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May 2, 2019
The perils and promise of India By Angelo Katsoras
India’s Prime Minister Narendra Modi was elected by a landslide in 2014. Five years later, he is now campaigning for re-election to continue building what he calls a stronger and more prosperous India.
However, public perceptions of what Modi has accomplished are mixed. On the one hand, he has presided over strong economic growth, passed landmark bankruptcy legislation, and replaced a hodgepodge of business taxes that varied from state to state with a nationwide Goods and Services Tax (GST).
On the other hand, there is discontent over the lack of good jobs available, the growing financial stress of farmers (a huge constituency), and the failure to further ease restrictive land and labour laws. Though India will continue to experience significant economic growth and the likely re-election of Modi will be looked upon favourably by the markets, how India deals with the above challenges will determine whether it is able to attain its full economic potential.
Some of Modi’s most significant reforms to date The goal behind the implementation of the 2017 GST legislation was to collect more revenues by forcing companies out of the black-market economy. India’s very low tax-to-GDP ratio—just 17.8% compared with the OECD average of 34% (2017 data)1—starves the government of much-needed funds. Early indications show the GST is having the desired effect: The number of registered businesses has increased from 6.6 million just before implementation of the GST to 12 million today.2 Another aim was to facilitate commerce across state lines. Under the old system, trucks waited for hours to pay various state taxes at checkpoints before being allowed to cross.
Under the 2016 bankruptcy law, companies must be liquidated nine months after declaring bankruptcy if no buyer is found. It marked a historic shift of power away from a well-connected class that kept control of their businesses while pushing losses onto the banks. India’s debt recovery rate has increased from about 20% in 2015 to 48% today. The average OECD recovery rate is 72%.3 However, a recent ruling by India’s top court eliminating some of the strict timelines involved will offer debtors a temporary reprieve and force the central bank to adjust certain regulations.
India’s massive digital ID rollout could be a game changer The assignment of a 12-digit identification number should allow most Indians to receive government aid via direct payment to their accounts, thus potentially eliminating corrupt intermediaries who often siphon such things as food aid before it reaches the intended user. Indians will be able to access these accounts via fingerprint or iris scans. However, many of India’s villages still lack bank branches or ATMs and there are fears this technology could be used to invade the privacy of ordinary citizens. Should this digital roll-out prove a success, the companies involved will no doubt offer their services to other countries.
Headline economic growth strong, but devil is in the details India is on an economic winning streak. The economy grew at an average annual rate of over 7% over the past five years. The IMF projects India’s economy will grow 7.3% in 2019 and 7.5% in 2020. Foreign direct investment hit $45 billion in 2018, up from less than $25 in 2014. Furthermore, India is set to overtake the United Kingdom in 2019 as the world’s fifth-largest economy.
These growth rates, combined with the enactment of key reforms, allowed India in the span of one year to gain 23 spots to be ranked 77th out of 190 countries in the World Bank’s 2018 ease of doing business index.
1 “A case for widening the tax base,” The Hindu, January 30, 2019 2 “India’s Modi says most goods to be hit with below 18 percent tax,” Reuters, December 18, 2018 3 “India is no longer a defaulters' paradise,” Nikkei Asian Review, March 24, 2019
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Headline figures mask a more complicated reality
Some economists have questioned the credibility of government GDP figures after significant revisions were made to the underlying data.
The November 2016 decision to withdraw 86% of bank notes in circulation overnight in a failed effort to reduce corruption and tax evasion resulted in severe cash shortages and is estimated to have trimmed one percentage point of GDP growth in the first half of 2017.
India imports 80% of its fuel, which means the economy generally suffers when prices are high. However, it is important to note that the impact of high fuel prices is partially cushioned by the fact that about one-third of India’s oil imports are re-exported as petroleum products.4
Putting India’s economic growth in perspective
While India recently surpassed China to become the fastest-growing major economy in the world (7.1% vs. 6.6% in 2018), it is crucial to take into account their different levels of economic development. After decades of double-digit annual economic growth, it is normal for China’s economy to slow down as it approaches middle-income status and its population ages. Indeed, given its much lower level of economic development, India should actually be growing at an even much faster pace than China.
4 “India Should Beware of Saudi Aramco’s Billions,” Bloomberg, April 20, 2019
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2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
India’s strong growth economic growth GDP annual growth rate (FY ends March 31st)
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NBF Economics and Strategy (data via Refinitiv)
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India’s employment challenges While employment data is hard to come by because more than 80% of the job market is informal, indications are that India is still struggling to create good-quality formal jobs.
