at Rs 4,75,532 crore, which is close to Rs 80,000 crore or 14.4% lower. This as mentioned earlier is not a good sign.
If the government had incurred this expenditure the actual fiscal deficit would have come in at close to 5.3% of the GDP.
When it comes to non planned expenditure the target was at Rs 1,109,975 crore. It came in around 0.44% higher at Rs 1,114,902 crore. Most of the non-planned expenditure is regular in nature and hence, like planned expenditure, cannot be done away with. But there is one accounting trick that the government can resort to even on this front.
It can postpone the payment of petroleum, food and fertilizer subsidies to the next financial year. Let’s take the case of petroleum subsidies for one. Rs 65,000 crore had been allocated on this front. The actual amount spent by the government has come in at Rs 85,480 crore. Of this amount a major chunk has gone towards payment of under-recoveries from the financial year 2012-2013 (i.e. the period between April 2012 and March 2013).
Hence, the amount allocated is clearly not enough for the payment of petroleum subsidies. In fact, data from the Ministry of Petroleum and Natural Gas suggests that the oil marketing companies have reported under-recoveries of a total of Rs 1,00,632 crore during the first nine month of 2013-14 (April-December) on the sale of diesel, PDS Kerosene and cooking gas.
So clearly the amount of Rs 85,480 crore earmarked in the budget is not enough. This means that the payments that need to be made on this front have been postponed to the next year. A recent article in the Business Standard estimates that subsidies of around Rs 1,23,000 crore will be postponed to the next financial year.
These are subsidies on petroleum, food and fertilizer which should have been paid up by the government in this financial year, but will be postponed to the next financial year. The article points out that the government will need Rs 1,45,000 crore to pay up all the subsidies but is likely to sanction only around Rs 22,000 crore. This leaves a gap of Rs 1,23,000 crore which will be postponed to the next financial year, and will become a huge headache for the next government.
This essentially means that the government will not recognise expenditure when it incurs it, but only when it pays for that expenditure. This goes against the basic accounting principles, where an expenditure needs to be recognised during the period it is incurred.
Lets now look at what Chidambaram and the government have done on the government earnings front to boost that number. The government has indulged in massive asset stripping to boost its earnings. A recent estimate in the Mint newspaper suggests that since January 2014, public sector banks have announced interim dividends of Rs 27,474.4 crore.
These are banks in which the government had put in fresh capital of Rs 14,000 crore earlier in the year. So the government gives from one hand and takes away as much twice as more from another. Also, it is worth noting here that the public sector banks are currently on a very weak wicket. As Shekhar Gupta wrote in a recent column in The Indian Express “You read any of the recent data from the RBI, reputed market analysts and brokerages, economists, even from Uday Kotak on CNBC-TV18 this Thursday. You will know that the current stressed, restructured or non-performing loans in the Indian banking system amount to nearly 25 per cent of their total assets. Kotak put the aggregate at Rs 10 lakh crore out of total advances of Rs 40 lakh crore. Scared yet? He says the banks’ total write-offs over the next couple of years could be Rs 3.5-4 lakh crore. The total net worth of all banks now is about Rs 8 lakh crore. In other words, half their net worth will be wiped out.”
In trying to meet the fiscal deficit target, Chidambaram has further weakened the Indian banking system. And then there is the case of moving money from government owned companies to the government. Take the case of the Oil India Ltd and ONGC buying shares in Indian Oil Corporation worth Rs 5,000 crore, a company which is expected to lose a lot of money during the course of this financial year. Hence, no investor other than the government owned companies would have bought IOC stock.
Continuing with asset stripping, the 90% government owned Coal India Ltd, recently declared a record dividend in January of Rs 18,317.5 crore. Of this, the government will get Rs 16,485 crore, given that it owns 90% of the company. The government will also get Rs 3,100 crore, which Coal India will have to pay as dividend distribution tax. This money should actually have been used by Coal India to develop more coal mines so that India does not have to import coal, like it currently does, despite having massive coal reserves. But that of course, hasn’t happened.
The icing on the cake was the sale of telecom spectrum which made the government richer by more than Rs 61,000 crore.
It isn’t a good idea to meet regular expenditure by selling assets. How many people you know survived for long by selling their home, their car and other assets that they owned, to meet their daily expenditure? Ultimately to meet regular expenditure, regular income is needed. The sale of assets to meet current expenditure is not a great practice to follow. This is because assets once sold, cannot be re-sold.
If all these factors highlighted above are taken into account, there is no way the fiscal deficit would have come in at 4.6% of the GDP. The number is at best a joke that Chidambaram and his UPA colleagues have played on the citizens of this country.
The article originally appeared on www.firstpost.com on February 17, 2014.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Rupee
More trouble for Chidu: Fiscal deficit hits 75% of target in first 5 months
Vivek Kaul
The finance minister P Chidambaram has reiterated time and again that the government will adhere to the fiscal deficit target of Rs 5,42,499 crore or 4.8% of the GDP(gross domestic product) that it has set for itself. On September 5, 2013, he had said that the fiscal deficit target of 4.8% of GDP was a “red line and the red line will not be crossed.” Fiscal deficit is the difference between what a government earns and what it spends.
But the latest data released by the Controller General of Accounts (CGA) on September 30, 2013, shows that fiscal deficit has already reached 74.6%(or Rs 4,04,651 crore of the targeted Rs 5,42,499 crore) of the full year target, as on August 31, 2013. Hence, three fourth of the fiscal deficit target has been reached during the first five months of the financial year (i.e. the period between April 1, 2013 and August 31, 2013).
