2015 was a bad year for the Indian economy, though Prime Minister Narendra Modi and his Finance Minister Arun Jaitely have been crowing from rooftops about India being the fastest growing major economy in the world. But facts suggest otherwise. In the budget for 2015-16, Jaitley set a nominal GDP growth target of 11.5%. The nominal GDP growth is now just 5.2%, or 6.3% below target. This is a big miss. The 7.4% growth that he has been so vocal about is the real GDP growth after factoring in the deflation of 2.2%. Comparing apples with oranges may fool some people for some time, but not everyone forever.
As they say, the proof of the pudding is in the eating. The economy grows on money deployed for gain. The off-take of credit from the banks is probably the most reliable indicator of economic activity. The prognosis was not very good in 2015 for
six critical sectors. The credit off take growth for Manufacturing has fallen from 21% to 7.1%; Construction from 27.4% to 4.1%; Mining from 17.1% to a negative 8.2%; Industries from 9.6% to 5.2%. Only Electricity credit off take has just about held course by dropping from 13.7% to 12.7%.
Corporate profit as a percentage of GDP in 2015-16 may drop to 3.9%, the lowest since 2003-04. Thus, the aggregate profit of Indian firms is likely to be stagnant at around Rs 4 lakh crore. The Savings to GDP ratio has been stagnant at about 28%, having fallen from a peak of 38.1% in 2008. So where is the money for investment going to come from?
Challenges for Indian Economy
This is the biggest challenge that confronts the Narendra Modi government. A larger share of money has to be invested to achieve growth, and create jobs for the one million young people who join the Indian workforce every month. The options are the eternal beg, borrow or steal. A good government does all three.
The Modi government came to power on the promise of building a brave new India, with a hundred new cities, and a network of high speed railways bringing the country closer together. It came to power on the promise of retrieving lost wealth sitting abroad, cutting down undeserved subsidies, and by vastly expanding the tax paying economy by incorporating into the official economy a major part of the “black economy”. This is now estimated by the National Institute of Public Finance and Policy (NIPFP), a Ministry of Finance think-tank, to be nearly three-quarters the reported GDP. The tax foregone due to the escape of income and revenues into the black economy can be anywhere between Rs. 30-40 lakh crore, or a figure in the range of $500 billion a year.
Even if a third of this is realised, India’s capital investment to GDP ratio will surge and will easily propel it to the status of the fastest growing major economy, with real growth in double digits. One does need a police state to do this. The government is already armed with all the powers it needs to fetch what truly belongs to it. But it’s the lax administrative regime that lets the revenues slip, mostly quite wilfully. So a tax collection reform regime must become its number one administrative priority.
Heralding Reforms
- Off-take of credit, a critical indicator of economic activity ,doesn’t look good in 2015.
- Biggest challenge is to get the much needed investment that can give a push to the growth rate.
- Tax collection reforms should be an administrative priority to prevent revenues from slipping away.
- Business environment needs to be more conducive for investment; focus should be on improving our rank in terms of ‘Ease of Doing Business’.
- Low Debt to GDP ratio, compared to other countries like China and USA, indicates India can borrow more to finance its development projects.
Need for Structural Changes
This is easier said than done. But Narendra Modi promised to grasp the bull by its horns and harness it to the use of the nation. He now needs to show the political will and administrative acumen to undertake the structural changes to make the bureaucracy more accountable and responsible. The government is contemplating a huge, across the board, pay increase of nearly 24% – which will add Rs 1.05 lakh crore to the Central Government’s Wage and Pension Bill. It must now connect this with changed service conditions that links salaries and advancement with performance, weeding out the corrupt and inefficient, and maintaining a hierarchical pyramid, but letting officers go at every level of promotion.
The next serious source of investment is Foreign Direct Investment (FDI) to build businesses and invest in India’s future. There is an important lesson the government needs to grasp here. Most of the FDI in India, as it is in China, is from own nationals. More than half of India’s FDI comes from havens like Mauritius, Singapore and UAE. This is less by multi-nationals investing in India, and more by Indians with money abroad investing in India. The challenge for Narendra Modi then is to make India look a good place for investment, more to our fellow Indians than Mark Zuckerberg and Satya Nadella.
Ease of Doing Business
Indians are the biggest source of foreign capital in many countries today. According to Global Financial Integrity, a Washington DC based think-tank, the illicit flows from India in the last decade averaged $51 billion a year. Last year it was $83 billion, far more than the FDI that came to be invested in India. Three quarters of this illicit outflow is by trade mis-invoicing. It will be quite easy to correlate prices of goods and services in global markets to actual realisations, Yet the Ministries of Finance and Commerce have been unable to co-ordinate their efforts.
But the important question here is why do Indians prefer to salt away money abroad? The answer is simple – because it can be easily put to work for benefit. Can India do better? This is again easier said than done. India is now 130 out of 189 countries in terms of “ease of doing business”, a World Bank composite index of eleven vital parameters. This is not exactly a ranking, particularly when the country is hungering for more investment. The only parameter where we seem to be well placed, at eighth place, is in protecting minority investors. But major foreign investors might perceive that as more of a bother than help, as it enables small shareholders to block the notions of greater good determined by the main shareholders.
In terms of both, the ease of starting a business and the ease of shutting down an unprofitable business, India fares very poorly. India must target to swiftly move up this ladder, and it can do so if rent collection stops are reduced. Most of the regulatory mechanisms in place are quite unnecessary, and the Narendra Modi government must come good on its promises here too.
Task Ahead
India’s Debt to GDP ratio of about 65% is among the lowest for a major economy. India’s External Debt to GDP ratio is a healthy 23.8%. China’s Debt/GDP ratio is 282% and the USA’s is 101%. Clearly India can borrow more to finance its development, particularly in building and modernising its infrastructure. India should now aggressively seek long-term investment in its development by issuing sovereign-guaranteed global bonds. Even after factoring the upper levels of prevailing international interest rates, this money is way cheaper than domestic capital, which comes with exorbitant interest tags. Ministries such as the Railways and agencies such as the National Highways Authority of India (NHAI), and the various port trusts should be tasked with seeking capital for their modernisation and expansion.
India has traditionally been debt averse, but debt is often the cheapest and fastest source of capital. But debt must be used effectively and efficiently to be repaid and to raise more debt. This again calls for making the government effective and efficient. This brings us back to the main task ahead for the Modi government – to present India with a better and more effective government.
You have your work for the year chalked out. Happy New Year Mr Prime Minister!
(The article originally appeared in The Asian Age. The author is Chairman and Founder of Centre for Policy Alternatives)
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