The New Indian Government and Challenges on the Economy Front

(This article was written for Insight-India An Indian Vision, an upcoming magazine from Adelaide, Australia.

Amitoj Gautam

As is the norm, every success comes entwined with countless expectations. Living up to expectations is a gauntlet which every victor has to take care of. Similarly, the present Manmohan Singh government is under immense obligation to deliver on several counts. The government can no longer whine about its helplessness due to the dynamics, exigencies and compulsions of coalition politics where it had to kowtow even before electorally miniscule partners. First and foremost, the Government has the onus of putting good governance on a high pedestal and reassert prime-ministerial eminence within the entire cabinet. Collective responsibility should be discernible with the new cabinet oozing with openness and accountability. Dr. Singh is known for being one of the vociferous and staunchest supporters of making ‘efficiency’ the ‘mantra’ of governance. He has to ensure that he should at least make a beginning in this direction with the ‘downward-filtration’ effect gradually percolating the novelty in other departments. Dr. Singh and his caucus need to strategize priorities regarding the upliftment of economy out of the recession morass. They need to act, and act very fast. The country needs to be financially secure again after all the upheavals sparked by recessionary ill-effects.

WHERE DOES THE ECONOMY STAND TODAY?

When the UPA government first came to power in 2004, India was indeed ‘shining’ with a healthy growth rate and booming economy. India had broken out from the shackles of ‘Hindu growth rate¹’ in the year 2003-2004 with economic expansion of the magnitude of 8.5%, the highest ever except in 1975-76 and 1988-89². The economy maintained its resilience in terms of growth, inflation and balance of payments (BOP), with the domino effect on consolidation of the growth momentum and macro-economic stability. The global economy was on upswing and so was India gaining from increased demand for merchandise and service exports. However, today growth has dwindled and nosedived from a peak of 9.6% of 2006-2007 and an average growth of 8.9% in the initial four years of the previous UPA government, to a much lower rate of 6% in the last fiscal. In the maximum drop in over a decade, India’s merchandise export was estimated to have gone down by 33.3 per cent in dollar terms in March 2009.  Even in the ‘State of Economy’ report released by the Confederation of Indian Industry (CII) on May 2, 2009, India’s gross domestic product was estimated to grow to 6.1-6.5 per cent in the current fiscal, much below the growth target of the Eleventh Five Year Plan (2007-2012). Prime Minister Manmohan Singh has raised a glimmer of hope with his assertion that that the new government will accelerate the reform process and would work with states in tandem for ensuring the implementation of the National Rural Employment Guarantee Act, Rural Health Mission, Urban Renewal Mission and populist welfare programmes targeted at poor, destitute, minorities and backward sections of the society.  “The election verdict is for inclusive growth. It is a verdict for equitable development. It is a verdict for a secular and plural India,” Mr Singh said. Coming down to global meltdown, Dr. Singh renewed his pledge that “India will have to continue to keep its savings and investment rates high and become more globally competitive, so as to be able to “face global economic challenges.” So the new government is faced with a situation where it needs to dovetail several measures aimed at resuscitating the ailing Indian economy, viz., perking up consumption, creating employment opportunities, propel the sluggish economy on an upward trajectory and restore the nation’s depleted and exhausted finances. The government also needs to assure healthy investment from both and public and private domains, enthuse economy with further stimulus packages, accelerate reform process, create markets and reduce fiscal deficit. So Dr. Manmohan Singh’s dispensation cannot afford to remain oblivious of the challenges before them with equal attention on the invisible, yet very much tangible constraints.

WHAT CAN THE GOVERNMENT DO TO STEM THE ROT?