Now how does the situation look in comparison to the past data? For a period of 16 years since 1998-1999 (for which the data is publicly available on the CGA website), the average fiscal deficit for the first five months of the financial year stands at 54.2% of the annual target.
During the period of the Congress led UPA government has been in power (i.e. Since 2004-2005), the average fiscal deficit for the first five months of the financial year has been 60.4% of the annual target. Last year it was 65.7% of the annual target.
In fact, only in 2008-2009 was the number greater than this year. As on August 31, 2008, the fiscal deficit for the first five months of the financial year had already reached 87.7% of the annual target. This was the year when the Congress led UPA government was getting ready for the Lok Sabha elections which happened in April-May 2009, and hence, had gone overboard on the spending front.
The fiscal deficit in 2008-2009 was estimated to be at Rs 1,33,287 crore or 2.5% of the GDP. It finally came in at Rs 3,36,992 crore or 6% of the GDP. The point being that when the Lok Sabha elections are scheduled to happen next year, the initial estimates of the fiscal deficit can be way off the mark. Lok Sabha elections are due in May 2014 as well. Before that there are several state assembly elections as well. So, it remains to be seen whether the Congress led UPA government sticks to the fiscal deficit target of 4.8% of the GDP or goes overboard with the expenditure as it did last time when the elections were due.
What also does not help the government is a slowdown in tax revenues. As Sonal Varma of Nomura points out in a note dated September 30, 2013, “Fiscal year to date (FYTD), net tax revenue growth was muted at 4.9% year on year (versus the budget target of 19.3% year on year) due to weak indirect tax collections (excise, services, customs), while government expenditure rose 17.3% year on year FYTD, within the budget target of 18.2% year on year.”
When the revenue is growing at around one fourth of the expected rate, meeting the revenue target will be very difficult. Expenditure on the other hand continues to rise more or less at the rate assumed in the annual budget.
Given this, the government will have to make a significantly greater effort to control its expenditure, if it has to get anywhere close to meeting its fiscal deficit target. As Varma puts it “In our view, the government will have to announce another round of spending cuts to offset the fiscal slippage from slowing revenue collections and to meet its financial year 2013-2014 budgeted fiscal deficit target of 4.8% of GDP.”
The government had announced some measures to cut expenditure on September 18, 2013. A mandatory cut of 10% in non plan expenditure of all departments was announced. This did not include expenditure on interest and debt repayment, defence capital, salary, pension and grants to states. Over and above this, restrictions have been put on holding seminars/conferences as well as air travel. These measures will not be enough and more expenditure cuts will have to be put in place. In fact, when the government was in a similar but slightly better scenario last year, it simply froze spending, during the last few months of the year.
As Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley, said in a recent interview to the Forbes India magazine “We achieved the [fiscal deficit] target last year, but you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that…So can the government meet its fiscal deficit target? Of course it can. But the price in this case will be economic growth.”
Varma had written along similar lines in a note titled Government Announces Austerity Measures and dated September 18, 2013. As she wrote “The spending cuts will adversely impact growth. High government spending was one of the main drivers of real GDP growth of 4.4% year on year in Q2 2013. With spending likely to be slashed and financial conditions much tighter starting July, we expect private demand to slow down further.” And this will impact economic growth.
The other option before the government is to raise diesel prices. The under-recovery on diesel being sold by oil marketing companies(OMCs) for the fortnight starting October 1, 2013 is at Rs 10.51 litre. In the previous fortnight the under-recovery on diesel stood at Rs 14.50 litre. This fall has been primarily on account of the rupee rallying against the dollar, leading to the price of oil falling in rupee terms. Despite the fall, at Rs 10.51 per litre, the under-recovery on diesel continues to be substantially high.
The government compensates the oil marketing companies for a part of this under-recovery and this means higher expenditure for the government. The oil producing companies like ONGC and Oil India Ltd, compensate the oil marketing companies for the remaining part of the under-recovery.
If the government has to meet its fiscal deficit target it needs to bring down the under-recovery on diesel. And this can only be done by raising diesel prices significantly. Currently, the oil marketing companies increase the price of diesel by 50 paisa every month, which is clearly not enough, given that the under-recovery is greater than Rs 10 per litre.
As Sharma put it “The government will have to raise diesel prices. Currently, they are Rs 9-10 behind on under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target.”
Other than diesel, there are significant under-recoveries on cooking gas as well as kerosene. The under-recovery on cooking gas for the week starting October 1, 2013, stands at Rs 532.86 per cylinder whereas the under-recovery on kerosene is at Rs 38.32 per litre.
The government is essentially in a situation where it has to decide between either meeting the fiscal deficit target or sacrificing economic growth. If it looks like that the government will be unable to meet its fiscal deficit target then India is likely to be downgraded by rating agencies.
A sovereign downgrade will see India’s rating being reduced to ‘junk’ status. This would lead to many foreign investors like pension funds having to sell out of the Indian stock market as well as the bond market, given that they are not allowed to invest in countries which have a “junk” status.
When they sell out, they will will be paid in rupees. In order to repatriate this money, they will have to sell rupees and buy dollars. This will increase the demand for dollars and put further pressure on the rupee, in the process undoing all the damage control carried out by the RBI to prevent the rupee from falling.
