Untying the Gordian knot

The key to an investment-driven growth strategy is to get the lubricant—money—flowing through the system

Earlier this week I was having a cup of tea with the CEO of a major chemical and food company when he asked me a question: “Arindam, I don’t understand what is happening in the economy. Are we going to be like Trishanku, suspended between the reality of anaemic demand growth and aspirations of ‘achhe din’? We just don’t see any demand growth and just cannot think of investing…” I was hard pressed to find a coherent answer to his comment/question.

We all know that the NDA government has pushed hard on its reform agenda to improve the investment climate and the ease of doing business, get the coal and mining sectors back on track by adopting a transparent auction process, simplify the rules on clearances, get fuel linkage issues sorted out, open up sectors like defence and insurance for FDI, etc. The list is long. Some of the big-ticket reforms such as GST and Land Acquisition Act are being studied by select committees of Parliament and hopefully will get enacted sooner rather than later. There has been some movement in easing up the constraints forced by the rigid labour laws which has disincentivised growth in formal sector jobs.

So why the sluggish economy that made the CEO feel like Trishanku, a feeling which I have now heard industry leaders express in recent conversations. If I look at the analysis/prognosis written up in business media, and comments made by many experts in the government or outside, different reasons are offered—which vary from a somewhat philosophical comment that it takes more than one year to get the stalled economic engine as large as India on track, and expectations of an early return to a heady growth of 7-8% was too optimistic since large-ticket reform areas of tax regime including GST, land acquisition, power distribution, labour laws are yet to be enacted. All these reasons are probably true, but the fact remains that many of these problems existed in the last decade, maybe with less intensity, when we saw high economic growth. So what gives?

I am not an economist and don’t claim to have a deep understanding of the linkages between different aspects of the Indian economy. But my experience as a management consultant tells me that when a problem is big and complex, we often end up addressing symptoms and not the real cause(s), and I wondered if it wasn’t the same for what we are seeing in the economy. To address such a situation, we try and develop a ‘systems view’ of the problem which shows inter-linkages between different issues and separates the root causes from the symptoms. So I tried to develop in my mind a similar systems view to see if one can find an answer to the CEO’s Trishanku question, connecting the dots of different data points and expert comments, and came up with a working hypothesis which I offer below as a series of interlinked issues.

Let me begin with demand in the economy. We know that Indian consumers were the growth engine for the economy in the previous decade. Once this engine stalled, restarting this consumption-driven growth engine after years of inflation and low income growth with interest rates still on the higher side has proven to be difficult. The new government correctly decided that focus has to shift to investment-driven growth, particularly in infrastructure where we had built up a huge backlog in pretty much every sector, and hoped that once growth picked up, consumption will start picking up too—creating a virtuous cycle.

However, investment in infrastructure cannot be made only by the government or public sector; private sector has to play an equal if not a more important role, as it had in the last decade. However, private infra companies have hugely stressed balance sheets with many of their projects stuck due to a variety of reasons, or cash flows lower than optimistic projections in the heydays of growth (for example, toll revenues from roads), or disputes with the government on payment, many of which are in the courts or in arbitration. Delays of even a few years in large capital-intensive projects such as steel can make it unviable, given the high interest rates in India, and even if clearances for these projects are given as this government has been doing, getting these projects back, achieve financial closure (often calling for debt restructuring) and off the ground is still a long-drawn process, given the stressed balance sheets of private infra players. So there can be a lag between approvals in place and getting these projects to ‘take-off’.

These stalled projects have also stressed the balance sheets of banks, which have seen a growth in their NPA levels and are thus finding it difficult to restructure the debt of infra companies—not only to get the stalled projects going but also to fund new ones. I have also heard that many banks have reached the cap on exposure to the infra sector, and are thus unable to take on fresh exposure without a major capital infusion or significant growth in deposits. While the government has talked about the need of a large capital infusion, the amount earmarked in the last budget was a small. The option of getting in public money by diluting equity of the banks seems to be a political no-no. The challenge to deposit growth seems to come from another direction with bankers saying that the ‘yield curve’ for an investor makes bank deposits unattractive compared to the higher interest on small savings schemes of the government. So the reality is that the deposit growth in banks is slowing down. The second order impact of stressed balance sheets of public sector banks, slow credit offtake and slowing deposit growth has banks worried; they are hesitant to go in for aggressive rate cuts despite RBI reducing repo rates.

Which brings us back to the starting point in my hypothetical systems diagram. That despite benign fiscal situation (from low oil prices) and moderate wholesale inflation, interest rates continue to be high in an economy that is struggling to reignite its demand engine, and so both SMEs who are most impacted by interest rates on investment decisions and ordinary consumers have gone into their shell. So we are kind of stuck like a Trishanku between the reality of sluggish demand growth and expectations of achhe din.

If this systems view of the economy is correct, then the key for an investment-driven growth strategy is to get the lubricant—the money—flowing through the system. Which, in turn, means that the infra companies should become ‘bankable’ and bank balance sheets should become ‘lendable’, and both have to happen at the same time. Is this doable? When I broached this question to a economist friend, he said yes, but it will involve some pain in the short-term for all the stakeholders—the government, banks and infra companies. I don’t think we have a choice if we have to make the achhe din come alive sooner than later.

The author is managing director, the Boston Consulting Group, India. Views are personal

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