The new government can make a beginning with reversing the recent trend of a balanced fiscal policy being substituted by the expansionary one. It can chart a new plan for fiscal consolidation by September-October of this year. This is the time when the analysts are expecting economy to experience revival symptoms. In the intervening period, however, it is needed to utilise fiscal space of about 2% of India’s GDP, generated by the decline in global prices of commodities and the consequent decrease in subsidy burden on the government, for bringing another stimulus package to the economy. The previous government had, in the interim budget, spelt out its blueprint for the reduction of fiscal deficit to 3 per cent and revenue deficit to zero by the Twelfth Five Year Plan. But, for the accomplishment of these twin goals, the government will require legislations in the nature of the Fiscal Responsibility and Budget Management Act 2003. India’s early growth trajectory was very much shaped by high savings and equally higher investments which, however came down from 39.1% in 2007-2008 to 35% in 2008-2009. The UPA-2 needs to re-invigorate this. One way is to harness the vast reservoir of India’s huge domestic savings, of the magnitude of 38% of the annual output in value terms, and channelise it into financial markets. It is unfortunate that at present only about half of this pool is invested in form of financial assets, with the chunk being locked in land and other assets. Domestic savings can serve to substitute foreign funds in terms of investment. The government also needs to look into the overseas borrowing norms for the NBFCs³ (Non-Banking Financial companies) which are bank like firms, deprived from the right to issue cheques or offering savings. It is ironical that private NBFCs are discriminated from accessing funds from IIFCL, the state-run India Infrastructure Company which was set up with the primary objective of availing funds to infrastructure projects. The government must bring private NBFCs at par with state-run NBFCs in terms of availing funds from IIFCL and restructure the borrowing norms for both public and private NBFCs. Juxtaposed to these structural changes, what is desperately required is to bring another company law with new auditing norms so that Indian economy is immunized against fraud of the nature of the Rs. 7,000 Satyam scam. The Manmohan Singh government needs to operationalise the Competition Commission of India which can regulate corporate behaviour and prevent big businesses from acquiring monopolistic hegemonies, thereby ensuring healthy competition in the market. India needs to strike balance between laissez-faire and welfare economics. Keynesian⁴ economics retains its primacy even today!

DISINVESTMENT, FDI AND EXPORTS

The new government also needs to intromit a fresh lease of life in the stalled disinvestment programme. UPA-1 could raise just Rs. 8,500 crore in the five years of government in stark contrast to Rs. 28,000 crore raised by the NDA government in the preceding five years period. So Dr. Manmohan Singh not only needs to come out with a new disinvestment policy, but he also needs to unwind the National Investment Fund (NIF) which was set up for the receipt of funds accruing from the disinvestment process. What the government can do is to re-route the funds to the Consolidated Fund of India so that it can simultaneously be used in the reduction of fiscal deficit⁵ and cutting the borrowing needs of the government. The new government is also required to unveil a new Foreign Trade Policy and facelift the Foreign Direct Investment Policy with parallel attention towards the effort needed to put Indian exports back on the track which was hit due to the global recession and concomitant fall in demand. India cannot be blind to the over-enthusiastic embracing arm shown by China, Brazil and Russia in attracting FDIs⁶. The government needs to further liberalise FDI norms and bring some modifications in the FDI guidelines announced by the government earlier in February 2009. In February 2009 FDIs inflow to India was a paltry $1.4 billion, one-fourth of what was registered in the same month in 2008. The guidelines issued in February as a response to this development does not count investment, made through companies owned and controlled by Indians, in the calculation of foreign investment while investments by those companies which are majority foreign-owned are considered as foreign investment. This had the debilitating and frustrating effect of converting the investments made even by India’s private sector as foreign investment. A dampener it was, the government needs to come out with reforms in this arena also. However, the most daunting task before the incumbent government is to re-energise the export sector which has been witnessing negative growth since the last eight months, registering a growth of just 3.4% in 2008-2009. Exports fuel India’s GDP to the extent of 17% of the total. Lot of work remains in the area of trade-agreements also. Contentious issues arising from the Doha round of WTO negotiations also need to be sorted out. Signing FTA (free trade agreement) with ASEAN (Association of South East Asian Nations) will open up &1.1 trillion South Asian market, bringing the much-needed respite to the Indian exporters who have had been reeling under the impact of evaporation of demand from the recession-hit West. ASEAN comprises about 9.5 per cent of India’s global trade.

