Session on “India Policy and Market Outlook 2020” by Dr. Anantha Nageswaran at First India Fixed Income Summit, Chennai 2019

Speaker : Dr. Anantha Nageswaran, Dean, IFMR Graduate School of Business at Krea University

Moderator: , Senior India Analyst at Observatory Group, LLC

Contributed By : Deivanai Arunachalam

Fixed Income Pic

Dr. Anantha Nageswaran, Dean, IFMR Graduate School of Business at Krea University spoke at the First India Fixed Income Summit. Here are the highlights of his presentation:

This is the first economic slowdown after social media entered our lives in a big way. We are in an era of impatience, hyper-ventilation and instant gratification. We expect policy change as soon as we publish a tweet. Policy implementation, however takes time; and time lags are indeterminate.

There is clearly an evidence of slowdown in private consumption. Even sales of consumer staples have slowed. The reason for the consumption slowdown is that the proportion of working population is reducing. It fell from 42% in 1993-‘94 to 35% in 2017-‘18. As a result income generation has taken a beating.

Trying to decipher the causes of slowdown for a country as large as India, operating within a democratic framework, we realise that long-term causes are not the only reasons. Despite these issues, India’s GDP had continued to increase from 3.5% to 5% and eventually to 6.5% and so forth. We need to identify the most proximate cause which is the collapse of the NBFC, precipitated by the collapse of IL&FS. There has been a sharp slowdown in credit, which is hampering capital formation. The corporate sector is trying to deleverage and get its balance sheet in shape as it did between 1998 and 2002. The 2003-2008 boom had been because the Indian corporate sector had worked its way to a very lean and mean balance sheet until 2003. Probably we are going through one such phase. This could be a bit longer as the extent of leverage is far bigger than before, so the adjustment is also taking time.

The gap between the lending rate and the repo rate is as high as it was during the taper tantrum in 2013 and 2016. The transmission isn’t happening in spite of the repo rate cuts by the RBI. Actual lending rate faced by borrowers isn’t going down as much as we’d like it to. Things have become slightly better in the third quarter.

Both lenders and borrowers are risk averse. Small savings interest rates are too high. So banks have to pay a higher cost to attract deposits – their lending charges are higher than they should be. Interest as a % of EBIT for BSE100 is very high. Interest expense is growing at the rate of between 10% and 20%. There is a clear burden on corporate balance sheets. So from their point of view, there is scope for further easing. In this context I would consider RBI’s decision to pause the interest rate cuts in December, (to put it mildly) an interesting one.

Andy Mukherjee, an erudite commentator, is of the belief that that the time might have come for India to have its Quantitative Easing program. This is a proposal for serious consideration, given that the transmission of rate cuts hasn’t had a sufficient impact to ease the situation. A limited duration QE can help bring down Government borrowing costs. A bulk of its fiscal deficit is contributed to by the interest cost that the Government bears.

Brazil and China might have turned the corner with regard to economic recovery. India is not alone in facing the slowdown. China doesn’t import as much as it should; it is a drag on global demand. It is a net exporter especially to ASEAN and other Asian countries. The US still remains a source of global demand. The growth rates in emerging countries have therefore fallen short of what was recorded pre-2008 and between 2009 and 2012.

We must separate the long-run (or structural) causes from the proximate (or cyclical) causes. Suppose you catch a flu, the intensity of the attack also depends on your long-run immunity and health. Structural factors do compound the cyclical slowdown. The debate about cyclical versus structural makes us forget that cyclical slowdowns can be an opportunity to address structural deficiencies. There’s a popular saying: Let’s fix the roof when the sun shines. But nobody does that. Neither individuals, nor institutions, nor governments. This is not a phenomenon prevalent only in emerging economies; this is the case all over the world.

So let’s not expect more from our governments when we don’t do enough ourselves. There are structural issues that have placed a cap on India’s potential:

1. Women’s employment in India is only 17% whereas it is about 37% internationally.

2. % of GDP spent on healthcare and health expenditure as % of overall government expenditure are very low. Out of pocket expenditure in India is as high as 60% only matched by Nigeria; China and Brazil have much lower rates. High out of pocket expenditure can tip a family back to poverty.

Education, health, women’s participation in the labour force are some of the structural factors that need to be addressed.

Let’s consider some economic indicators from the recent OECD economic survey:

1. Vacant housing as a % of total dwelling units: India has a fairly high vacancy rate at 12% compared to some developing and many developed countries. The best way to reduce excess supply is to bring down prices. The floor space index is way too low. Singapore, Hong Kong etc. are at much higher levels. It is a state-level subject – Tamil Nadu increased it somewhat modestly, but we have a long way to go.

2. Affordability – India’s real GDP per capita growth in the last 6 years has trailed the growth in real home prices. This is due to the artificial sense of excess demand. In many countries such as China, Turkey, Mexico and Indonesia real GDP per capita growth has outpaced growth in real home prices. The best economic stimulus is to lower prices.

Agricultural statistics at a glance 2018:

Marginal land holdings (less than 1 hectare) constitute nearly 2/3rds of overall land holdings. The average size of land holdings in India was 1.23 hectares in 2005-06; it dropped further to 1.08 in 2015-16.

An 8% growth rate in India is difficult to sustain because we have never recording such a rate for even half a decade without causing the economy to overheat. It has not been possible to achieve an 8% growth rate continuously without high inflation, a high current account deficit or an overvalued rupee. The main reason for this is that we are fragmented and do not have scale efficiencies.  We are well below the optimal farm size; similar is the case with factories.

Fragmentation is evident even in the corporate sector – there is a bulk of companies with paid up capital less than INR 50,00,000. Less than 300 companies have a PBT more than 500 cr. Almost 300,000 companies don’t pay any tax whatsoever. We have a large number of small entities.  To lift people sustainably out of poverty we need to achieve scale efficiencies. Not by resorting to capital misallocation like China has done. But by moving towards the median figure.

Some of the obstacles that lie on this path are:

1. Export performance of textiles: National textiles exports share as a % of world textile exports is below 4% for India. India has stagnated while Vietnam has been able to achieve substantially on this front (6%). Bangladesh has been able to catch up as well.

Why textiles? It is one of the items that require relatively less literacy/skill levels, before the country scales the economic ascent to more value-added products. If we can’t crack this, then it is difficult to crack sophisticated, value-added exports.

Do we have the credit and the savings mechanisms required to achieve this scale (to attain middle-income or higher-income status)? The answer is an emphatic no, because:

1. Banking sector assets as % of GDP is well below S East Asian / North East Asian countries

2. M2 money supply as % of GDP is also low

3. Our credit markets are relatively shallow

4. Banking system needs to become bigger to cater to our infrastructure and investment needs

5. Households savings rate – the Gross Financial Savings of households was 10.9% in 2017-‘18. Net of liabilities it is 6.6%. The E Asian countries had a rate in excess of 20%.

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