A weaker rupee will mean that our oil import bill will shoot up further. We will also have to pay more for the import of coal, fertilizer etc. This will put further pressure on the fiscal deficit as the government expenditure will increase given that it currently offers subsidies on oil as well as fertilizer.
To conclude, in order to meet its fiscal deficit target the government will have to raise diesel prices and at the same time cut its expenditure dramatically, which will have an impact on economic growth. As things currently stand, it looks like the government will have to sacrifice economic growth on the altar of the fiscal deficit.
If the government does not meet its fiscal deficit target then the repercussions of that will also have a huge impact on economic growth. Hence, the choice is between the devil and the deep sea. As Franklin Roosevelt, the President of America between 1933 and 1945, put it “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.” The Congress led UPA government has been running high fiscal deficits for way too long and the negative consequences of that have started to catch up.
The article originally appeared on www.firstpost.com on October 2, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Phata Poster Nikla Zero – Why Rajan hasn't joined the party
Vivek Kaul
Raghuram Govind Rajan, the governor of the Reserve Bank of India, has refused to join the party.
The financial markets were expecting the Rajan led RBI to cut the repo rate in its Mid Quarter Monetary Policy Review. But that has not happened. Instead the repo rate has been raised by 25 basis points(one basis point is equal to one hundredth of a percentage) to 7.5%. Repo rate is the interest rate at which RBI lends to banks. Hence, the BSE Sensex has fallen by more than 500 points after the policy review was announced. As I write this it is down by around 350 points. The rupee is now quoting at 62 to a dollar, having touched 62.6 to a dollar earlier.
So now Rajan is suddenly looking like a villain after having been turned into a hero by the media over the last few weeks. As a Facebook friend quipped Phatta Poster Nikla Zero.
What Rajan has done needs to be analysed in line with the economic philosophy he believes in. A major reason for increasing the interest rate is high inflation. As the Monetary Policy Review points out “What is equally worrisome is that inflation at the retail level, measured by the CPI (consumer price inflation), has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence. Although better prospects of a robust kharifharvest will lead to some moderation in CPI inflation, there is no room for complacency.”
This statement is totally in line with Rajan’s thinking on the issue. In fact, Rajan has clearly pointed out in his earlier writings that RBI should simply concentrate on managing inflation instead of trying to do mulitple things at once.
As Rajan wrote in a 2008 article (along with Eswar Prasad) “The RBI already has a medium-term inflation objective of 5 per cent…But the central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
And given this the RBI ends up being neither here nor there. As Rajan put it “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should ‘just’focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation and intervening in currency markets only to limit excessive volatility…an exchange rate that reflects fundamentals tends not to move sharply, and serves the cause of stability.”
Currently, the RBI is trying to control inflation, accelerate economic growth and stabilise the value of the rupee, all at the same time. Something which is not possible. Rajan understands this well enough. “The RBI’s objective could be restated as low inflation, and growth consistent with the economy’s potential. They amount to essentially the same thing! But it would let the RBI off the hook for targeting the exchange rate. And that is the key point,” Rajan wrote in the 2008 article cited earlier. Given this focus on inflation, it isn’t surprising that Rajan has chosen to go against market expectations and raise the repo rate. His belief is that if inflation is brought under control, other things will sort themselves out.
Rajan is also trying to address the high current account deficit by raising the repo rate. Lets try and understand how. As the monetary policy review of the RBI points out “However, inflation is high and household financial saving is lower than desirable.” Lower savings have an impact on the current account deficit. As Atish Ghosh and Uma Ramakrishnan point out in an article on the IMF website “The current account can also be expressed as the difference between national (both public and private) savings and investment. A current account deficit may therefore reflect a low level of national savings relative to investment.”
If India does not save enough, it means it will have to borrow capital from abroad. And when these foreign borrowings need to be repaid, dollars will need to be bought. This will put pressure on the rupee and lead to its depreciation against the dollar.
This is something that Rajan said in an interview to the India Brand Equity Foundation. As he said “Current account deficit (CAD) essentially reflects the fact that you are spending more than you are saving. That’s technically the definition of the CAD, which means that you need to borrow from abroad to finance your investment. Ideally, the way you would reduce your current account deficit is by saving more, which means consuming less, buying fewer goods from abroad and importing less. Or, the other way is by investing less, because that would allow you to bridge the CAD. Now we don’t want to invest less. We have enormous investment needs. So ideally, what we want to do is save more.”
And to achieve this “the first way is for the government to cut its under-saving or its deficit.” “The second way is when the public decides to save more rather than spend. We need to encourage financial saving,” Rajan said in the interview.
The fact of the matter is that India has not been saving enough over the last few years. As the recent RBI financial stability report released in June 2013 points out “Financial savings of households…have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.”
Financial savings are essentially in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore. This has largely been on account of high inflation. Savings have been diverted into real estate and gold in the hope of earnings returns higher than the prevailing inflation.
Also people have been saving lesser as their expenditure has gone up due to high inflation. And the financial savings will only go up, if inflation comes down, pushing up the real returns on various kinds of deposits.
“Households also need stronger incentives to increase financial savings. New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability,” wrote Rajan in a column in April 2013.
Rajan has increased the repo rate hoping that bank’s and other financial institutions increase the interest rates on their deposits. This will encourage people to save more. Also, by trying to control inflation Rajan hopes that the real return on deposits (nominal return minus inflation) will go up. Once this happens, people are likely to stay away from investing in gold. If people stay away from investing in gold, it helps bring down our imports and hence, also the current account deficit. This puts lesser pressure on the rupee. The current account deficit(CAD) can also be expressed as the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
Also, as India saves more the need to borrow from abroad will come down. India’s external debt as on March 31, 2013, stood at at $ 390 billion. Of this nearly 79% debt is non government debt. External commercial borrowings(ECBs) made by corporates form nearly 31% of the external debt.