MULTI-FACETED POLICIES ARE NEED OF THE HOUR

The new government also needs to needs to attend to the needs of two primary sectors of agriculture and industry. Agriculture, despite its miniscule contribution (17.5%) to the GDP, still remains the mainstay of Indian economy because of its high share in employment and livelihood creation. India achieved high growth in farms sector from 2003-2004 to 2007-08, but it is now experiencing low growth. If India is to repeat and sustain its more than 8% growth rate on a continual basis, farm sector has to grow at 4% which is improbable until and unless technology is transferred to the farms. Similarly, Indian industry, too, needs multiple antidotes as shrinkage in exports coupled with recession hit industrial production severely, and indirectly affecting employment scenario. As agriculture and industry are the prime absorbers of skilled and un-skilled workers, it is high time for the new government to put these two lynchpins of Indian economy back to smiling mode. Attainment of energy security should also be one of the top-most agendas of the new government. The UPA government needs to push reforms in the energy sector by providing seven-year tax-exemption for natural gas production, deregulating auto fuel prices, and making the subsidy regime more target-oriented. Rural electrification as mentioned in the Congress manifesto, reduction of aggregate and technical losses and curbing power distribution losses need a renewed thrust. India’s power generation capacity stands today at around 1,47,000 MW (Megawatt)  with the Eleventh Five Year Plan envisaging addition of further 78,500 MW. With most of the conventional sources reaching optimum-limit to the point of exhaustion, the country needs to accelerate generation of nuclear energy and tap other renewable sources of power. The Indo-U.S. Nuclear agreement may prove to be a big boon in India’s stride towards energy security. Development, in the true sense of the expression, means economic and social development. So the government needs to extend the social safety nets especially in areas of food supply, job creation, education and proper health and medical care. One of the most effective tools for poverty amelioration is high and sustainable growth. The Manmohan Singh government is also expected to bring reforms in the infrastructure sector with special emphasis on roads, ports and urban development. Public-private partnership in the transport sector is particularly expected to gain momentum. More bandwidth allocation and advent of 3G⁷ spectrum are on the anvil in the telecom sector. No less important is the listing of state-owned Bharat Sanchar Nigam (BSNL). In the aviation sector, the government has to extricate the major airliners out from the financial crisis. The airline industry suffered severe losses, to the extent of Rs. 10,000 crore, in 2008-2009. The three Indian airline giants, viz., Air India, Kingfisher and Jet Airways, have a debt of about Rs. 30,000 on their heads. The government ought to bring a new aviation policy which allows domestic carriers to fly overseas.

EXUBERANT MONEY MARKETS!

The Manmohan Singh government is going to exercise tremendous influence in the shaping up of Indian markets. Though, going by the current inklings, Indian markets are more guided by global financial developments than the domestic polity wielding any major influence. Ever since Dr. Singh picked up the reins of power in his second innings, the markets have responded enthusiastically with the month of May proving to be the best in a decade. Investors at the Dalal Street picked up gains of 28% in May 2009 making it the best month in the last decade. Indian stock markets became fatter by $4.1 billion in May. Foreign Institution Investments (FIIs⁸) are expected to keep the market buoyant in the near future. In another development, Indian companies trading on American bourses, i.e., ADRs⁹ (American Depository Receipts) were witness to the thriving of their total market value in the excess of $20.41 billion in May, with ICICI Bank and Wipro accounting for about fifty percent of the total market capitalisation. The prevailing market sentiment was again exemplified by the addition of $6.4 billion to the foreign exchange reserves, comprising foreign currency assets, gold and drawing rights with the IMF (International Monetary Fund) in a single week and total of $9 billion accruing in three weeks of May ending 22.  These are highest growths in more than a year. However, much of this addition came through the portfolio route¹⁰ and was accounted by non-dollar assets with the negative trend of government borrowing from the RBI under the WMA¹¹ (Ways and Means Advances) continuing unabatedly. Analysts believe that this current trend is unsustainable as there still remains a wide cleavage between fundamentals and the market. This gap needs to be narrowed down thorugh the stimulus packages¹². Disinvestment can serve to provide funds for pushing the primary market¹³ which, in turn, can bolster the secondary market¹⁴. The presence of a stable government at the Centre is also a major booster for creating an Indian banking supergiant. The previous government had taken initiative for the merger of State Bank of India, the country’s largest bank, with six of its associate banks, but the Left aborted the move. Bringing the cost of credit down should also be one of the priority areas of the new government with an emphasis on priority sector lending.

