The year 2014 onwards, one is bound to see India facing its worst economic crisis, irrespective of the fact whether Mr. Modi becomes PM or not. Since it is the first time India will face an economic crisis without any luck or local stimulant as Manmohan Singh’s actions (or rather lack of them) have exhausted India of any option, and India is staring at serious crisis without any arrow in its quiver. With 6th Pay Commission stimulus tapering off and with the almost negligible capital formation for last few years, attempts of bringing back growth by having same old & tired textbook measures – like interest rate cuts – are not going to yield any positives. The author argues that the only way India can escape this crisis is by building consumption in short-term and capital formation in long-term, which means taking extraordinary counter-intuitive measures like deflating real estate sector and boosting SME/manufacturing/infrastructure by simplifying rules/reducing the interest rate.
2014 is here and somehow things look a lot better than what they were six months ago. Political change is in the air. AAP party, in a historical mandate, has been sworn in Delhi, and Raghuram Rajan, the new RBI Governor is making all the right noises. Suddenly from the despair of 2013, we seem to usher in a new year with a lot of positive vibes and hopes. No longer are talks of Indian rupee hitting a new low or Sensex collapse ruling news channels but newspapers are filled with reports of growth in hiring, salary increments and SENSEX hitting 25,000 by May 2014.
In fact, there is a wide-spread hope and belief that Indian economy will go in further overdrive if Narendra Modi / BJP gets the decisive victory which is, at best, a wishful thinking, and at worst, simply a mirage. This thinking stems from the fact or view that India was able to manage earlier economic disturbances on account of smart leadership maneuvers, and hence, coming crisis can also be taken care of by the sheer leadership of Narendra Damodar Modi. Before jumping to such conclusions, probably one needs to understand the Indian context and earlier brushes with economic crisis faced by the nation in a post-liberalized world.
India, despite being one of the ancient civilizations, has a very short history of being an independent state and even shorter history of being a liberalized economic market. This means that as a nation we have hardly any experience of boom/bust cycles as pre-1991, average household budget used to follow Hindu rate of growth governed by a monthly quota of ration and benevolence of state, while post-1991 India has just seen a phenomenal increase in overall wealth and conspicuous consumption.
Though post-1991, India did face an economic crisis in 2001 and 2008, but due to a variety of unintended situations, all these crises failed to make any impact as details below.
Dotcom Bubble and 2001 Economic Downturn
Post-liberalization (1991), the World and India stared at its first recession at the beginning of 21st century, when the dot-com bubble collapsed and 9/11 attacks happened, bringing global economic engines to almost a halt. However, other than some offer withdrawals at Indian management institutes, 2001/02 recession didn’t impact India at all for a variety of reasons. A lot of levers got in play to push the Indian economy on a growth trajectory despite the overall slowdown. Of all reasons, the foremost engine driver was BPO/KPO sector which not only created huge job opportunities in major cities but also absorbed the pain caused by the slowdown of IT industry. While BPO/KPO sector was keeping job growth fast and driving export income, on the domestic front, Infrastructure (road/port, etc.) and telecom sectors were taking shape.
The NDA Government, led by Prime Minister Atal Bihari Vajpayee, focused on building world-class roads all across India and rolled out the golden triangle. On the other hand, the entry of MTNL in mobile services with incoming calls becoming free led to price-drops and super explosion in growth of subscribers.
These two factors, i.e., improved road infrastructure and growth in telecom subscriber numbers, unlocked constraints in the economy and in fact paved way for one of the biggest GDP expansion India had ever seen, and year after year India clocked 7%+ GDP growth. This super rocket growth helped SENSEX break every record every quarter and India joined China in being the darling of fund managers on Wall Street. Billions of dollars were raised by funds to participate in India story. In a way, India had arrived on the world economic stage.
2008/09: Subprime Mortgage Crisis and Lehman Brothers’ Bankruptcy
While India was marching ahead to glory, far far away, USA was busy rediscovering nirvana in housing/mortgage driven by cheap Greenspan dollars whose solution for every problem was a little more liquidity. However, the party soon ran out of fuel and the world was hit by one of the biggest financial crisis with stalwarts like Lehman Brothers going bankrupt and 100s of banks in the US collapsing under subprime load. The whole world went into crisis except one country – India. While the majority of people were led to believe that India survived on account of the leadership of then economist PM; however, the truth is India survived the aftermath of Global Recession more by luck than any other thing, and least by Govt actions.
