On paper India is the world’s fastest growing economy at 7.5% which should be the envy of the world at a time when the IMF has pegged global growth at 3.1% and fellow BRIC countries are witnessing slower growth. The current account deficit is in check and is forecast to be 1%-1.5% of GDP ensuring that India is nowhere near a repeat of its 2013 balance of payments crisis.
The Modi Era
Prime Minister Modi remains a popular and charismatic leader who appears to enjoy an attractive mandate half way through his term according to the latest opinion polls.This is in addition to a widespread opposition and a struggling main opposition party. He enjoys a full mandate providing India with political stability for the first time in 30 years and keeping petty coalition politics at bay.
While many expected big bang reforms since Modi’s mandate in 2014, they have rather been incremental. In the World Bank’s recently released ease of doing the business rating, India rose just one place to 130. The organisation itself claims that it did not catalogue two major reforms in the Bankruptcy Code and the biggest tax reform since independence the GST bill. Several experts, expect India to jump multiple places on the back of the GST reform alone.
Neither has the recent liberalisation of the FDI regime (India received record FDI last year) been documented. So while major reforms on land and labour are stuck, there have been enough reforms to keep international investors interested in the Indian growth story. Any further economic reforms may depend on the performance of PM Modi’s political party in the politically significant state elections of Uttar Pradesh which are coming up in February-March 2017 (the state election is carried out in phases).
So why has the government, despite a supposedly rosy picture, (whose union budget under finance minister Arun Jaitley won applause for being fiscally prudent in bridging India’s budget deficit) just asked parliament for an extra $7.5bn to be spent on infrastructure? Make no mistake; India badly needs infrastructure. But the timing of this request is significant highlighting the fault lines in the Indian economy.
Lack Of Jobs
In a nutshell, the statistic which worries PM Modi the most is chronic unemployment. He rose to power by promising jobs to the country’s youth. Unemployment is at a five-year high as the country is simply not generating enough employment in the organised and unorganised sector.
No matter how popular he may be now, weak job creation and India’s demographic bulge has the potential to topple him. Already several states ranging from the PM’s home state of Gujarat to Haryana have seen several castes demand reservation in government jobs due to lack of jobs in the private economy.
This raises a question if GDP growth is an ideal measure for an economy such as India? Economists have speculated in the past that India needs 8% GDP growth to sustain employment of the millions joining the workforce year on year. However, it did on take into account the technology and innovation developments which have killed jobs in the IT sector in India.
In the past decade, IT and BPO processing which forms 8% of GDP have mopped up India’s well-educated middle class, providing well-paying jobs. Indian firms such as TCS have concentrated on being cheaper than the competition rather than being moving up the value chain. They have fallen victims to automation as a result of failing to invest in R&D. A report by the World Bank claims that automation threatens 69% of jobs in India in the long term turning demographic dividends, which was seen as an advantage into a weakness.
Technology aside, there are several reasons for this weakness in the jobs market in the short term. To paraphrase the former central banker Dr Rajan, Indian GDP is puffed up to 7.5% as a result of the deflator effect due to a fall in commodity prices e.g. oil which India imports. This implies that while revenues and sales of Indian firms have remained constant, the cost of inputs has fallen boosting profits. This process, however, does not generate jobs.
India’s exports have been in constant decline for the past two years. While India has benefited from low oil prices providing macroeconomic stability, refining petroleum products are one of the country’s largest exports. In an ideal scenario, a barrel of Brent crude would be at $80 to allow Indian exports to bounce back without causing alarm in the current account deficit.
Furthermore, the regions India exports to are in a slowdown. It highlights a weakness of narrowness from lack of diversity of products and area parts India does business with. India’s trade with South American and Africa is negligible. The effort to remedy the same will take diplomacy, effort and time. Some 20% of Indian imports go to the Gulf region which has been hit by low oil prices. Remittances (a big chunk from the Gulf) are expected to drop 5% to $65.5bn.
The EU, another key export market has seen a slowdown since 2012 which has subdued exports. In total, 4% of Indian exports go to Britain, which is in the EU, for now. The Brexit vote, with the subsequent fall in the pound, has wiped 0.5% of the value of Indian exports in 2016. An EU-India FTA which was meant to boost the Indian textile industry (a mass employer second only to agriculture) is stuck in doldrums since negotiations began in 2007.