INFRASTRUCTURE AND REALTY SECTOR NEEDS DOVETAILING

Last, but not the least, the new UPA government has to bring the real estate market back on its track. This sector has witnessed steep fall in its fortunes in the last year. In this tumultuous period, the Non-Resident Indians from the U.K., the U.S., Canada, have provided a lifeline to the realty sector by lifting its spirits. Even in such hard times, the deep-pocketed and influential NRI¹⁵ community has been on a house-purchasing spree whether it is in Delhi or NOIDA. Far away from their motherland, the ever nostalgic NRIs have been at the vanguard when they were perhaps needed the most. Now, the government can infuse life in this sector by bringing down the interest rates within the reach of common man. Analysts point out a modicum step of bringing down the interest rate by 2% can reduce the EMI (Easy Monthly Installment) on a similar earlier loan for 20 years by about 13%, enabling house-seekers to have their own roof. An improvement in the real estate sector will follow once the banks return to their aggressive lending. Liberalizing of FDI norms in the sector will serve to bring down the prices. The Manmohan Singh government’s thrust on infrastructure development in form of roads, electricity, and water supply has beneficial effects for the real estate sector as well. These developments would free quantum of land for housing development. The policy-makers can also focus upon the development of infrastructure in the countryside, Tier II and Tier III cities and satellite towns. The existing cities are already over-populated, over-crowded and over-exploited. They have already reached saturation point where only vertical expansion is possible. In big Indian cities, only the sky is visible as the horizon has vanished in the maze of housing jungles! But this is fraught with serious consequences as it distorts the man-land balance, putting natural resources like water-table under severe stress. Besides, exerting stupendous pressure on the land means that even fertile lands which should normally be earmarked for food-raising is also encroached upon without any compunction, jeopardizing the already vulnerable environment. Fanning out is the only pragmatic solution left which should be vigorously pursued. What matters the most is connectivity! So the government needs to bring out a holistic plan in which infrastructure and real estate development can go hand-in-hand. With Dr. Manmohan Singh heading a stable government, strategic investors are once again taking interest in the real estate sector with foreign funds raising money for investment. Milestone Capital Advisors, ASK Investment Holdings, Morgan Stanley Investments, and Birla Life Asset Management Company are some of the mutual funds¹⁶ which have taken lead in raising funds for investment in the real estate sector. In this direction, while ASK Investment Holdings has set up a Rs. 500 crore PMS fund, Birla and Milestone have announced their plans to raise Rs. 2,500 crore and Rs. 600 crore respectively for investments in the realty sector. So finally the realty sector seems to be on its comeback mode as all these mutual funds have promised annual returns in the vicinity of 20-25 per cent. In nutshell, real estate sector is really getting warmed up! If the Indian real estate sector is getting warmed up, no less important is the avenues which have opened up before Indian HNI¹⁷ (High Networth Individual) investors in an age vitiated by global recession. The downfall of real estate markets across the globe has led to crash of property prices in developed countries like U.S., U.K., Australia, South Africa, and Singapore. This has triggered a marked increase in demand from Indian buyers interested in making investments in overseas property. Globalisation has indeed weaved global economies!