Data from the independent Centre for Monitoring Indian Economy estimated unemployment at 7.2% last February, its highest level in 29 months. This organization has also claimed that India lost 11 million jobs in 2018 (a figure disputed by the government).5 Perhaps in view of the upcoming election, the Indian government cancelled the planned release of its latest labour survey in February.
One area where India has long held a competitive edge is information technology services. Indian IT firms provide services ranging from entering/analyzing data to providing customer support for western corporations. Unfortunately, IT is not labour intensive, which means India must rely on other sectors to generate employment.
Public-sector job openings are regularly flooded with applicants. Last year, 19 million people applied for 63,000 vacancies in India’s national railway authority.6 When the Uttar Pradesh police advertised 62 messenger jobs in the same year, 4,000 PhDs, 50,000 graduates, and 28,000 post-graduates applied for the positions. 7
Given that nearly half of India’s 1.2 billion people are younger than 25 years old, the country needs to create almost 10 million new jobs a year just to keep up with the potential workforce. Otherwise, India’s demographics will go from being an advantage to a major source of political instability.8
5 “Wanted: Jobs for Indians,” Fortune India, April 16, 2019 6 “Narendra Modi’s Election Challenge: Create Jobs. Lots of Them,” Atlantic Monthly, April 9, 2019 7 “Wanted: Jobs for Indians,” Fortune India, April 16, 2019 8 “‘The Youth Bulge’: India Struggles to Employ an Exploding Population,” Wall Street Journal, April 22, 2019
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Comparison: GDP per capita PPP(constant international $)
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NBF Economics and Strategy (data via IMF)
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India
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India’s struggling manufacturing sector Despite Modi’s “Made in India” policy unveiled in 2014, manufacturing went from accounting for 17% of GDP in 2006 to 15% in 2017.9 By comparison, China’s manufacturing sector went from representing 32.5% of GDP in 2006 to 29% in 2017 (World Bank).
Companies with more than 100 full-time employees generally cannot fire people without government permission. Despite India’s low wages, this encourages manufacturing companies to either stay small or expand via automation. In an effort to alleviate this problem, the federal government passed legislation in March 2018 allowing certain employees to be hired for limited time periods. However, the widespread use of this system in Europe has created a divide between protected and non-protected workers, and become a significant source of political tension.
Companies struggle to secure land for industrial or infrastructure investment. Any sale of land requires the approval of at least 80% of affected owners and must also pass a social-impact test.10 Compensation is set at double the market value for urban property and four times the value for rural land.
India’s race against robots. Historically, most countries have climbed the economic development ladder by using low-cost labour to attract manufacturing investment. However, the growing automation of industrial processes means cheap labour is slowly becoming less of a competitive advantage. All of this increases the urgency for India to pass economic reforms sooner rather than later in order to benefit from manufacturing while the sector still relies on a substantial human component.
India’s inefficient farming sector The relative lack of jobs in the manufacturing sector prevents many Indians from leaving their farms and migrating to urban areas. This also stops many farms from being consolidated into more economically viable larger units. On top of this, farmers are struggling with high fertilizer prices, low yields, water scarcity, and low crop prices. One point above all highlights the sector’s inefficiency: Despite employing close to half the population, the agriculture sector accounts for only 15% to 17% of GDP.11
In an effort to calm the ire of farmers in the run-up to the election, Modi announced direct annual cash payments of 6,000 rupees ($85) to farmers with less than two hectares of land. This is the equivalent of about a month’s earnings.12 The Congress Party, the main opposition party, announced that it supports annually giving 72,000 rupees ($1,045) each to 20% of India’s poorest families.
Shortage of water yet another challenge facing India
India has 17.9% of the world's population but only 4% of its available freshwater supply. Despite the fact that India is one of the most water-stressed countries in the world, its citizens pay some of the lowest water prices anywhere. This means that, on the demand side, consumers have little incentive to conserve water while, on the supply side, investors have little motivation to build pipes and treatment plants.