Agriculture, which is 17% of GDP but employed 50% of the working population, has seen two consecutive years of drought (and contractions) before this season. The rural economy has suffered as masses of jobless farm labourers have found themselves without any means of employment.
The Debt Trap
However, all these reshape much more fundamental issues at the heart of the Indian economy. Unlike China, which is driven by the state, Indian growth has been driven post the 1991 liberalisation by the private sector, who has been the dominant force in generating jobs. India has also been a consumption driven growth story so exports, while disappointing, are not that critical in the short term. What has killed job creation is a drop in private investment. It shrank 3.1% in the April to June quarter sending alarm bells ringing in New Delhi.
India faces a chicken and an egg scenario. The state-owned banking sector is dogged by non-performing assets (NPA). India’s former central banker, Dr Rajan, had claimed that the NPA crisis would be over by March 2017 on the back of fixed deposits by Indians as the country has a robust saving rate of 29%. However, what is alarming is that Indian private banks, thought to be efficiently run, have seen a substantial increase in bad loans in Q3. Many are starting to believe that getting over the NPA crisis might be a longer process.
In the aftermath of the 2008 financial crisis, Indian corporate entities gorged on cheap and plentiful debt. From 2003-2004 to 2013-2014 corporate debt has risen from 14.8% to 34% with the bulk coming post-2009. As the RBI under Dr Rajan rightfully cracked down on state-owned and private banks to safeguard and boost their balance sheets, lending has stalled. Private sector players for their part too are scaling back on projects in favour of paying off debt. Naturally, despite interbank interest rates being at three-year lows, the bulk of these cuts have not been passed by the banks, watering down their impact.
While the job prospects of the middle classes have dimmed due to a realignment in the business model of the IT industry, the informal jobs market has been heavily hit by a slump in the heavily indebted construction industry, as inventory has piled up due to a weakness in mortgage approval by the banks. Construction along with textiles were two segments to absorb the most unskilled labour in the last decade.
Is Government Spending Sustainable?
With the private sector, especially construction, failing to generate jobs and weakness in international growth, spending on vital, tangible infrastructure (which is labour intensive) to boost demand is the right idea. The question is how much can India afford to spend to retain its 7.5% GDP statistic and for how long can it afford to do so? S&P has maintained India’s BBB- rating (a step above junk status) for the next two years based on worries of worsening fiscal discipline as the Modi government tries to spend through a weak business cycle. The chart below shows India making good progress in balancing the books regarding a declining budget deficit. But any extra spending will preserve the gains made.
However, signs are emerging that the Indian government can afford to pump in some extra money for a while. The GST bill (tax bands have recently been revealed) is expected to be implemented in April 2017. Should the government roll it out successfully, revenues will rise substantially as firms that were dodging taxes have nowhere to run. The Modi government has a target to raise revenues to 20% of GDP. This would allow India to spend on vital infrastructure without compromising fiscal discipline.
After months of decline, Indian exports are bottoming out with an improvement in international trade on the horizon. This combined with OPEC failing to reach a deal (price of oil which India heavily imports will remain subdued) might see India running a current account surplus and generating jobs under PM Modi’s “Make In India” scheme.
Good monsoon after two years has meant agriculture is expected to rise by 4% creating millions of jobs in the informal sector during the harvest season and stimulating the rural economy. Inflation (with food items being 54% of the Indian consumer’s basket) has fallen to 4.3% implying room for further rate cuts.
The Way Forward
Dr Rajan’s successor, Dr Urjit Patel, is seen as being much more aggressive in slashing interest rates to boost business. Crucially the country’s largest lender State Bank Of India (SBI) has finally passed on the rate cuts to its retail consumers, signalling a higher impact of rate cuts in stimulating the economy. All of the above is indicative that the government may not have to spend heavily for long to nurse the economy.
While there are several green shoots as mentioned above, the government on its part needs to think out of the box. $7.5bn for a $2.25 trn economy is not a significant sum. With the private sector reeling in debt the Public Private Partnership Model was seen as being redundant, with no firm ready to partner with state entities. Moody’s has suggested an enhanced PPP model based on similar ones implemented in other Commonwealth countries such as the UK, Canada and Australia, to ensure every billion spent goes further. It is this type of creative policy-making that will define the reign of finance ministry Arun Jaitley and will ultimately decide if PM Modi is elected for another term. For the moment, India can be seen as either a glass half full or a glass half empty.