The trouble is that a lot of this external debt needs to be repaid before March 31, 2014. NRI deposits worth nearly $49 billion mature on or before March 31, 2014. Nearly $21 billion of ECBs raised by companies need to be repaid before March 31, 2014.This will mean a demand for dollars and thus further pressure on the rupee. If India’s borrowing from abroad comes down in the coming years that will mean lesser pressure on the rupee, as the demand for dollars to repay these loans will go down. But for that to happen financial savings need to go up. And that can only happen if inflation is brought under control and real returns on fixed income instruments (like deposits, bonds etc) go up.
Of course, raising the repo rate just once by 25 basis points is not enough for all this to be achieved. Hence, chances are Rajan will keep raising the repo rate in the days to come.
The article originally appeared on www.firstpost.com on September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
"Voters are wondering aloud how their “breakout nation” became a “breakdown nation"
Ruchir Sharma is the head of emerging market equities and global macro at Morgan Stanley Investment Management. He generally spends one week per month in a developing country somewhere in the world. In 2012, his book Breakout Nations – In Pursuit of the Next Economic Miraclebecame a best-seller. The paperback version of the book was recently published.
The book among other things pointed out that the most important factor behind decade long economic boom in the emerging markets, a worldwide flood of easy money, had been largely overlooked. That era of easy money is now coming to an end, believes Sharma. “My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can,” said Sharma. In this free-wheeling interview he speaks to Vivek Kaul.
Recently you wrote an article in the Foreign Policy magazine titled “The Rise of the Rest of India”, in which you talk about Indian states that have done well over the past few years. What are the factors that make for a breakout state among the Indian states?
A very simple definition is that the state has been able to consistently grow above the national average over a five to ten year period. Often you can associate that growth to some change in policy or leadership which has taken place. It is the same as the concept that I have used in my book Breakout Nations.
What is the concept of Breakout Nations?
It is about which are the countries that are likely to grow faster than the emerging market average and compared to other countries in the same income group, over a five year period. The same concept I have applied to the states in India. The question I have tried to answer is which are the states which have grown above the national average for a five to ten year period. Often this growth is associated with some leader who has to come power.
Which are the states right now you feel are the potential breakout states or have already broken out?
The states where the most impressive results have been seen are Gujarat, Bihar, Madhya Pradesh Odisha, Chhattisgarh, Delhi etc. These are the places where typically you have seen growth. The ones where the most impressive delta or change has taken place, have basically been Bihar, Odisha, Madhya Pradesh, Chhattisgarh etc. That area has done well.
What about Gujarat?
Gujarat has done well. But Gujarat was already doing well in the previous decade. Its impressive that it has done better from a higher base. Similarly for Maharashtra, growth rates have been okay, but in the last couple of years they have begun to fall. And Maharasthra is so dependent on the legacy industrial base or the whole golden triangle of Mumbai, Pune and Nashik, that I don’t know how to call it a breakout state necessarily.
Does the Indian constitution need to be re-jigged to give Indian state more economic power?
I’d say that maybe later but to me that is not the big thing. India has three lists, central, state and the concurrent list. And the big thing in India which has happened is that a lot of the issues which were in the state list and the concurrent list have been usurped by the the centre over time. And this has got to do with environment, mining, labour and even things like food. The whole culture needs to be a collaborative culture rather than the centre deciding or one leader deciding that okay these are the five things that India is going to do. We have had centralised leadership in the past. We have had the Indira Gandhi days. Now you can argue that is that what you want? Economic growth wasn’t great during that period. You can argue that it sowed the seeds of secessionist movements rather than bringing the country together. So I am not sure this heavy handed centralised leadership is what works for a country like India, where the polity is so diverse.
How can this be tackled?
The first thing you can start doing is by giving the power back to the states. India’s constitution envisaged a federal structure. It is just that over time particularly the 1970s and the 1980s, a lot of the state powers were usurped by the centre in the name of centralisation and in the name of the the secessionists taking over. Using that kind of cover, a lot of power was usurped. The whole point is that when you have national schemes, you have to give much more flexibility to the states. For example, the planning commission is now talking about 10% discretion to the states. That can be increased to 30% or 50%, rather than the criteria and the mandates being set by the centre.
In a recent column for the Financial Times you wrote “The irony is profound…Voters are wondering aloud how their “breakout nation” became a “breakdown nation”, seemingly overnight.”
That’s right.
Can states be breakout states when the country is in a breakdown mode?
Of course not. The national average is ultimately summation of the states. The only reason for optimism that I still find is that at the state level things are a bit better. State level leaders understand how to succeed in various parts of India rather than having a one size fits all national policy. Having said that, there are issues at the state level as well. Many states have their own crony capitalists. At times they are autocratic and anti democratic. But my entire point is that there is a ray of optimism.
Five years ago we were drawing straight lines stating that India’s GDP growth has been 8-9% and if it continues for 10 years where will we be. If it continues for 20 years where will we be and so on. Today it is hard to be optimistic on the country because there is so much negativity which is going around. To me the breakdown is a perception thing more than a reality.
Are there things that can be done to set it right?
