Is India heading for another economic crisis?

The government thinks that it can buy peace with its own people, not by providing an environment for growth, but by bribing them into silence, writes M R Venkatesh.

The confluence of two arterial roads - Kodambakkam and Nungambakkam High Roads - in Chennai is a huge bottle neck. At that very junction the Tamil Nadu electricity board had set up a transformer which has been converted into an open urinal by passersby.

Adjacent to this transformer, two small shops had sprung up almost a decade ago robbing the pedestrians of walking space. As walkers climb on to the road at great personal risk, the already narrow stretch of road gets much narrower, leading to huge traffic snarls.

Strangely, the administration that allowed these shops to come up in the first place has failed to demonstrate spine in removing these encroachment. Government machinery that remains unsuccessful in clearing roadside encroachments in the centre of a metro is supposed to fight against Chinese or Pakistani encroachments in distant Arunachal Pradesh or Siachen! 

What is galling is that the Hon'ble Madras high court has granted a stay on this encroachment. With due respects, I am pretty sure that if only the Lordships were compelled to use these roads, the verdict in such cases would obviously be different. 

And the UPA leadership assumes that reforms - read FDI in retail, Insurance or Airlines - will widen roads, clear roadside bottlenecks and provide walking space to pedestrians. Crucially, it is also assumed to provide employment to the two shop keepers, provide toilets below the transformers and make our dirty cities look pretty. 

The mess at this Chennai-junction epitomizes all that is wrong with our economy. It is all about skewed priorities. It is about poor governance. It is the story of India being beset with a billion such bottlenecks, lack of infrastructure and administrative will.

Contrary to the expectations that our government addresses these issues up-front, from ports to airports, education to electricity, employment to environment, it assumes that foreign capital, foreign technology and worse still foreign initiative that will do the trick.

Fascinatingly, this is packaged as "reforms" by our government! It is indeed surprising that sections of the media and intelligentsia fall for such crass attempts of our government and gulp the nonsense.

Little do we or our government realize that barring tin-pot banana republics, there is no instance in recorded history of foreign capital, initiative and technology becoming the engine of domestic growth. Worse still, this psychology of depending on foreigners to address our internal mess is stifling domestic private initiative too.

It is not out of place to mention that psychology is crucial to investments. Policies that dampen psychology of local entrepreneurs choke domestic private initiatives and investments. That explains why several corporate are sitting on piles of cash (and refusing to invest) while domestic household savings get channeled into gold.

And where local businessmen are loath to do business, why should foreign businessmen invest in India? Elementary Watson!

Worse still, the government thinks that it can buy peace with its own people, not by providing an environment for growth, but by bribing them into silence. It believes in crony capitalism for the rich, slogans for the middle class and subsidies for the poor will do the trick. And that is the crux of the issue.

The net result is that it is no longer an issue of productivity. Rather it all about production. It is no longer about manufacture. It is all about infrastructure. It is no longer about competitiveness. It is all about psychology.

Believe me it is now no longer about fiscal reforms but all about physical side of reforms.

Something has terribly gone wrong

It was not so long ago that economists believed that an eight percent growth in India was sustainable. With bottlenecks as explained above, forget productivity for the moment, physical production of goods and services has dropped significantly.

These supply side shortages fuel inflationary pressures. That in turn necessitates huge imports into India. That makes Rupee extremely vulnerable. Equally that results in India being dependent on foreign money to fund its imports.

With eighty per cent of our fuel requirements being imported, Rupee depreciation in turns makes (imported) fuel costlier. Coupled with a weak physical infrastructure, this means that we are actually becoming a high cost, inefficient, vulnerable and import dependent economy - just as we were in the late eighties.

Surely all this is bound to have a profound impact on the Indian economy, notably its financial sector. According to well-researched and documented reports of Credit Suisse:

• Of a sample of over 3,500 companies (with aggregate USD 330 bn debt in FY11-12), earnings of 28% of such loans were insufficient to meet interest liabilities (much less principle) in the fourth quarter of FY12. Moreover, 50% of these corporates had earning lesser than its interest cost for more than 4 quarters in the last 7 quarters.

Obviously high interest rates are not the sole cause of this stress. And as press reports suggest, this has only worsened in FY 12-13.

• Restructured loans in FY12 are estimated to be at a high of 7-11% of total loans. With many of stressed corporates yet to be recognized as one, such levels can rise to over 20% shortly.

  This is frightening to say the least and can have profound impact on the financial sector, rupee and the Indian economy.

• Over last five years, Indian banks have witnessed strong (20% CAGR) loan growth. However, this has increasingly been driven by select ten corporate groups; (evidence of crony capitalism?). While the aggregate debt of these ten groups has jumped 5 times in the past five years and now equates to 13% of bank loans and 98% of the banking system's net worth.

  Therefore, surprisingly now in terms of the concentration risk, Indian banks rank higher than most of their global peers.

• Economic slowdown has in turn resulted in significant stress to specific sectors (power & metals).

  Consequently, financials of these groups are also stretched with four of the above-mentioned ten having earnings insufficient to payout interest for their borrowings.

• Over past three years, bank loans, the reports points out to power sector having grown approximately three times and now aggregate in excess of USD 60 bn. With our thrust on power sector, bank exposure to this sector is now significantly high at 10% of total loans.

  However with weak physical reforms carried out by the Government, stress on these loans comes from poor off-take, erratic fuel supply and sundry developer risk.

• If the Plant Load Factor of these new plants falls anywhere below 65% of its rated capacity it would be inadequate to meet its debt servicing needs. The 54 GW of capacity planned to come up in the next 24 months could be the tipping point for these risks to come to a fore as none of it is supported by appropriate sale agreement.

  All these are surely bound to have significant impact on the asset quality with our banks.

In denial mode

While petroleum import is understandable in India, with billions of tons of coal reserves, importing coal (obviously out of a flawed coal mine allocation policy) is sheer madness.

Yet the government is in denial mode. So is our media. Interestingly, the stock market that boasts of several "analysts" is at a high. As is their wont intelligentsia is playing a perfect cheerleader to this hara-kiri.

The government assumes that it can cure psychology of domestic entrepreneurs by announcing "reforms" - one that intriguingly makes India dependent. While surely foreign capital (as is technology) is welcome, let us not forget that foreign capital can at best supplement not replace domestic capital, entrepreneurs and their initiatives.

If the experience of the past two-decades of reforms is any indication, approximately ninety-eight - yes ninety-eight -  percent of the total investments made in India has come from domestic savings with the balance two coming from abroad as foreign capital. What is forgotten in the melee is that given the state of global economy, where is the mythical foreign capital?

Given this paradigm, naturally, foreign capital is loath to enter India. If foreign capital has to enter India, there must be a steady assured flow of the same in foreseeable future. For that to happen, Indians must invest in India. And for that to happen, India requires different set of "Reforms."

We have come to a stage where reforms need no longer directed at an international audience. It can neither be elitist, nor can it be exclusive. It has to be physical. It has to be inclusive. Unfortunately, a government headed by an economist Prime Minister is economical about this fundamental aspect of economics.

Surely, we are in a catch-22 situation. We need foreign capital to fund our imports, not fund investments. Nevertheless this makes foreign capital wield a disproportionate influence on the domestic economy. Obviously to get even this foreign capital, we are forced to sell our family silver? Even for sloganeering, time has run out. Hasn't it?

PS: Given this scenario, the Rupee runs the risk of depreciating sharply and abruptly. Should that happen, the 1991 economic crisis would look, like a walk in a park.

The author is a Chennai-based Chartered Accountant. He can be contacted at mrv@mrv.net.in