India seems to be never 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's gross domestic product (GDP) rose 43 per cent between 2007 and 2012. This is slightly lower than China's GDP, which rose 56 per cent but is much faster than the two per cent growth of the developed economies in the same period.
Economists rushed to outdo each other in playing up the India story. Growth forecasts of 8.5 per cent per annum, or even higher, became commonplace. Morgan Stanley, the US investment bank, predicted that India's growth would reach nine to 10 per cent, outpacing China's "pedestrian" eight per cent, within three to five years.
India's poor public finances, weak international position, structurally flawed businesses, poor infrastructure, corruption and political atrophy threaten to overwhelm its future prospectsIn a report titled India: Better Off Than Most Others, Macquarie Capital argued that India's traditional weaknesses were now strengths underpinning growth. These weaknesses include a predominantly state-owned financial system lightly integrated to foreign markets, sluggish exports growth because of the bureaucracy and the large agricultural sector producing only for domestic consumption. Indian leaders shuttled between international forums, basking in their new found status and power. At the World Economic Forum at Davos, representatives of the government and corporate India 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". The Indian media focused on the nation's "greatnesses", relying on extraneous facts. The fact that the market capitalisation 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.
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 nine per cent between 2012 and 2017. By late 2013, India's economic growth had slowed below five per cent, high by the standards of developed countries, but well below the levels required to maintain the economic momentum and improve the living standards of its citizens.
Elements of the India Shining story remain intact - favourable demographics with a youthful population, large domestic demand base and high savings rate. But 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.
From the membership of the prestigious BRICS (Brazil, Russia, India, China, South Africa), India is now part of the BIITS (Brazil, India, Indonesia, Thailand, South Africa), the acronym for the most vulnerable emerging economies.
In recent years, India has consistently run a public sector deficit of nine to 10 per cent of GDP. 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 had already exhausted 84.4 per cent of its annual fiscal deficit target of Rs 5,42,499 crore or 4.8 per cent of GDP. Interestingly, Finance Minister P. Chidambaram had reiterated time and again that the target set was a 'red line' which would not be crossed.
Between April and October 2013, the government had already exhausted 84.4 per cent of its annual fiscal deficit target of Rs 542,499 crore. It is unlikely to meet its budgeted deficit targetIt is unlikely that the government will be able to meet its budgeted 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 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.
The Indian government's debt is around 70 per cent 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.
Mounting Corporate Debt
Swiss bank Credit Suisse in its August 2013 report House of Debt - Revisited estimated the gross debt of 10 Indian corporate groups for 2012/13 at Rs 6,31,024.70 crore, having risen by 15 per cent 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 to 70 per cent, are denominated in foreign currency, meaning that the sharp depreciation in the rupee will have added to the debt burden.
Bad loans are concentrated in sectors such as power, aviation, infrastructure, real estate and telecom. These industries are characterised by government involvementIn an environment of booming stock markets between 2005 and 2008, foreign currency convertible bonds (FCCB) provided companies with low-cost debt. However, the combination of a fall in share prices and in the value of the rupee (in which the shares are denominated) means the FCCBs will not convert and will need to be repaid. The repayment in foreign currency will crystallise large currency losses. In addition, refinancing the FCCBs will result in much higher borrowing costs, which will affect the profitability of Indian corporations.
Slowing growth, tighter credit and other economic problems have increased corporate defaults to the highest level in 10 years. Non-performing loans are now above 3.6 per cent 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. Many suspect these 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 per cent of the banking system. The bad loans are concentrated in sectors such as power, aviation, infrastructure, real estate and telecom. The common element is that these industries are characterised by government involvement and have suffered from erratic policies or wholesale interference. In electricity, state-owned utilities have accumulated losses of $14 billion, partly 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 the backers stakes, which is often not acceptable except in extremis.
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.
India is plagued by inadequate infrastructure. In critical sectors such as power, transport and utilities, there are significant shortages. Political pressure to keep utility costs low has impeded investment. 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 ensure access to coal. Increasingly, the problems have made foreign investors cautious, creating a shortage of 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 per cent of students do not complete school. The workforce has an illiteracy level of 40 per cent. India's overall adult literacy rate is 66 per cent compared with 93 per cent in China.
Indian leaders have been urging investors to trust them. But the country and its elite seem unable to face the truth and undertake fundamental long-term changes.Some universities, especially the 16 Indian Institutes of Technology, are world-class. But their limited capacity means there 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 to100 million underemployed or surplus low-skilled workers in agriculture.
Political paralysis is a major impediment to development. Successive governments have failed to undertake the reforms necessary to foster growth, create employment and ensure development. Required changes in land and property laws have not been made. Problems in acquiring land are delaying infrastructure projects. Reform of tax laws, including introduction of a direct sales tax code correcting cumbersome difference between individual states, have not been completed. Changes in mining and mineral development regulations to allow environmentally-controlled exploitation of mineral wealth have not been made.
Other crucial areas remain unaddressed - rationalising unwieldy and economically distorted subsidies, implementing economic pricing of utilities, promoting foreign investment in key sectors and reforming agriculture, especially the wasteful and inefficient logistics system for transporting produce. Reform of labour markets and privatisation of key sectors has not progressed. Lack of progress on reforms remains a barrier to international investment.
Corruption remains a problem. The 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 democracy is increasingly ossified.
In his book, India: A Million Mutinies Now, writer V.S. Naipaul pithily captured India's internal political disputes. Today, about a third to a half of India is affected by 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.
In the 1980s, 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 reforms exacerbated by corruption, threatens to make the condition unmanageable, more quickly than most assume.
Indian leaders have been urging investors to "trust them". But the country seems unable to face the truth and undertake basic long-term changes.
Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk
(As told to Vivek Kaul)