One flaw to me is this culture of lack of accountability. If you look at India today the lack of accountability starts of from this whole separation of party and government. This has really been one of the fault lines of India which is that to run a country with a division between party and government is really very difficult. It fosters a culture of lack of accountability.
Could you elaborate on that?
There is this perception that has been for years now that there are something things which when you ask the people in the party, that why they are not being done, they say its the government’s responsibility to do this. And you ask the government and they tell you we don’t have the political power to do it. That lack of accountability then just flows down, with everyone being busy protecting their own turf and not taking any collective responsibility for anything. So that fault line to me for one needs to end, which is that you can’t have the separation of the party and the government. Also the fact is that if you look at the world what you see is that technocrats have not been very good as heads of states.
What do you mean by that?
They have been very good as support staff. But as heads of states if you look at Latin America and Asia, in the past, there are more examples of mass based leaders being successful. This is because reforms are political in nature. You can’t have them being administered by technocrats. Technocrats neither have the political understanding nor the political capital to implement reforms. Reforms need to be sold to people. Hence they are political decisions. Given this, you need a mass based leader at the top.
So that brings me to the logical question. Is that leader Narendra Modi?
See I am not sure of that. I don’t want to get into this thing about who it should be or who it shouldn’t be. My entire point is the fact that you have mass based leaders at the state level. The states are not run by technocrats. The breakout states that I speak about are run by politically smart people, who understand what needs to be done for development, and who get that connection of what is good economics and what is good politics. They see the bridge between the two. To me its about mass based leaders. Whether India can have this at the national level, I am a bit more sort of doubtful about.
But do successful state level leaders transform into national leaders?
It has never happened. Never. That’s the staggering point. Many leaders have tried to go out. The list is a long one. From Sharad Pawar to Mulayam Singh Yadav and even someone like a Mayawati, they have all tried to build a national footprint but they have never been able to succeed. Often having strong regional roots is a liability at the centre because then they begin to associate you only with one particular state. Even in the Congress I find it fascinating that there is so much talk as to who could be the next candidate for Prime Minister. I would think that logically it should be a chief minister rather than any of the national leaders.
But no one comes to my mind when I think of the Congress chief ministers…
Exactly. Logically we should argue that by any chance if Sheila Dikshit wins the next election then she should be the automatic choice for being the next PM candidate assuming that Rahul doesn’t want the top job. Someone like her should be the top person for that job. You need someone with a mass base, who understands politics.
What has suddenly gone wrong with the rupee. Between January and May it yo yoyed between 53.5 to around 55.5 to a dollar. But after that it has fallen dramatically...
A lot of it has to do with this fault line across emerging markets which is the fact that all countries with a high current account deficit have really taken a big hit as far as their currencies are concerned. The whole game began to change, as is well documented by now, after the Federal Reserve decided that it wants to think about tapering off its quantitative easing. After that the the US interest rates have risen a lot. The 10 year interest rate has gone up by 100 basis points since May. This has obviously led to people evaluating how much money they want to put up internationally.
But is the rupee falling just because of the Federal Reserve thinking about going slow on money printing?
The fact is that we have our own domestic problems which are compounding the whole thing. There is a sense that no one’s in charge and that we have an election coming up. There is a sense that it will be very hard for the government to make tough decisions to remedy this situation. Also, some of the problems have not been fully appreciated or recognised. One thing that we are just about coming to realise is that corporate India has too much leverage. It is very concentrated leverage amongst a few companies.
Do you see the rupee falling more?
We are in the midst of a panic and magazine articles have their own time cycles. In panics I just can’t say where these things will stop.
Can we say that the rupee is falling because the rupee is falling?
It’s a global panic now. The train has left the station and you can’t now catch it. And where it stops I don’t know. That is the sense I get. This is not say that this is not our problem. If we did not have a large current account deficit we wouldn’t have this problem today. But the fact that we have a large current account deficit and are being punished globally for it, is just a reality.
Should the RBI try and stop the rupee’s fall or let it find its own level?
I don’t think that we have a local solution anymore. All that the RBI can do is to moderate the fall. But we have seen with other currency attacks that when currencies are under panic foreign exchange intervention can be very ineffective. The classic case was the British pound in 1992. What India can do is to figure out how to correct these things over a period of time, which is what we should think about. RBI or whoever it was in charge in Delhi was doing much worse before. They were following this bureaucratic impulse that you come up with this one decision all the time to show that you are doing something.
Is India anywhere close to Thai crisis of 1998, where the country more or less ran out of foreign exchange?
I don’t think that it is as extreme as that. What happened in Thailand was a very extreme situation. Their short term debts and current account deficit were larger than what we have. Having said that one thing that I have known about crises is that you only know about these things post facto which is that after every crisis you come up with new factors to add to the list of the things that you should watch out for. I think that is the whole point. If you look at the past crises this does not seem as dire as what we saw in East Asia in 1997-98 or in India in 1991. But my only caveat here is that you always come up with the real reasons post the crisis.
Economic theory has it that as the currency depreciates exports go up and imports fall. But in the last two years as the rupee has fallen, our trade deficit(the difference between imports and exports) has gone up dramatically. How do you explain that?
The recent fall of the rupee has been very sharp but before this the rupee was adjusting for the high inflation we have had for such a long period of time. Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist.
What are the other impacts of a falling rupee?
One of the factors that has been under-appreciated in this drive to see the currency go lower is that there is a negative effect also on the huge foreign exchange loans taken by the corporates. So even though there is not much that can be done to stop the rupee’s fall you can’t at the same time wish that you can just devalue your way to prosperity because there is a negative feedback loop which takes place.
