Economy: Batting on a Doctored wicket?
The government needs to summon the political will to step up capital expenditure by trimming subsidies, instituting more efficient, intelligent and diligent taxation and attracting more FDI
Mohan Guruswamy Delhi
When we want to evaluate the economic performance of a nation, the first indicator we seek is the GDP growth. Whatever the Finance Minister may say, the economy has slowed down considerably. The government has now slashed its full-year economic growth forecast to 7-7.5% from its mid-year forecast of 8.1-8.5% made in December 2015. With almost a full quarter to go, and no new credible government impetus possible, it looks like even 7% may be a bridge too far.
We must not forget that these GDP numbers have an inbuilt padding in them. The GDP growth rate was tweaked a bit in February last year to put India on a higher trajectory, by giving itself an added 2.2% as a bonus by resorting to some statistical legerdemain. This led even Reserve Bank of India Governor Raghuram Rajan to comment: “There are problems with the way we count GDP which is why we need to be careful sometimes just talking about growth.” Rajan cited the example of two mothers who babysit each other’s kids and each pays the other. There is a rise in economic activity, but the net effect on the economy is questionable. He said: “We have to be a little careful about how we count GDP because sometimes we get growth because of people moving into different areas. It is important that when they move into newer areas, they are doing something which is adding value. We do lose some, we gain some and what is the net, let us be careful about how we count that.”
By this padded measure, growth in the last year of the UPA government would have been a good looking 6.9% instead of the dismal 4.7% calculated then. The current year-end projection means that even a full two years after Manmohan Singh demitted office, the GDP has grown a mere 0.5%. Take out the bonus of 2.2% and you have a more plausible growth of 5.2%, which is in line with the original IMF forecast.
Nominal GDP growth rates are measures at current market prices and corporate profitability also usually grows at that pace. For example, India’s nominal GDP growth used to be in the range of 12-15% in the past several years and corporate profitability also used to be in that range. The inflation rate is reduced from nominal GDP growth rate to calculate the real GDP growth rate. Since Indian inflation used to be in the range of 4-8% in the past, the real GDP growth rate used to be in the range of 6-9% since you get real GDP growth after adjusting nominal GDP growth for inflation. But in 2015-16 we have a deflation of about 2.2%; this means the nominal GDP growth is 5.2%.
In the Budget for 2015-16 the Union Finance Minister set a nominal GDP growth target of 11.5%. The nominal GDP growth is just 5.2%, or 6.3% below target. This is a big miss. The GDP growth of 7.4% that he is crowing about is the real GDP growth. He is comparing apples with oranges.
If one were looking for green shoots, the first place to look at would be the growth of credit by scheduled commercial banks. For the six critical sectors, namely, Industries, Manufacturing, Mining, Electricity, Construction and Other Infrastructure, as compared to April-September 2014-15 in 2015-16 the growth has perceptibly moved into the slow lane. Credit off take growth for Manufacturing has fallen from 21% to 7.1%. Construction sector off take has slowed from 27.4% to 4.1%. Mining credit off take has fallen from 17.1% to a negative 8.2%. Only Electricity credit off take has just about held course by dropping from 13.7% to 12.7%. Industries credit off take has also perceptibly slowed from 9.6% to 5.2%.
Any farmer will tell you that the time for credit is while preparing the land, buying seed, pesticides and fertilisers, and investing in equipment. After that he waits for nature to play its role and for green shoots to emerge. Our Finance Minister, however, is hoping for green shoots without the credit off take that goes before it. While we are on green shoots, look what happened to credit to agriculture and allied activities. This increased by just 11.1% in June 2015 as compared with an increase of 18.8% in June 2014.
A confluence of hostile weather that hurt agricultural output, high rural consumer inflation, and fall in seasonal employment as farm and construction labour has squeezed rural demand. One other major man-made factor in this is that the present government, in its anxiety to tamp down inflation, did not continue with the trend of higher farm support prices established by the UPA.
This added to the woes of the rural sector, which also saw the return exodus of construction labour from abandoned projects. Between 2004-04 and 2011-12, an estimated 37 million people left the farm sector. The resultant labour shortages were reflected in rural wages, which grew by 15-20% each year. During the past year rural wages grew by only 6%.
