Pradip Shah, chairman, IndAsia Fund Advisors, who tracks the Indian financial scene closely, believes foreign flows could taper off this year as investors look for opportunities in other markets. In a conversation with Shobhana Subramanian, Shah says that this could leave the private sector with less money with which to fund its growth plans.
What are you making of the macroeconomic situation with growth slowing down?
For the last 30 years we?ve had a growth rate of 6.2% and with the reforms coming in, there was considerable progress so, in the last few years, we?ve seen 8.5%. But when we compare ourselves with China, we cannot but be disheartened; we were at the same level in 1990?their GDP was $910 billion and we were at $720 billion. Today, their per capita income is at $4,500 and we?re roughly at one fourth. Even in terms of purchasing power parity, they?re twice us at $6,500 (we?re at $3,300). So, clearly we have a lot of catching up to do. But when we see what is going on in India, we wonder whether we will ever catch up. There are such brilliant people in government but no governance and no accountability for wrongdoing. We are perpetuating a culture of allowing wrongdoing to go on unpunished and we?re encouraging the young generation, which is our future, to think in this manner.
Instead of hitting 9% GDP growth, we?re going back closer to 8%…
Yes, we are seeing a slowdown. The consequence of inflation for the poor has been so severe and the pressure on households has been so high that people have had to cut back on essentials, like soap, to maintain food budgets. We see government policies that are well-intentioned but implemented badly and allow for leakage, so the benefits don?t go to the poor. And there are other adverse consequences too. While the mid-day meals have helped attendance in schools, children?s protein intake and so on, we?re not seeing the same with the NREGA. About Rs 1,12,000 crore has been spent in the last five years. What is the outcome? These expenditures were supposed to result in some outcome and we are supposed to have some accountability.
But we?ve seen nothing; it?s been allowed to become a black hole with a lot of leakage. There has, no doubt, been some benefit, but a lot of it has seeped away into the hands of politicians. And where it has reached the poor, it has unfortunately had the deleterious consequence of discouraging productive work and so underemployment is getting perpetuated. So, we need to fine-tune NREGA. Because the government is concerned about votes in the next two and a half years, it wants to come up with more programmes like the Right to Food. No one objects to these but there cannot be seepage. The Congress knows that sops are a political weapon but these have dysfunctional consequences via subsidies distorting the economy.
How are investors reading the slowdown and the policy paralysis?
Without doubt there is some disappointment among investors. Even when we were emerging from the global crisis, India was getting a premium to competitors, like China, but that has been a short-lived period. We?re now back to a discount and it?s facile to say that it?s a discount for democracy. Within the democracy, we have shining examples of competent leadership and liberalisation, like in Bihar, where there has been inclusive development. So, investors are willing to come in at a discount but not at a premium. The Reliance-BP deal is one of the largest FDI investments into India so far and it means strategic players are willing to come in because India has demonstrated growth and promises more. But along with that growth will come dissonance because if the needs of the poor are not addressed, law and order will become a problem. While strategic players will come in because they cannot afford to stay out?you see Siemens making an open offer at a multiple of 39 times?clearly there is some caution. The financial investors, who have the ability to move money, are asking for a discount, not a premium that we were asking for last year.
So what kind of foreign portfolio flows do you see this year compared with the record $29 billion that we saw last year?
I think it should be substantially lower, given the governance stories that are coming out and given the opportunities for investors in other markets. The US may not be bounding ahead but it?s certainly moving towards growth. Perhaps you will see the same in some European economies. Germany, for instance, continues to do well. So people will see opportunities outside, perhaps even in China, which has managed to hold its own compared to others. Therefore, India will be less attractive to foreign investors because the competition is doing better and our own problems are tarnishing our image.
A fair share of the foreign flows goes into the primary market. Given that interest rates are inching up, do you think companies might be short of funds?
Logically, our investment to GDP ratio should fall; it has already come off from a peak of 37% odd to 34.5%. I heard the government say it is expecting an investment to GDP ratio of 36% and I wonder whether that is achievable. Interest rates are already high and the availability of capital has become more difficult, from both the equity and debt markets because of the tight liquidity situation we?ve been encountering. So it is not possible to be so sanguine that we will have 36%. Also, we have not yet brought down our capital to output ratio as we should; as infrastructure improves, one would expect that to happen. Also there is a bit of gold-plating in capex and easy availability of capital led to over-expenditure on capex so, to some extent, we may have hidden capacity or hidden possibilities of getting higher revenues but we have not been able to exploit them. Whatever it is, at 36% one would expect a growth rate of 9% is possible. But we will not achieve this because, as I said, we will not achieve 36%; we will possibly achieve 32-33% investment to GDP. Because there are so many projects in the works and they will have to be completed. The government is no longer a leader in starting new projects and we are relying on the private sector. So, we need a facilitative capital market to fund the growth.
Will government borrowings crowd out growth?
One of the good things that happened this year was that the government didn?t need to borrow too much because it earned from spectrum licences and divestments. It is now spending, as part of its budgetary expenditure, and so money will come back into the system and that will ease the liquidity in the market. But the uncertain part is how much money will flow in from outside because that was also supporting liquidity in the market; if money flows out, we will have a shortage of liquidity in the system. Also, with the crisis in the Middle East, there is going to be some capital flight to safety worldwide, the Middle East money will go into the dollar. Oil is at $106 a barrel and that does not augur well for India. We should logically have been insulated from some of the political risk of the Middle East. Although we are not in a bad shape politically, but economically we cannot be insulated.
So how do we manage the current account deficit, which was being funded by short-term flows?
Either we increase remittances, get more tourism revenues and invisibles or we should control the domestic usage of oil. The government had taken the bold step to enable the policy for a passthrough mechanism but has not done it. So we have done it up to $70 but beyond that we are exposed to a fiscal subsidy. We need to increase prices of fuels at the pump to conserve oil and improve the trade deficit, which is unsustainable.
What are three things the FM could do to reassure the markets?
Since the government wants to move towards fiscal consolidation, I think it should get away from fuel subsidies immediately because, although there may be some inflation, it will lead to the conservation of fuel and, at least, it will solve the fiscal issue. To ease the pain, they could phase it out and make adjustments through the excise mechanism. Don?t introduce a food subsidy bill or a Right to Food Bill just now.
Improve the PDS but don?t create populist expectations because it is difficult to withdraw them. Also excise duties should be trimmed?revenues will come from better volumes.