In 2006, Indian Govt without any idea of the upcoming 2008 financial crisis, set up 6th Pay Commission to review and revise the salary of Govt employees. The Commission came with its report in 2008 and released arrears in 2009-2010. This commission impacted almost 20 million Govt employees (Central and State Govts) and resulted in an annual increase of INR 12,561 Cr per annum (USD 2.5 Billion per year) and one time arrear of INR 30,000 Cr (around USD 6 Billion). As expected, this worked as mini-stimulus, as almost all of it went into auto and housing sector. The table below is almost self-explanatory where one can see growth in sales of passenger cars which witnessed the largest increase of 27% in the year 2009/10 and 2010/11, while the commercial sector was hardly growing.
However, lack of any new initiative and slowing down of the economy due to policy paralysis resulted in almost zero job growth scenario and impacted car sales. Automobile sector faced slower growth in 2011-12, which turned into negative growth as automobile sale decreased every month in 2013.
2013 Onwards: Of NREGA / Fiscal Deficit and Real Estate
The year 2009 saw the re-election of Dr. Manmohan Singh led Congress Govt, which made analysts believe the beginning of another golden era since the government was no longer at the mercy of mercurial left parties and a prison to their economic agenda. It was expected that government emboldened by its electoral win, will unleash economic reforms, which coupled with GST and DST will catapult India much ahead of China.
However, in a karmic turn of events, all deeds of UPA I came to haunt UPA II. Bad moral hazard expenditure, like NREGA, increased labor cost for marginal farmers, thus created supply-side challenges while 6th Pay Commission returned to haunt Govt in the form of the high fiscal deficit which ballooned to 6% from earlier range of 2.5% to 3.0% in 2006.
Hence, despite all the talk of big revival and growth, India, in fact, is in the middle of a crisis as is evident by the following:
- The automobile sector is seeing negative growth: 9-month consecutive drop in sales. Leading companies like Ashok Leyland, Tata Motors, etc., are cutting production schedule and realigning workforce.
- Telecom sector after posting consecutive growth is now slowing down and is no longer front end driver of the economy.
- Infrastructure remains in the middle of nowhere as no large projects are being announced while earlier projects which had absorbed billions of dollars are yet to see the light of the day, thus creating a real crisis for investors as all invested capital remains locked as an unproductive asset.
- PE funds who had invested big time in Power / Infrastructure and roads in 2007-09 are yet to see any return of capital and majority of investment remains under water.
- PSU banks, which helped real estate sector weather the storm in year 2009 by restructuring loans and saved it from big crash, is again staring at next level of restructuring, since the real estate players got greedy post-2009 and led to a price growth of 3x in the last 5 years and focused on EBITDA protection rather than cash flow management.
Real Estate – The Double Whammy
Real estate in India remains an interesting asset class, which has given best returns among all asset classes since 2000 and continues to rise despite the call of bubble burst now and then. In a way, the real estate sector in India, while showcases success and growth, also symbolizes as whatever is wrong with the Indian economy. Today, the real estate sector poses the following challenges:
- Very high housing prices in comparison to median earning. Housing in India is expensive or at par with housing cost in the developed world.
- Debt level at real estate companies is at an astronomically high level where some of the companies, like Jaypee Infratech, have a very high level of debt posing a systemic risk to Indian banking sector, as noted by RBI Governor in a recent statement.
- Real Estate sector growth has to lead to jumping in housing prices by 5x to 10x in last 10 years while rentals have also jumped by the same level, though salaries have not kept pace at the same level. Today, the majority of free cash flow at the household level is going either in EMI payment or rent, which is restricting discretionary spend and thus creating a slowdown in consumption.
As one can see the Indian economy is facing a unique crisis of having high inflation and very low growth. This unique scenario has made limited options available to RBI, which anyway never moves beyond Keynesian models. High inflation will eliminate the possibility of a rate cut as there is this naïve belief in India that low-interest rate will fuel inflation and will further impact growth. The powers in finance ministry need to understand that India is not west and does not have the luxury of enormous resources as well as well-oiled supply chain. Inflation in India is not a function of more demand but supply-side constraints, which becomes worse with higher interest rate and crony capitalism.
The only way Indian economy will find wings again is if real estate sector collapses (price reduction of 30% to 50%) and help to unlock all productive capital locked there and manufacturing becomes friction-free, which is the elimination of red-tapism and paperwork for small and medium enterprises.
So in a nutshell, RBI and finance ministry need to reduce interest rates for SME sector and agriculture while doing away with housing loan interest tax breaks, increase interest rates for housing by at-least 300 basis points for the additional house. Till this is done, the local economy will remain sluggish and will not witness any fundamental shift at grass-root level and 2010-2020 will be more of a lost decade than an Indian decade.