The growth of motorcycle sales, which are considered a bellwether of the rural economy, has now become sluggish. While two-wheeler sales rose by 8.09% to hit 1.60 million in 2015, motorcycles have only grown by 2.5% to 1.07 million. Tractor sales have fallen from 6.3 lakh annually to 5.51 lakh last year.
India’s merchandise exports contracted for the 12th straight month in November 2015 on the back of a weak global recovery. Indian exports fell 24.4% in November, dropping to $20 billion. Exports had also contracted by 17.5% in October. Imports fell sharply by 30% in November to $29.7 billion, led by a fall in both oil and non-oil imports. Almost all categories of imported items, other than pulses, fruits and vegetables, and electronic goods, saw a decline in November.
Corporate profit as a percentage of GDP in 2015-16 may drop to 3.9%, the lowest since 2003-04. The aggregate profit of Indian firms is likely to be stagnant at around `4 lakh crore. The savings to GDP ratio has been stagnant at about 28%, having fallen from a peak of 38.1% in 2008. So where is the money for investment going to come from?
Overall Foreign Direct Investment (FDI) in India grew by 27% year-on-year to $30.93 billion in 2014-15. Mauritius accounted for about 29% of the country’s total FDI inflows. India attracted $9.03 billion in FDI from Mauritius in 2014-15, whereas it was $6.74 billion from Singapore. Both these countries are tax havens and money from them is mostly passed through funds. So who is actually investing in India?
Countries like the US and the UK together make up 50% of M&A acquisitions in India, and Japan is responsible for another 10%, together accounting for three-fifths of FDI via M&A inflows into India. While M&A data will tell us about the citizenship of the corporates, we will never know the citizenship of their primary owners. But, according to those familiar with this, Indians are the biggest source of FDI investment in India.
Like FDI into India, Indian FDI overseas also mostly transits through tax havens. The Netherlands and Singapore attract most of the FDI from India, with a share of 28.8% and 15.2%, respectively. The British Virgin Islands and Mauritius have a share of 10.3% and 7.0% with an investment of $3,687 million and $3,029 million made in these countries, respectively. Clearly, India needs to become more attractive to Indian investors!
In addition, a huge amount is sent abroad illicitly via financial channels. Washington, DC-based research body Global Financial Integrity (GFI) has calculated that more than $439 billion of illicit funds flowed out of India between 2002 and 2012. Illicit funds can be money from evasion of taxes or capital controls, bribes and kickbacks, or proceeds of crimes like human and antiquities trafficking. We care about illicit funds because they are a drain on the economy that, in many ways, perpetuates poverty and inequality worldwide. India exports 4.0% of its GDP illicitly or 10.3% of its foreign trade. Last year it sent out via these channels about $51.63 billion, which is equal to 215.4% of the incoming FDI.
The opening of FDI up to 49% in the construction sector is a modest refinement of the existing rules, but also a step backwards. Under the tweaked rules, FDI is allowed in projects with a minimum built area of 20,000 sq m, down from a previous 50,000 sq m threshold. The minimum capital investment by foreign companies was $5 million. India earlier allowed 100% FDI in real estate development but with strict conditions, including a lock-in period of three years during which the investment could be repatriated. Now that lock-in period is removed, but capping the FDI in construction at 49% is regressive rather than reformist. Besides, how does this address the problem facing the construction sector?
Raising FDI limits from 26% to 49% in any sector can hardly be deemed a reformist move. What the foreign investors are looking for is unfettered control over their investments, and not being forced into a partnership with the regime’s CII and FICCI cronies. It makes little difference if FDI is raised from 26% to 49%. Which defence major will transfer its proprietary technology to a venture in which it is forced to have a minority stake?
Besides, what is the rationale for imposing a 49% ceiling on a business planning to make weapons here when 70% of defence purchases are from overseas companies, which are 100% foreign owned? Wouldn’t it have been simpler and more intelligent to announce sourcing from even 100% FDI companies as long as the manufacturing was local? By doing this, the value addition will accrue to India’s economy and there could also be collateral benefits in the form of local vendors and technology absorption. Clearly, more thinking is needed on the question of FDI.
The government needs to summon the political will to step up capital expenditure by trimming subsidies, instituting more efficient, intelligent and diligent taxation, and attracting more foreign direct investment, not only in industry but even more in infrastructure expansion and modernisation. Till then green shoots will be just like shaven grass strewn on a doctored cricket pitch. Something Finance Minister and Delhi cricket czar Arun Jaitley is very familiar with.