In 1980, British Prime Minister Margaret Thatcher coined a phrase that became famous all over the world. Speaking of the radical reforms that her government had introduced—reforms that broke the back of the trade unions, curbed inflation and vastly improved productivity—she said, “There’s no easy popularity in what we are proposing, but it is fundamentally sound. Yet I believe people accept there is no real alternative.” The phrase, there is no alternative, became the acronym TINA, which was widely used while arguing the case for free markets. But in 1980, it was first mooted at a time when the UK was mired in a deep recession, with very high unemployment. India is now at a TINA moment. In the coming general elections, the economy just cannot afford more populism and continuing uncertainty.
The impact of the current government’s policies on economic growth needs no reiteration. The International Monetary Fund (IMF), in its recent country report on India, estimates that newly announced investment projects had fallen from an average of 10% of gross domestic product (GDP) in 2006-07 to a mere 1% of GDP by 2012-13. By mid-2011, stalled and shelved projects had risen to 2.5% of GDP. The government did realize its errors and went in for a course-correction, but it was too little, too late. The problem has also been that the current government speaks in different voices, with that of the very capable finance minister often being drowned out by the din emanating from party headquarters.
The new government will face two important external risks. The first one is the end of quantitative easing in the US and higher interest rates there. The risks are so high that both Reserve Bank of India (RBI) governor Raghuram Rajan and Indian representatives at the recent G20 conference have called on the US Federal Reserve to consider the impact on emerging markets before taking their decisions. The other external risk is that of a hard landing in China. Chinese debt is both very high and on very shaky ground. Close to half of global fund managers believe that the biggest tail risk to markets is a Chinese hard landing.
That doesn’t mean, as the current government insists, that it’s only global factors that are responsible for the slowdown in India. The IMF country study brings out the negative impact of deteriorating business confidence and heightened uncertainty. Taking an index of economic policy uncertainty created by economists Scott Baker, Nicholas Bloom and Steven Davis, the IMF finds that while the current level of policy uncertainty in India has come down a bit since its 2012 peaks, it’s still very high. The report clearly says, “The current level of uncertainty exceeds its post-Lehman highs, suggesting that uncertainty is primarily driven by India’s domestic policy challenges, and not by global uncertainty such as related to changes in expectations about QE (quantitative easing) tapering.” It concludes that half of India’s investment slowdown is the result of policy uncertainty, falling business confidence and supply bottlenecks.
There are bigger worries on the horizon. Slowing growth has resulted in bad loans going up sharply among public sector banks. Add restructured assets and the stress among banks is now very high indeed. IMF’s country report shows that, in 2012-13, 17.3% of bank advances were to loss-making firms. It goes on to say that if a subdued economic outlook and global liquidity tightening continues for long, further deterioration in corporate health and subsequently higher restructured advances and non-performing assets (NPAs) can be expected. In short, if the economy doesn’t turn around quickly, United Bank of India may not remain an exception and more public sector banks could be in trouble.
The new government will be faced with domestic headwinds as well. A hawkish RBI with inflation targeting may continue to keep interest rates high. Not that its approach is wrong—higher real rates are needed to boost financial savings and make a structural improvement in the current account deficit—but in the short term, it does create a higher hurdle rate for investments. Indeed, IMF has called for maintaining the tight monetary policy stance for a prolonged period. The current government has met its fiscal deficit target by pushing back expenditure and bringing forward dividends, making the next finance minister’s task even more difficult. The right to food legislation will increase subsidies. And the new land acquisition policy will make it more difficult or delay the acquisition of land for industry. Tough structural reforms can no longer be put off. And unlike in 2009, the new government does not have the luxury of increasing government spending.
Most importantly, there are the social costs. National Sample Survey Organisation data shows that 16.3% of young urban male graduates were unemployed in 2011-12 and that figure can only have gone up since then. The longer the economy remains stuck at low growth rates, the worse will be the unemployment problem. Economist Vijay Kelkar had estimated that the economy needs to grow by 7% annually to absorb the increase in its labour force.
In short, it can no longer be business as usual. Business confidence has to be revived, supply bottlenecks have to be eased, investment resuscitated and structural reforms initiated. That’s a tall order for any government. But at least the odds of success improve if we have a stable business-friendly government that can take quick decisions and instil confidence in industry. While no Indian government can remain immune to populist pressures, we can at least have a government that stresses development rather than doles. The good news is the opinion polls suggest that Indian voters increasingly recognize this.
Manas Chakravarty looks at trends and issues in the financial markets.
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