Another challenge facing India is high bad debt levels It is estimated that over 10.3% of India’s bank loans (nearly $200 billion) either cannot be repaid or must be restructured largely because of loans funnelled (often under political pressure) into large-scale infrastructure projects without due diligence. Government-owned banks control about 70% of all banking assets in India and they have the highest exposure by far to bad debt.13
9 “A vote of confidence in India as nation heads to polls,” Bloomberg, April 7, 2019 10 “THE MODI GOVERNMENT'S REFORM PROGRAM: A SCORECARD, Center of for Strategic & International Studies, 2019 11 “Has Narendra Modi been good for business?” Nikkei Asian Review, February 20, 2019 12 “With India’s Election Looking Close, Modi Packs Budget With Handouts,” New York Times, February 1, 2019 13 “Bad debts may still be a headache for India’s state banks,” CNBC, April 9, 2019
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Source: “India Risks Fresh Bad-Debt Pile Up as Weak Banks Resume Lending,” Bloomberg, March 22, 2019
India’s sovereign debt levels
India’s sovereign debt as a percentage of GDP has remained stable since the financial crisis. From 2008 to 2018, India’s sovereign debt declined slightly from 74.5% to 70% of GDP. At 19.8% of GDP, India’s external debt compares favourably with that of many other emerging-market economies. Forty-eight percent of this external debt is denominated in U.S. dollars and 37% in Indian rupees. India’s foreign exchange reserves are at US$426 billion.14 However, the possible recapitalization of its financial sector could either raise these debt levels or shrink its foreign reserves.
India in the midst of an election India’s elections for its lower house (Lok Sabha) began on April 11 and will last through May 19. Ballots will be counted on May 23. The vote is spread over six weeks because of the daunting logistics of organizing the world’s largest electorate of roughly 900 million voters.
In 2014, the Bharatiya Janata Party (BJP) led by Modi became the first party to win a majority in the lower house of parliament since 1984. It took 282 of the 543 seats, an increase of 166 from the previous election. In stark contrast, the Congress Party (CP), which had long dominated the political scene, won only 44 seats, 112 fewer than the last time.
14 IMF, August 2018
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Lower-house seats won by BJP and CP in past general elections
Source: “India airstrike on Pakistan hits Gandhi's election hopes,” Nikkei Asian Review, March 26, 2019
As for India’s upper house (Rajya Sabha), the states nominate 233 of its 245 members. The remaining 12 are presidential appointments. Every year one-third of the members retire and a similar number of MPs are nominated. Neither the BJP (73 seats) nor the CP (50 seats) is close to holding a majority in this house. Most legislation must be approved by both houses.
The game-changing terrorist attack
Just a few months ago it looked like Modi’s election victory might be in doubt. Then came the terrorist strike against Indian troops in February. Modi’s airstrikes against Pakistan shifted the agenda away from the economy and his approval ratings soared.
Source: “India airstrike on Pakistan hits Gandhi's election hopes,” Nikkei Asian Review, March 26, 2019
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Polls indicating return to coalition politics
While recent opinion polls now show that Modi’s BJP is on course to remain in power, few people think Modi can repeat the success of 2014 when the BJP won an outright majority in the lower house. This means that BJP will likely have to depend on as many as 10 coalition partners to govern. This would mark a return to the style of governance that has dominated India for the past 30 years. In fact, the last time the Congress Party was in power (2009-2014), it led a governing coalition of 12 parties.
It important to note that India’s decentralized political system means that government cannot advance its agenda anywhere near as fast as can the leaders in China where power is concentrated in one party. The Indian government must negotiate with a myriad of groups, including factions within the coalition and the states. Furthermore, given that India is a democracy, it cannot engage in major infrastructure/investment projects without first consulting the local population. Chinese authorities do not have this obligation.
Investment conclusion From an investment perspective, India presents several advantages, particularly young demographics, low-cost labour and a globally competitive IT sector. These advantages have been reinforced by an improving business climate thanks to a reform of the tax code and implementation of a new bankruptcy law. Also, investors have generally reacted positively to the growing prospect of a Modi-led BJP victory because they consider Modi and his party to be more pro-business than CP, the main opposition party.
However, the inability to further loosen restrictive land and labour laws is preventing India from reaching its full economic potential. Without these reforms India’s manufacturing industries will remain hard-pressed to acquire land for new factories and/or will continue to shy away from hiring full-time workers for fear they will not be able to lay them off during an economic downturn. The very likely return to coalition politics makes it unlikely that any progress will be made in these areas in the foreseeable future.
While India will likely not attain the levels of economic growth experienced by China during its rise to near middle-income status, we do feel it will continue to grow by around 6%-7% annually over the next several years. This will be reinforced by the government channeling significant funds toward infrastructure, direct cash deposits, and healthcare. Modi has pledged to spend $1.4 trillion on infrastructure during the next five years if he wins the election. His government has also begun implementing one of the world’s most ambitious public healthcare programs in recent history. The People’s Health Care Plan aims to provide 500,000 rupees ($7,000) in annual hospital coverage to 107 million of India’s poorest families.15 The risk that automation will make it increasingly difficult to generate enough good quality jobs make these programs more crucial than ever to avoiding social unrest. However, these growing financial outlays point towards higher levels of deficit spending over the next several years.
15 “The World’s Cheapest Hospital Has to Get Even Cheaper,” Bloomberg, March 26, 2019
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