Getting investments to pick up requires getting the risk-reward ratio right, and right now that’s getting worse.
The steady slowing in India’s growth prospects, it is obvious, is directly related to the sharp slowing in investment levels (see graphic), from 34.3% of GDP in FY12 to 31.7% just before Narendra Modi came to power, and then to 27.1% in FY17. The biggest decline, contrary to what most believe, is not in investment by the private corporate sector but in what is called ‘household’ investment, which is investments by individuals in housing and by small businesses—like an export unit in Tiruppur. But, as Axis Bank chief economist Saugata Bhattacharya argues (https://goo.gl/LuDHpV), this is related to the slowing in corporate investment after 2008—with jobs growth slowing, so did household investments or those by small units. So corporate investments are what matter.
Why did corporate sector investments slow? That is the question prime minister Modi and finance minister Arun Jaitley are grappling with—indeed, the various stimulus packages they are working on are related to the failure of private investment to grow fast enough. There are, as this column has pointed out before, various other reasons for the slowdown other than the fall in investment growth. After two years of drought, Modi’s policy of restricting farm exports, for instance, ensured rural demand didn’t grow as much even after a good monsoon as farm prices collapsed in the face of higher production. And decades of poor labour laws and weak infrastructure, along with an expensive rupee, ensured India’s exports—a key growth-driver—never rose fast enough to take advantage of China vacating various global markets (https://goo.gl/wfQrHL).
Industrialists, it is obvious, will take on risky investments only if there is a reward to be got—and the riskier the investment, the greater the reward that is required to justify the outlay. It is to lower the risks involved, for instance, that the government is trying to fix various Ease of Doing Business parameters. The problem, however, is that while businessmen are not reporting any dramatic difference in the time/money needed to obtain critical clearances, in some ways risk levels have gone up since Modi came to power; in many areas, with no improvement, the risks remain as high as in the past—so with sluggish growth in local and global demand, there is no compelling reason to raise investment growth in a big way.
This newspaper has extensively documented how telecom losses have steadily risen due to the government combining expensive telecom auctions with high annual revenue-share-based licence fees; things have only got worse with RJio coming in, with what the incumbents’ alleged was predatory pricing and Trai’s distorted policies. In which case, it is difficult to see incumbent telcos making more than just defensive investments. In the gas sector, the refusal to honour—for two long years—the UPA’s promise to hike prices to market levels made investments riskier and, as a result, fresh exploration ground to a halt. In the pharmaceuticals space, the government did little to fix the UPA’s policy of price controls that directly affected about a fifth of the industry’s production volumes but, if its draft policy is implemented, this could rise 2-3 times.
There are, sadly, several examples from various industries. Seedtech firm Monsanto limited its India investment in the face of price controls on its cotton seeds and the government trying to put a cap on royalty payments along with introducing compulsory licensing of its technology. If continuously slapping tax demands on the retrospective tax victims—instead of resolving the cases—wasn’t bad enough, Japanese company DoCoMo found the government not only stymieing its exit from India, RBI even opposed implementation of a foreign arbitration award in its favour.
Apart from the uncertainty of whether electricity reforms will actually work, firms that have signed PPAs are finding several state governments reneging on them. General Electric’s diesel locomotive plant’s future now looks uncertain. Apart from the uncertainty that agriculture exporters continue to face, the gaurakshaks and the abattoir mess have made beef exports an iffy business…
If the uncertainty created by courts in, for instance, cancelling mining licences or extending prohibition on restaurants/bars on/near highways wasn’t bad enough, the anti-profiteering authority has further added to the fears of harassment of business. For SMEs, both demonetisation and GST have, in any case, added considerably to their costs, and the government has yet to come up with a plan to comprehensively address this. The impact of the investment slowdown can be ameliorated in the short run by the government increasing spending, or announcing new schemes such as the Saubhagya Yojana that Modi announced on Monday, but it cannot be a substitute.