And a lot of exports are import dependent…
Yes. There is a negative feedback loop because the corporate sector is heavily indebted in foreign currency. So that is the problem.
So there is a corporate debt crisis brewing up. You have pointed out in the past one in four Indian companies does not have enough cash flow to repay its debt. How do you see that playing out?
Those companies are just going to be shunned for a long period of time. People are now just investing in the 15-20 big companies and keeping away from the rest. India has lost a major competitive advantage. India’s advantage that used to be quoted to foreign equity investors, particularly portfolio equity investors, was how we have a huge number of companies to invest in. That has shrunk incredibly now. Some of these companies are not going to be able to survive, that’s the harsh reality.
Oil prices are at an all time high in rupee terms. What sort of impact will that have on the fiscal deficit. The finance minister said today(on August 27, 2013, the day the interview was taken) that come what may the government will meet the fiscal deficit target of 4.8% of GDP. Can we buy that?
We achieved the target last year. But you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that. Or the government will have to raise diesel prices. Currently, they are Rs 9-10 behind on the under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target. So can the government meet its fiscal deficit target? Of course they can. But the price unfortunately in this case will be economic growth.
If they don’t increase diesel prices they have a problem. If they do increase diesel prices they have a problem.
Exactly. That’s the negative feedback loop I talked about. The days when you could just move the exchange rate from x to y and hope that exports will pick up, is a very simplistic solution. It does not take into account the negative feedback loops that can arise in terms of corporate debt denominated in foreign currencies and also the fact that the oil import bill gets considerably worse.
There is a small cottage industry that has sprung up in trying to explain why the current fall of the rupee is due to international factors. How much of the rupee’s fall is due to international factors and how much of it is due to local factors?
Probably we can divide it 50:50. As I said, the fact of the matter is that if we were not running a current account deficit today, we would not be having this panic. Sure there would be some sell off because all emerging markets are under pressure. Growth forecasts across emerging markets have been downgraded regardless of their current account deficit. Nevertheless, it is ironical that the Chinese currency is up for the year. The currencies of some of the countries like Mexico and Philippines have fallen very slightly because they don’t have current account deficits. It is a very current account deficit centric problem that we are currently seeing now.
But the current account deficit did not appear overnight.
This is the irony, that the crisis has been badly managed. These fault lines have existed for a while. The current account deficit has been going up continuously over the last two to three years above levels which most economists consider to be sustainable. And we ignored that. In our desire to keep growth artificially high in 2009 and 2010, we engaged in a lot of stimulus government spending. We let our fiscal deficit blow out. We violated the FRBM (Fiscal Responsibility and Budget Management Act) and have never ever gone back to that. The Prime Minister has ignored so many fault lines.
Could you elaborate on that?
He dismissed crony capitalism as being something which possibly is the right of passage that any country going through an early stage of development will have to go through. Every such country will have its own robber barons. So what is the big deal that India does? He dismissed the rise in inflation by saying that rise in food prices are a sign of prosperity. He kept on going on about how savings and investment ratios are so high that growth is unlikely to ever dip below 8-9%. And on each one of them any sort of serious economic analysis would suggest that these arguments were flawed.
And this had a huge impact?
We know that if you have crony capitalism it can lead to a backlash against wealth creation. Look at issues like the ban on iron ore exports, the mining of coal etc. Some of this is because we have had crony capitalism and that has led to a backlash against wealth creation and that has led to these bans to start with.
What about the inflation argument offered by Manmohan Singh?
The whole business about inflation rising because of a rise in prosperity is a real myth. Why has China not seen this massive inflation problem despite 30 years of great growth? Why did Korea and Taiwan did not see any sustained inflation pressure? Or even Japan during there very high growth phrases? Why? This is a total myth. India’s inflation rankings have deteriorated considerably. Our inflation used to be always below the emerging market average for the last 20-30 years. It’s only in the last three to four years that we have been way high than the emerging market average, not just bit higher, but way higher. Also, other countries with high savings and high investment have also seen a growth fall off. The Soviet Union’s investment to GDP ratio was 35% before the collapse. It was all bad investment. This is what happens when there is too much academic focus on things.
In a recent column in the the Financial Times you wrote “A not so funny thing happened while the world was watching for an emerging market crisis to erupt in China. The crisis erupted in India instead.” Could you elaborate on that?
For the first half of the year a lot of focus was on China. China has had a massive credit binge over the last five years. And in recent times we have seen in the US, Spain etc, typically countries which have had a massive credit binge are vulnerable because when you increase your debt over a short span of time of three to five years you accumulate a lot of bad assets. And that leads to trouble for the entire banking system. So people have been very worried about the high debt to GDP ratio in China. Even I have been concerned about it and written about it. There were people sending out alerts on a China crisis. I think very few people were sending out alerts about a India crisis.
Nobody did.
Exactly. That’s the irony to me. Everyone was looking for a crisis in China and it ends up erupting in India, first.
The Indian economic growth has fallen to around 5%. Do you see us going back to the good old Hindu rate of growth of 3.5%?