NRIs AND NEW INVESTMENT OPPORTUNITIES

With Dr. Manmohan Singh calling the shots again, the Non-Resident Indians (NRIs) widely distributed all across the planet earth, have before them a new window of opportunities beckoning them. The Indian governments in the past had opened up the economy for FDI which was warmly embraced by the NRIs. With reform process getting another boost up in the form of Dr. Singh, NRIs can invest in banking, housing, insurance, education and multitude of other sectors more conveniently. While in the banking sector, NRIs/PIOs are entitled to access loans both on repatriation and non-repatriation basis; the Indian government has ensured that housing finance institutions approved by the National Housing Bank and the Commercial Banks offer housing loans to them at status par with an Indian resident. Insurance Companies like the National Insurance Company avail of NRIs with special insurance schemes. NRI bonds and Development bonds are some of the special schemes offered by the Indian government to the NRIs for making hassle-free investments. With the markets’ exuberance amply lucid since the formation of new government in New Delhi, the investors in general and NRIs in particular can feel enthused. They can feel at ease while investing in domestic mutual funds and shares, government issued instruments, and convertible and non-convertible debentures issued by an Indian company. With around 40% of world’s top Fortune companies making India the seat of their operations, Goldman Sachs’ continuous infusion of investments in Indian real estate and infrastructure sectors, and Morgan Stanley’s more than belief in returns from investments in India, the NRIs can, too, exude the same-old confidence which they have always posed in India. With Dr. Singh at the centre-stage, there is no room for negativism and inhibitions. The Manmohan Singh government’s plans to tighten the KYC¹⁸ (Now-Your-Client) norms for mutual fund investments in order to curb the flow of black money into the Indian capital market is a testimony to what the new government is all about! It is noteworthy that recently the British NRIs led by Balwant Kapoor, President of the Indian Overseas Congress of Britain, pledged to contribute their mite, how modicum it may be, in India’s development and economic prosperity. What Mr. Kapoor has done needs to be emulated everywhere across the globe.

Footnotes

1. 1. Hindu rate of growth refers to the low annual growth rate of the Indian economy before 1991, which stagnated around 3.5% from 1950s to 1980s.
2. 2. A growth rate higher than 8 per cent had been achieved in the past in only three years: 1967-68 (8.1%), 1975-76 (9.0%) and 1988-89 (10.5%).
3. 3. A non-banking financial company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by government or local authority or other securities. NBFCs perform functions akin to that of banks; however they cannot accept demand deposits; are not a part of the payment and settlement system and as such they cannot issue cheques drawn on itself.
4. 4. Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle.
5. 5. Fiscal deficit is the difference between the government’s total receipts (excluding borrowing) and total expenditure. Fiscal deficit gives the signal to the government about the total borrowing requirements from all sources. The primary component of fiscal deficit includes revenue deficit and capital expenditure.
6. 6. FDI or Foreign Direct Investment is any form of investment that earns interest in enterprises which function outside of the domestic territory of the investor. For an investment to be regarded as an FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign affiliates.
7. 7. 3G is the third generation of telecommunication hardware standards and general technology for mobile networking, superseding 2.5G.
8. 8. FII is an investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. The term is used most commonly in India to refer to outside companies investing in the financial markets of India.
9. 9. An American Depository Receipt (or ADR) represents the ownership in the shares of a foreign company trading on U.S. financial markets. ADRs enable U.S. investors to buy shares in foreign companies without undertaking cross-border transactions.
10. FDI is defined as a company from one country making a physical investment into building a factory in another country. The direct investment is in contrast with making a portfolio investment, which is considered an indirect investment. FIIs, NRIs, and Persons of Indian Origin (PIOs) are allowed to invest in the primary and secondary capital markets in India through the portfolio investment scheme (PIS). Under this scheme, FIIs/NRIs can acquire shares/debentures of Indian companies through the stock exchanges in India.
11. WMA is a facility under which the government (state as well as the centre) can borrow from the central bank to meets its daily revenue mismatches.
12. A stimulus package is a combination of several measures to get the economy moving (stimulated) again. The basic purpose behind such a package is to get money into people’s hands to get them spending, to get banks to loan money, and get people jobs.
13. Primary market issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Primary markets are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee its sale directly to investors.
14. Once the initial sale is complete in primary market, further trading is said to conduct on the secondary market, which is where the bulk of exchange trading occurs each day.  It is where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges – such as the New York Stock Exchange and the NASDAQ are secondary markets.
15. Non-resident Indians are people of Indian origin who are born outside India or people of Indian origin who reside outside India. Persons posted in U.N. organisations and officials deputed abroad by Central/State Governments and Public Sector undertakings on temporary assignments also come under the umbrella of Non-Resident Indians.
16. Mutual Fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.
17. HNI is a classification used by the financial services industry to denote an individual or a family with high net worth. The most commonly quoted figure for membership in the high net worth “club” is $1 million in liquid financial assets.
18. In its drive to stem the flow of black money into the capital market, the Indian government plans to further tighten Know-Your-Client (KYC) norms for mutual fund investments. Currently, KYC norms are applicable only for investments of Rs 50,000 and above.