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Can India duck the global recession?

This article was first published by the author in the pages of The Hindu Business Line on the 14th of July, 2015

Our export dependency cannot be wished away. The way out lies in reforms to unshackle the domestic economy

The world economy is slowly slipping into a 1930s like depression, said RBI governor Raghuram Rajan while advising against the competitive monetary easing by central banks. Though the RBI tried to downplay governor’s remarks subsequently, the world economic situation is really bad.
China’s poor trade data show that it will go down on growth path faster than its policy makers would want. West Asia does not have a clue about how to deal with subdued crude price that is likely to continue for some more time. Brazil and Russia are expected to post negative GDP growth. Japan poses a risk of inflation.
Things seem to be somewhat better in the US because of better performance by its auto sector and comfortable employment data.
Uncertain times
In India, with changes in GDP computation method, things look okay, but only on paper. India’s corporate sector has posted its worst results in FY2014-15. Uncertainties over monsoon remain. Industry output (IIP) grew by 2.7 per cent (y-o-y) in May compared to 4.1 per cent (y-o-y) in April 2015.
Corporate investment is not picking up, and India’s export has been hovering around $300 billion for last three fiscals. Continuing its declining trend over the last six months, India’s merchandise exports shrank by 20.2 per cent to $22.35 billion in May 2015.
Given its high export/GDP ratio of over 23 per cent, India can’t easily escape the implications of an all-out global recession that’s looming. Yet India can still take several (internal) measures that can help minimise the damage.
Given the size and complementarities of its provincial economies, implementation of GST can unleash India’s animal spirits by reducing cascading of taxes and freeing up interstate trade in merchandise.
That will also create a pan-India common market of $2 trillion GDP and 1.2 billion people — a big attraction of any investors — and add as much as 2 per cent to GDP.
India needs to walk the talk on ease of doing business (given its poor ranking at 142) that is suffocating entrepreneurship. Liberalisation of FDI has become an instrument for export promotion in a world dominated by regional and global production networks.
An overcautious approach of raising FDI caps in a phased manner, say, from zero per cent to 26 per cent to 49 per cent to 51 per cent (e.g. for defence or insurance) will simply not work given the country’s huge investment requirements with $1 trillion for infrastructure development alone.
It also calls for an end to arbitrary tax demands or introduction of tax laws with retrospective effect.
Given the high multiplier effect of public investment in infrastructure and huge infrastructure gap from roads, ports to power supplies, and stressed balance sheets of infrastructure companies, government will have to jumpstart the investment cycle. Increased public investment is likely to be followed by increased private investment.
Home truths
Another sector that can help is the troubled housing and construction sector. The sector’s growth is stuck by poor financial health of real estate companies and high capital gains taxes.
Dominance of black money in the sector limits working class participation. Slower regulatory approval affects the increase in supply of housing units.
Delayed delivery of apartments by builders adds to the misery of home buyers who have to manage both EMIs and rent.
Builders manipulate the payment schedule in a way that long before the actual delivery of apartments they have already collected 95 per cent of receivables. One-sided apartment buyers’ contracts ensure that builders escape paying penalties for delayed delivery while they extract as much as 18 per cent per annum if the buyers delay payment.
Reduction in interest rate is presented as a panacea to solve all the problems of housing sector as lower interest reduces the cost of capital for builders and EMIs for buyers. However, any cut in interest rates aids the holding power of builders.
The math is simple — 1 per cent rate cut would mean ₹50,000/annum saving on a ₹50 lakh flat, but it would mean a saving of ₹50 crore/per annum on a loan of ₹5,000 crore that many Indian builders have. Thus, rate cuts helps builders to artificially keep apartment prices high or raise them after regular intervals irrespective of demand condition to improve margins and please investors.
A better approach would be to hike FSI in top cities, create an effective housing regulator with time bound regulatory approvals. Reduction in capital gains tax will check black money transactions.
It’s a common knowledge that there is strong nexus between builders-bureaucrats-politicians with vested interests in status quo that will not like the supply of housing units to increase in tandem with demand.
Yet, if these steps are taken, they will generate huge multiplier effect from the backward and forward linkages that housing sector has with sectors such as cement, steel, consumer durables and transportation and other services.
MSMEs as catalyst
India has over 45 million micro, small and medium enterprises (MSMEs), mostly sole proprietorships that employ over 100 million people i.e. roughly half of non-farm workforce. If supported well, MSMEs can do wonders to propel India’s growth. Credit — cost and availability — is their main hurdle. Recently set up Mudra Bank can play an important role.
Besides, there is a large domestic market for basic services such as eating out, retail and tourism that can be relied upon to maintain growth momentum. Despite diverse geographies and rich cultural heritage, India has not been able to tap its tourism potential. India received just 6.9 million foreign tourists vis-à-vis China (55.6 million) or Malaysia (25.7 million) in 2013.
India also needs to tighten its belts for making it safer for women tourists to travel alone wherever they want. All the above measures will help India tide over the looming recession.
Any takers?