Friday, June 2, 2017

Indian economy update - the perception fairy marches on?

I have not blogged about the Indian economy in recent times. My assessment, contrary to the impression conveyed by booming equity market and mainstream commentary, is not very promising. Even without the expected decline in output in Q4 2016, the signatures of weakness (even from just the last few days of reports) are everywhere - IT sector hiring (also here), general economy-wide hiring, heavy equipment makers, factory output, non-food bank credit growth,  rising corporate debt, concealed private bank NPAs, and so on. This really does not make for pretty analysis and as Ananth puts it, the emperor (the economy) is almost naked.

I see four major problems, over and above the global and other structural headwinds,

1. Sustainable growth has to be built on private capital investment which appears no closer to recovery. The underlying Gross Domestic Savings and Gross Fixed Capital Formation have declined steeply since 2007. The rising corporate indebtedness, even as many of the biggest companies in infrastructure, steel, telecoms, power, and textiles hobble with massive debt loads, mean that a revival of private investment cycle may not happen anytime soon.

2. The banking sector is in shambles. Non-food bank credit is at an unbelievable 4% (it beats the hell out of me how we are having 7% GDP growth with such numbers!). The NPAs continue to rise and there are signs that even the much feted private sector banks too may be no different. In fact, the shocking 558% divergence in NPAs for 2015-16 between Yes Bank's audited annual report and RBI's asset quality review should count as a scandal, necessitating an enquiry by the regulator holding both the management and the auditors accountable. Even outside the NPAs, god knows what proportion of the remaining loans are some form or other of "ever greening". And all this appears to be getting worse with no end in sight.

3. India's most valuable resource is its large population, the foundation of the country's growth potential. The large population is expected to supply the skilled labour, enterprising businessmen, and voracious consumers that can propel sustained and high economic growth for decades. But unfortunately, each one of those impact channels faces serious problems - poor quality of education, excessive dominance of micro-entrepreneurs, narrow formal sector jobs and consequent limited consumption class.

4. To fix all these problems, and even to enable markets, require a capable state. But the Indian state is shockingly weak. Worse still, even insiders under-estimate the degree of atrophy. Most people acknowledge implementation deficits, but somehow stop short of shining light on the plumbing of state capacity. The solutions to addressing implementation deficits take the shape of fads - process re-engineering, outsource, privatise, and now digitise. These are all going to get you only so far. After all, neither can adaptive learning nor an electronic medical records, just on their own, make significant dent on poor quality of primary education and healthcare respectively. 

Right now, the government is doing its bit to prop up growth. And in a large economy like India, the government can have a significant marginal contribution to growth. But there is only so much the government can do, and before long such reliance can end up with deficits and debt build-up.

The even more dismal economic and political environments in many other major economies compared with the relative stability here, and the enduring narrative of a large market, great potential, and the precedent of China's growth makes India stand out. But how long can the perception fairy continue to sing?

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