Saturday, January 7, 2012

Reversing India's Downward Trajectory

The country can regain growth momentum with rate cuts and telecom reforms

Shyam Ponappa / January 5, 2012

The welter of confusing pulls and pushes on India’s political economy makes finding the way forward really difficult. The government apparently cannot sustain economic reform initiatives, and does not have the finances for a stimulus package. The private sector is sitting on cash, but cannot invest because it is facing slowing growth and reducing margins. Known problem areas in infrastructure cannot absorb investment despite critical shortages in output — power generation and distribution is an example. Is there really nothing that can be done but to wait and watch while everything slowly grinds down?

The circumstances are formidable: a cantankerous Opposition using scorched-earth tactics, an anarchic citizenry usurping law-making functions after the abdication by the government and the Opposition, and an administration stupefied by the CAG phantom and other witch-hunts, with media Rottweilers searching through the carnage for the scandal-of-the-day.

This article identifies critical factors at the heart of the matter, and suggests remedial action. Slowing growth is the primary problem, and can be reversed without political manoeuvring.

The Crux: Reverse Slowing Growth

Some underlying factors that drive everything else need to be recognised and dealt with. For India at this stage, growth is all-important. This is the issue to be recognised and addressed.

The slowdown is largely self-inflicted, by escalating interest rates in a misguided effort to counter inflation. Yes, there are many other problems, but unless we have high growth for years together, other problems will swamp not only the analysis, but all efforts at execution. The consequences could be devastating — not only because of the large numbers of people who are not adequately housed and fed, but because a flood of young people entering what could be a productive workforce may end up on the streets instead.

There are two aspects to India’s growth. The largest component (growth of six to seven per cent) is driven by domestic demand. On top of that, foreign investment can add one to three per cent, to take annual GDP growth to eight to nine per cent, or perhaps even more. One can quibble, but the relative proportions are from two-to-one to four-to-one. It needs to be understood, however, that the incremental growth is driven by foreign investment, which is attracted by existing growth, and builds on it. Absent domestic growth, foreign investment dries up; worse, it flows out when growth is seen to be decelerating. This in turn increases downward pressure on the rupee.

This is the situation we have been heading towards, and are now squarely in. If domestic growth continues to stall, an outflow of foreign portfolio investments could put more pressure on the rupee. Domestic growth, therefore, has to be revived. Immediate steps are possible in two areas.

Lower Interest Rates

The Reserve Bank of India (RBI) does not need the approval of our contentious politics, nor of the public. All it needs is the understanding and willingness to reduce interest rates. If this happens, large businesses can concentrate on domestic investment instead of being driven offshore to protect their future, while small and medium businesses are not emasculated by high interest. It’s hard enough dealing with poor productivity because of a lack of physical infrastructure. High interest rates – factors within the nation’s control, with no political headwinds – are the last straw.

Academics and theoreticians may argue that with inflation being high, real interest rates are only around three to four per cent, but anyone who has run a profit centre or dealt with practical finance knows that these arguments don’t hold. When margins are dropping and interest costs are high, businesses run down, reinforcing the downward momentum.

In this context, a recent article on these pages by Jaimini Bhagwati highlights an enduring problem: central banks’ lack of accountability (“How unaccountable are central banks?”, Business Standard, December 16: /news/jaimini-bhagwati-how-unaccountablecentral-banks/458599/). It’s as though central bankers play to their own coterie of other central bankers, holding tight while the ships go down. If you need convincing, consider Alan Greenspan’s assessment: “…the origination of subprime mortgages – as opposed to the rise in global demand for securitised subprime-mortgage interests – was not a significant cause of the financial crisis.” Collateralised debt obligations indeed triggered the crisis, but there can be little doubt that loans premised on mansions for everyone lead to disaster, like any pyramid scheme.

As for the RBI’s accountability, the “presumptive loss” from the reduced GDP because of interest rate increases could be two to three per cent a year. One per cent is around Rs 92,000 crore, making three per cent Rs 2,76,000 crore.

Telecom Reforms

Positive sentiments can and must be triggered by constructive reform in telecom, through extending the revenue-sharing approach to pay-for-use spectrum and network sharing. This, too, needs more applied logic and problem solving expertise rather than political finesse.

After an encouraging Draft National Telecom Policy-2011 (NTP-2011) last year, there are unsettling signs. One is recurring delays, with a new policy expected in June 2012.

Second, there’s the confusing juxtaposition of spectrum sharing in the draft policy with recent statements about more auctions. The draft policy mentions spectrum trading for “efficient and optimal utilisation”, but if spectrum sharing results in both, presumably the need for trading will arise only for holders to get the assets off their books. The realpolitik is that dominant operators want auctions to corner scarce spectrum for their exclusive use, while the others want auctions for a lucrative sell-out. But this ignores the public interest, comprising users who want good, affordable broadband services, and defence, security, and other government needs that are in our collective interests.

The government has a unique opportunity to clear up India’s telecom policies, although precipitated ignominiously by the scams. Now, the government must grasp the nettle by extending the revenue-sharing principle of NTP-99 through open access to spectrum and networks. Other necessary elements include:

- compensation for dominant players for giving up their advantage, with

- stakes in appropriately structured consortiums for Next Generation Networks, and

- incentives for affordable broadband delivery.

Interest rates can be cut tomorrow. A sound telecom policy on the above lines could be formulated by June.

shyamponappa at gmail dot com