No that’s not been my case. Hopefully things have changed there. There is a lot of natural buoyancy. What I do find more impressive compared to 30-40 years ago is the quality of state chief ministers. They have improved a lot in comparison to the 1970s and the 1980s. In fact even the 1990s. The moment we think of the third front we all get a bit scared because we think of the motley crew which ran the government in the mid 1990s. If you look at the state chief ministers today, they are generally better. My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can. We overshot for a while, we can undershoot for a while. That is still my base case scenario. I am not willing to give up on India and say that India is going to go down the route of 3% growth which existed till 1980. Also it is important to remember that the aspiration levels of the people here are too high now to tolerate that kind of an outcome. They will force something to happen to change that outcome.
Any view on the food security bill which was recently passed by the Lok Sabha?
I have no strong view on that. My concern is about the fact that you can’t keep writing cheques that which the country can’t cash. We need to understand that we can only spend that much. And if we have to spend extra then we have to show stuff that we can cut elsewhere. The big damage of the food security bill is not the bill itself but the fact that why was this not used at the very minimum by the Prime Minister as an excuse to say okay, if you want to pass this, you have to raise diesel prices by an ‘x’ amount, so that we offset some of the cost.
The interview originally appeared in the Forbes India magazine edition dated September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
The Great Indian FDI conundrum
Our politicians think our problems come from being connected with the world, but the reality is we are too little connected to the world, says Pankaj Ghemawat.
Vivek Kaul
The United Progressive Alliance government is fond of telling us that India’s weakening macroeconomic indicators – a falling rupee, a declining stock market, rising bond yields – are the result of being tied to a weak global economy and factors external to India. But if you were to ask Pankaj Ghemawat, Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Barcelona, Spain, India is not exactly as globally connected as we think it is.
Ghemawat has constructed a broad index of international integration, the DHL Global Connectedness Index, which was first released in November 2011. The 2012 version of this index was released last year and it shows India closer to the bottom. “This index extends beyond trade to incorporate capital, information and people flows as well, and covers 140 countries that account for 95% of the world’s population and 99% of its GDP,” says Ghemawat.
India ranks 119 out of 140 countries on the depth of its global connectedness. “When it comes to trade intensity, India still ranks in the bottom 25% in the sample. As far as capital connectedness is concerned, it is closer to the median,” says Ghemawat.
Capital connectedness is calculated from measures of foreign direct investment (FDI) and foreign portfolio equity investment into the stock market of the concerned country. India’s decent performance on capital connectedness is primarily on account of the huge money that has come into the Indian stock market from abroad in the last decade and big outward FDI flows in the form of overseas acquisitions by Indian corporates.
If one looks at just inward FDI, the performance is dismal. As Ghemawat puts it, “In terms of inward FDI stock (i.e. foreign companies having built or bought businesses in India) expressed as a percentage of GDP, India comes in the bottom 10%.”
FDI flows into India have also fallen in three out of the last four years. For 2012-13, FDI fell by 21% to $36.9 billion, government data show. The United Nations Conference on Trade and Development (UNCTAD), in a recent release, said that FDI inflows to India declined by 29% to $26 billion in 2012.
The government has, faced with an unsustainable current account deficit (CAD), has been trying to encourage FDI into the country to firm up the rupee against the dollar. Last year in September, the government opened up FDI in multi-brand retailing with the rider that each state can decide whether it wants companies like Wal-Mart to set up shop within its borders.
But since then not a single dollar has come into the sector. “One reason for foreign money not coming in is that investors are not sure whether the policy will continue as and when a new government comes in. Also, letting states set their own rules on such an international economic policy matter is basically unheard of elsewhere,” said Ghemawat. Towards the middle of July 2013, the government relaxed FDI norms in 12 sectors, including telecom, insurance, asset reconstruction, petroleum refining, stock exchanges and so on.
Ghemawat feels that there is a lot that India can learn from China on this front. China started opening up its retail sector to FDI in 1992, initially with various restrictions, but ultimately allowing 100% FDI in 2004. This benefited them with foreign players bringing in new management practices along with supporting technology and investment capital. And we shouldn’t forget the complementarity for foreign retailers between sourcing from China (contributing to China’s export boom) and selling there.
Ghemawat argues that much of the fear about FDI in retail is exaggerated, because even with full liberalisation, foreign retailers would hardly come to dominate the Indian market. “Retail is a very local business, where an intimate understanding of customers, real estate markets, and so on, is essential to success.” He cites a recent estimate that 40 foreign players account for only about 20% of organised retail in China, to suggest that foreign and domestic retail could thrive side-by-side in India.
“Foreign retailers don’t always win out against domestic rivals,” he adds. “Electronics retailers Best Buy from the US and Media Markt from Germany both shut down their stores in China in the last few years. They just couldn’t compete with local rivals Gome and Suning, which had greater domestic scale and business models more attuned to the Chinese market. Home Depot also exited China in 2012. But Chinese consumers gained anyway – competition against foreign retailers spurred locals to improve customer service, one of their weak points.”
Coming back to data from the Indian market, Ghemawat notes an interesting factoid from the 2013 Economist Corporate Network Asia. The nominal GDP of India grew by 12.6% in 2012. In comparison, the sales of MNCs (mainly Western) in India grew by only 6.3%, only half as fast as the GDP. “While this could be viewed as positive regarding Indian firms, a difference of such a big magnitude is probably reflective of a lack of openness,” said Ghemawat.
There are multiple reasons for India’s poor showing on these indicators India regularly figures in the bottom tier of countries in terms of the extent to which its policies promote trade. In the World Economic Forum’s 2012 Global Enabling Trade Index, India figures in the bottom tier. On the market access parameters, in particular, it figures third from last in a list of 132 countries. Ghemawat also cites the OECD’s FDI restrictiveness index which he has inverted into the FDI Friendliness Index. “India again figures in the bottom 10% of 50 countries in terms of the extent to which it encourages FDI.” No amount of ministerial cajoling of potential foreign investors is likely to outweigh the impact of such protectionist policies.
