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Boom and bust of the Indian economy

January 18, 2016 15:06 IST

Private investment will respond only to sustainable reform, not to a false demand revival born of tax breaks or public spending, notes Mihir S Sharma.

It is fashionable to question whether India's economy is "really" growing at seven per cent a year. 

Many argue that this doesn't "feel" like a seven-per-cent-growth economy.

The point usually is that the government has not done enough in its 20-month tenure to accelerate the economy, and return it to the high-growth path that it wandered off in 2012-13. 

The claim that the government could have done more is not incorrect. But the thinking underlying that claim is off-base.

Yet, it is this mistaken thinking that affects the measures and policies being demanded in order to spark this supposedly missing growth. 

In order to understand why much current thinking about Indian growth is off-base, it is necessary to note two things about economic revivals.

Both involve looking more closely at the problems that are built up in boom years, and how they must be unwound. 

The first is that, during boom years, unrealistic assumptions about the future are made.

When the boom ends, those who make the assumptions need to take a haircut.

In this process, disputes about sharing the loss burden arise; the quicker those disputes are settled, the quicker the economy will revive.

This is a different process from simply "clearing" projects - after all, many may have turned unviable.

Fortunately, the government has taken some steps to deal with these myriad little wars of attrition, particularly in the roads sector. 

A more general and impartial process of settling these disputes is still awaited, though I have been told one is being worked on, and am confident it will eventually arrive. 

The second is that the boom economy was, by its very nature, unsustainable. In India's case, the pre-2012 boom was sustained by cheap inputs - land, capital, natural resources.

Natural resources will not be near-free again, for sound political reasons; and land, for similarly sound political reasons, will not be freely handed out by the state again.

Capital will not be so readily available given the economy's debt overhang, the Reserve Bank's inflation hawkishness, and public-sector banks' troubled books. 

Nor is it wise to try and ensure the post-boom economy is structured like the boom economy.

In the West, real estate and finance had grown too large, and a post-boom economy should ideally return them to a more sustainable size; India, too, must refrain from excessive targeting through incentives and policy action of those sectors - like infrastructure - which had led the boom economy.

As the minister of state for finance, Jayant Sinha, correctly told this newspaper in December, a revival will be led by different sectors from those that had led the boom.

The problem is that it is difficult to, ex ante, identify these sectors.

It looks like it will be healthcare, it may be affordable tech - but we can't be sure.

The government must not try this feat of identification, but instead ensure all sectors have access to an enabling investment and regulatory environment. 

In this context, looking simply at what has fallen since the boom years - private investment in certain sectors - is exactly the wrong thing to do.

Yes, there is a crisis of investment. But that cannot be "solved" by trying to restore pre-2008 conditions on land or capital; by artificially boosting demand through expanding public spending, as happened in 2011; or simply by exhorting the private players in those sectors to take risks. 

Private investment will respond only to confident expectations of future security and growth. 

Such confidence will only be built up when those doing the investing recognise the errors of the past have been corrected - that dispute settlement, in case of investments going bad, will be speedy, and that any investment will be safe from judicial and regulatory challenge if and when the political climate changes.

The only way to secure that safety from any imaginable future challenge is through changing laws.

The bankruptcy code is the right template for how such safety can be assured; providing project-specific pushes, or changing the "risk template" in private-public partnerships, is the wrong one.

Moving burdensome compliance online is inadequate in terms of providing sustained security for investment, when compared to changing the arbitrary laws on the books.

Long-term investment responds to long-term security. It will see through any false "demand" revival born of tax cuts, or exemptions, or a ramp-up in spending. 

In other words, the government should not avoid the hard task of changing laws and regulations; it should not target specific sectors, like tech startups or electronics; it should not imagine that "clearances" of big projects, state-coerced land acquisition, and bullying banks to lend will revive investment.

Such measures will not work properly; and to the extent they do, they will simply lead to another build-up of the problems that caused the economy to stutter in the first place. 

The error made by those who worry the economy does not "feel" like it is growing is born of such assumptions - that a reviving economy will "feel" like it did back during the boom years.

It should not. Those years were marked by big-ticket investment in infrastructure and other projects that boosted our investment-to-GDP ratio but have been shown up, subsequently, as disastrous choices born of hubris and stupidity.

It should be obvious that big, over-optimistic investment announcements are not a sign of success; they are a sign of unsustainability. 

If you stop focusing on such announcements, then even by the "feel" test, the economy seems to have pulled out of a slowdown - in urban areas, at least.

True, inflation is down thanks to cheap oil, so the illusion of constantly growing wealth it provided is absent. But pierce that illusion, and look more clearly at everything around you.

The headline may be that home loans are struggling - but, in fact, in Tier-II towns, there's been double-digit growth in disbursement.

Consumer-facing businesses - shops and restaurants - are setting up, not shutting down. 

Anecdotally, sponsorship for events and cultural activities has become much easier to come by. 

India's advertising budgets were up 16 per cent in 2015, according to the marketing analysts Warc, and will be further up by between 13 and 14 per cent this year.

Hotels report that business travel has increased. Luxury car sales are up.

The distress in rural areas, however, is visible in the decline in sales of two-wheelers; that needs urgent attention, and the Centre is right to declare that the next Budget will have a rural focus.

If anyone has a right to "feel" the economy is not on the right track, it is the rural poor, who have seen a two-year stagnation in real wages - even though growth in overall private final consumption stabilised above five per cent in 2015.

Rural India clearly needs revitalising; urban India does not need tax breaks, another stimulus, or pandering to fashionable sectors like the app economy. 

So, ignore those criticising the "feel" of the economy.

In spite of all the noise, the truth is this: the government's handling of the economy has so far been competent, if uninspired.

Certainly, it should be urged to do better, to spend real political capital on structural reform. 

But let us not ask it to repeat the errors of the past, or to make new ones.

Mihir S Sharma
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