India’s celebrated position as the world’s fastest-growing large economy conceals a dangerous weakness: Too few people seem to want to invest in the country. Even going by the government’s growth figures, private investment is shrinking at an increasing pace—by 1.9% between January and March, and by 3.1% between April and June.
The government is struggling to make up for this lack of confidence with its own money. Recent reports suggest officials may seek parliamentary approval for $7.5 billion of additional spending over the next five months, which they hope will increase growth by 0.4 percentage points.
The strategy isn’t new. When he entered office, Prime Minister Narendra Modi confronted a slowdown in private investment that had brought India’s growth down from near double digits in 2010 to around 5 to 6% in 2014. He and his economic team decided then that public spending was the answer. They hoped that boosting government expenditure would “crowd in” private investment—that it would raise investors’ spirits, fuel optimism and lead to major private-sector activity on the ground.
But that’s simply not happened. And it’s worrying that, with half its term gone, the government seems unable or unwilling to admit that its approach isn’t working.
There are two reasons for India’s dangerous investment gap. First, the financial pipeline for new investment is broken. In India, funding for new projects tends to come from the banking sector, which is dominated by state-controlled banks. Unfortunately, state banks are struggling with their balance sheets. They’ve got a large number of bad debts to clean up; while many have been accounted for in the last couple years, more will no doubt emerge. The result, of course, is that credit growth has been anemic. As a matter of fact, bank lending to industry actually contracted in August for the first time in a decade.
The government has done too little to fix the pipeline. There’s only one real solution: to reduce the economy’s dependence on public sector banks, which are so vulnerable to manipulation by influential tycoons. Instead, officials have not only taken the idea of privatizing these banks off the table, but are now promising to be more “pragmatic”—read: more lenient—about forcing them to clean up their books.
Second, investors have been burned too often in the past by arbitrary government decisions; disputes over taxation or environmental regulations have stopped work on many projects. Infrastructure investment in particular continues to be held up—about half of India’s large projects are delayed—tying up capital and leading to big losses for investors.
Investors will need to see concrete change before they start putting money back into the economy. The government has made a lot of noise about easing the task of doing business, a key element of Modi’s flagship “Make in India” program to boost manufacturing. And some low-hanging fruit has been plucked; the country rose four spots on the World Bank’s “Doing Business” ranking last year, to 130th. But Modi has often stated that he doesn’t even know what “big bang reform” would look like. He’s thus focused more on pushing public investment than promoting the sustained deregulation and reform—to labour and environmental rules in particular—that would restore investor confidence.
Many investors openly say now that real change remains elusive, which is why companies have met government promises with their own promises, not money. Consider what was being sold as one of the big successes for “Make in India”—a promise from Taiwan-based Foxconn to set up a plant in Maharashtra. Over a year has passed without any sign of that investment.
Even companies that have committed money are having second thoughts. Another supposed success of Modi’s PR blitz was to have been a new Ford plant in his native Gujarat. But Ford’s CEO Mark Fields said this week that the company was “reviewing alternatives” for India; he was more pessimistic about operations there than in any other emerging market.
The government seems oblivious to the warning signals. Worse, its choice to double down on public spending is doubly dangerous, as it will jeopardize one of the few unquestioned successes of the past few years: the restoration of stability to India’s budget mathematics. The government has already overshot its fiscal deficit target for the current financial year by a larger margin than at any point in the past five years. Simply spending more and more won’t help—and might well hurt. Bloomberg
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