These indicators, of course, translate into low productivity and lack of infrastructure required to carry out a profitable business. “The Global Competitiveness Report tells us all we need to know about India’s poor infrastructure and low productivity,” says Ghemawat. “India currently ranks 59th on the list (out of 144 countries). It has fallen 10 places since peaking at the 49th spot in 2009. Once ahead of Brazil and South Korea it is now 10 places behind them. China is 30 places ahead of India,” he adds.
When it comes to the supply of transport, energy and ICT (information, communications technology) infrastructure, India is 84th on the list. This lack of infrastructure is the single biggest hindrance to doing business in India, feels Ghemawat. And this has kept foreign investors away from the country. Also given India’s weak health and basic education infrastructure (where it is 101st on the list), India remains low on productivity, which is an important factor for any foreign investor looking to make an investment. And as if all this was not enough it is worth remembering that it is not easy to start any business in India. Every year the World Bank puts out a ranking which measures the Ease of Doing Business across countries. In the 2013 ranking, India came in at rank 132 on the list – the same as in 2012. When it comes to starting a new business In
dia is 173rd on the list. Hence, foreign investors have an option of starting their business in a much easier way in many other countries. Given this, why should they be hurrying to India?
The spate of recent scams also has not helped the way India is viewed abroad. There is significant evidence to show that corruption hampers trade. Says Ghemawat: “According to one study, an increase in corruption levels from that of Singapore to that of Mexico has the same negative effect on inward foreign investment as raising the tax rate by over 50 percentage points.” India stood at 94th position in Transparency International’s 2012 Corruption Perception Index. “Given this, tackling corruption has to be a priority,” adds Ghemawat.
The moral of the story is that although India is much more open than it used to be 20 years ago, there is a lot that still needs to be done. And this is important because there is a clear connect between the global connectedness of a country and measures of prosperity. As Ghemawat puts it, “There is a strong positive correlation across countries between the depth of a country’s global connectedness and measures of its prosperity, such as its GDP per capita and its ranking on the UN’s Human Development Index. To be sure, correlation is not the same as causation, but statistical analysis indicates that after controlling for initial income levels, countries with deeper global connectedness have tended to grow faster than less-connected countries.”
The point is further buttressed by one look at the list of countries that are on the top of 2012 DHL Global Connectedness Index created by Ghemawat. These countries are the Netherlands, Singapore, Luxembourg, Ireland, Switzerland, the United Kingdom, Belgium, Sweden, Denmark, and Germany. In the recent past some of these countries have been caught up in the aftermath of the financial crisis, but it’s important not to let recent growth rates overshadow measures of current prosperity, on which all of these countries far surpass India.
Ghemawat gives the example of the Indian information technology sector. “Ask this simple question to yourself: Would Indian IT companies have been as globally competitive if we had protected them from international competition?” The answer of course is no. But that is the case with the business services sector. There is a huge protective moat around it. This, despite the fact that the sector has a huge potential to create jobs.”
And he backs his argument with numbers. “Although some services (like haircuts) will always be delivered locally, liberalizing trade in services alone could boost global GDP by at least 1.5%.” In India’s case, opening up business services is even more important given that we don’t trade much with our neighbours due to various reasons. “For example, Indian trade with Pakistan, according to one study, is only 2 to 4% of what it might be under friendlier circumstances. The rest of India’s neighbours are relatively small and poor, presenting limited opportunities compared with, for example, the benefits China realised by tying into Japanese and Korean production networks. It is neither exaggerated nor xenophobic to say that one of India’s key structural problems is that it is located in a difficult neighbourhood,” says Ghemawat.
Countries tend to trade the most with their neighbours. Ghemawat explains, “all else being equal, if you cut the distance between a pair of countries in half, their trade volume will go up almost 200%. Add a common border, and trade rises another 60%. That’s why more trade happens within world regions than across them, and the US’s top export destinations are Canada and Mexico.”
In India’s case, at least over the short-to-medium term, trading primarily with neighbours won’t be workable (though Ghemawat does urge India to take the lead on regional integration in South Asia). Hence, he feels that some business services can be outsourced over greater distances than many categories of merchandise are traded, since physical shipment of products is not required.
One exception he notes is how, recently, China became India’s biggest trading partner, overtaking the United States. But Ghemawat feels that caution is in order. “India runs a huge trade deficit with China and exports mainly primary products there: Cotton, copper and iron ore account for nearly one-half of the total. Given the limited progress the US has made in rebalancing its trade with China, it’s hard to see what India might accomplish within any reasonable timeframe,” he says. Trade deficit is the difference between imports and exports.
Ghemawat also feels that India has a lot to gain by encouraging trade within states. “I have been trying unsuccessfully for years to get hold of data on trade between Indian states,” he says. “India has a lot to gain by encouraging and increasing trade between states. As the former Chairman of Suzuki once put it to me, what India needs is not external trade liberalisation but internal trade liberalisation. And I heard Ratan Tata say something similar about the need for more integration and fewer barriers within India. For a large country, the potential gains from internal trade are typically much larger than those from international trade,” Ghemawat concludes.
The interview originally appeared in the Forbes India magazine in the edition dated Sep 20, 2013