Excerpts from the Mid-Year Economic Analysis, 2014-15

Medium-term economic growth depends on ensuring macroeconomic stability (which India is achieving) and on creating an enabling environment for the private sector to invest which the new government has embarked upon reflected in the policy reforms enacted thus far.

Fundamentally, India’s medium-term growth prospects are promising, and trend rate of growth of about 7-8 per cent should be within reach.

With basic public good provision and investment tapping into cheap labour, India can easily get closer to its growth frontier laying a strong foundation for the long run Stock Market Trading Tips

But India faces challenges. Investment has not durably rebounded. There are the usual headwinds from the external sector. But at the current conjuncture the gradual reversion to normal monetary policy in the US is less of a threat to India, given the improved macroeconomic situation, broad balance in the external sector and reserves that provide a modicum of insurance against shocks.

And, barring exceptional developments such as the ongoing turmoil in Russia, the external environment in terms of oil and agricultural commodity prices, is not likely to turn adverse.

Rather, India faces challenges that are mostly domestic. The most important among them relates to the experience of the past few years that led to over-exuberant investment, especially in the infrastructure and in the form of public-private partnerships (PPPs). There are stalled projects to the tune of Rs 18 lakh crore (about 13 per cent of GDP), of which an estimated 60 per cent are in infrastructure Personal Numerology Trading Tips

In turn, this reflects low and declining corporate profitability as more than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median debt-equity ratios at 70 per cent is among the highest in the world.

The ripples from the corporate sector have extended to the banking sector where restructured assets are estimated at about 11-12 per cent of total assets. Displaying risk aversion, the banking sector is increasingly unable and unwilling to lend to the real sector Commodity Trading Tips

India has been afflicted by what might be characterised as the “balance sheet syndrome” with Indian characteristics”. Like Japan after the real estate and equity boom of the late 1980s, and like the US after the global financial crisis, balance sheets are over-extended. The Indian case resembles Japan more than the US, since it is firms’ balance sheets (and not those of consumers) that are over-extended, exerting a drag on future investment/spending.

This syndrome has three distinctively Indian characteristics. First, India is not suffering from recession or stagnation. Economic growth, despite all the difficulties, is still 5.5 per cent not 1 per cent or negative.

Second, drawbacks in the Indian real sector co-exist not with weak macroeconomic demand but with moderately strong demand (at least relative to supply) reflected in moderately high inflation and a moderately high current account deficit. Japanese and American balance sheet recessions were associated with price deflation. A consequence, which contrasts with the current predicament in the Euro area, is that India’s fiscal indebtedness (ie the stock problem) has been improving, courtesy of high inflation, while that in the euro area is worsening from deflation Free Stock Share Tips

Another consequence is that fiscal pump-priming is less of an option for India.

Third, perhaps even more distinctly, the Indian balance sheet problem has also arisen partly out of public-sector financial concerns, which led to the encouragement of private-sector investment in infrastructure via the so-called public-private partnership (PPP) model.

Growth in real capital formation was around 15 per cent and private corporate investment surged, East-Asia-style, over a very short period — from 6.5 per cent in 2003-04 to 17.3 per cent in 2007-08, amounting to an increase of nearly 11 percentage points of GDP. Investment was based largely on the perception that growth rates of 8.5 per cent would continue indefinitely and banks, especially public-sector banks could lend to private sector investors in infrastructure Financial Astrology Trading Tips

As the growth boom faded, projects turned sour, leaving a legacy of distressed assets. This stock problem is weighing down profits and, hence, investment. The problem is compounded by relatively weak institutions. Effective legal processes (the corporate debt restructuring system and the SARFAESI Act) that can allocate the pain of past decisions among investors, creditors, consumers, and taxpayers are a work-in-progress.

The way forward
First, the backlog of stalled projects needs to be cleared more expeditiously, a process that has already begun. Where bottlenecks are due to coal and gas supplies, the planned reforms of the coal sector and the auctioning of coal blocks de-allocated by the Supreme Court, as well as the increase in the price of gas which should boost gas supply, will help Intraday Trading Tips

Speedier environmental clearances, reforming land and labour laws will also be critical.

But even if the backlog is cleared, there is going to be a flow challenge: Attracting new private investment, especially in infrastructure.

The PPP model has been less than successful. The key underlying problem of allocating the burden from the past — the stock problem that afflicts corporate and banks’ balance sheets —needs to be resolved sooner rather than later. The uncertainty and appetite for repeating this experience is open to question.

In this context, it seems imperative to consider the case for reviving public investment as one of the key engines of growth going forward, not to replace private investment but to revive and complement it Nifty Trading Tips

Note... that while private corporate investment surged in the boom phase, public investment, too, grew by about 3 percentage points. And just as corporate investment declined by 8 percentage points between 2007-08 and 2013-14, so too has public investment by about 1.5 percentage points.

Pro-cyclical public investment during the downward phase has been driven in part by fiscal targets which have resulted in large cuts toward the end of the financial year as the constraints of fiscal consolidation have loomed large.

The case for public investment going forward is threefold. First, there may well be projects for example roads, public irrigation, and basic connectivity — that the private sector might be hesitant to embrace. Second, the lesson from the PPP experience is that given India’s weak institutions there are serious costs to requiring the private sector taking on project implementation risks: Delays in land acquisition and environmental clearances, and variability of input supplies (all of which have led to stalled projects) are more effectively handled by the public sector. Third, the pressing constraint on manufacturing is infrastructure. Power supply and connectivity are key inputs that determine the competitiveness of manufacturing Personal Numerology Trading Tips

For these reasons, especially the difficulty of repeating past experience under conditions of weak institutions, consideration should be given to address the neglect of public investment in the recent past and also review medium-term fiscal policy to find the fiscal space for it. It is worth emphasising that India has a fiscal flow problem but not a stock problem because the ratio of government debt to GDP has declined substantially over the past decade due to a combination of high growth and high inflation.

Going forward, debt dynamics will continue to work in India’s favour as long as growth remains around 6 per cent and the primary deficit remains in the current range of 1 per cent of GDP. A case not just for counter-cyclical but counter-structural fiscal policy, motivated by reviving medium-term investment and growth, may need to be actively considered Free Stock Share Tips

To be sure, a greater role for the public sector will risk foregoing the efficiency gains from private sector participation. A balance may need to be struck with targeted public investments, carefully identified and closely monitored, by public institutions with a modicum of proven capacity for efficiency, and confined to sectors with the greatest positive spill-overs for the rest of the economy.

These may then be able to crowd in greater private investment Nifty Trading Tips