India’s currency is strong, the stock market is rising, and long-term interest rates are under control. The technical recession that ruined the June and September quarters is probably over. Prime Minister Narendra Modi has rolled out the red carpet for industries ranging from automobiles and solar panels to specialty steels. The iPhone supply chain is interested in setting up assemblies.
So is everything looking up for the post-coronavirus Indian economy? Barely.
The problem is in the demand. Companies protect operating profits, or avoid losses, by cutting jobs and cutting wages. The rupee has not suffered the double-digit declines seen this year from Brazil and Argentina to Turkey and Russia. That’s because imports collapsed after Modi’s Covid-19 lockdown in March, and the trade deficit narrowed. Goldman Sachs Group Inc. has raised the rating of the Indian equity market to “overweight” the optimism of vaccines, while the local bond market is optimistic due to austerity, despite the inconvenience. Twelve large states, accounting for three-quarters of total gross domestic product, may have to cut capital spending by as much as $ 36 billion in the fiscal year through March, estimates ICRA Ltd., an affiliate of Moody’s Investors Service.
How will the gap in private consumption and public investment be filled? The world economy is not in a position to absorb many new goods, and improving market share takes time. This week, the government approved $ 20 billion in production-linked incentives for 10 industries that could give India a better tomorrow. They are spread over five years. They won’t help today.
An obstacle is the low starting point. India’s exports never had much added value overseas built into them, reflecting the country’s isolation from global supply chains. Over time, these “backward links” have weakened, according to economists at IDFC First Bank Ltd. Forward links, the value India adds to the products consumed globally, has not disappeared either. The contrast with China couldn’t be more striking:
To get in the game, India needs more than soups. The bureaucracy has to shed its long-standing suspicion of Soviet-era imports. A country with $ 560 billion in foreign exchange reserves, or 20% of GDP, should not make it difficult to import tires and axles for companies that re-export trailers. India is the second largest exporter of human hair. If wig makers source duty-free shampoos and conditioners from abroad, they won’t bankrupt local soap makers who have 1.3 billion scalps to lather at home.
Asian export powers, from South Korea to China, have addressed the issue of fair and swift tax rebates on imported inputs. Also, India’s goods and services tax rate on exports should be zero. After all, the GST is a local consumption tax. Exporters shouldn’t have to tie up working capital chasing reimbursements, or get bogged down in unnecessary paperwork.
Some laws are changing. Growers have been given the freedom to sell produce outside of state-designated market yards. They can enter into contract farming agreements with buyers. Up to 44 federal labor codes have been consolidated into four. Over time, Indian companies should grow and become more productive. Rapid adoption of digital technologies will boost competitiveness. Using 5G and the Internet of Things to control energy theft will help lower rates for industrial customers.
But these supply-side reforms will not create their own demand. On Thursday, India said it will shoulder the burden of social security payments if private employers create new jobs at the base of the wage pyramid. Movements like this work well in developed economies. They don’t go far enough when most workers don’t have provident fund accounts.
One way to fuel demand may be for the government to settle its overdue bills, says economist Indira Rajaraman. Take solar panels. To be done locally, renewable energy producers must increase investment after this year’s Covid outage. For that, its customers, financially weak state distribution companies, must pay promptly. In BloombergNEF calculations, a one-year delay for half the payment causes the internal rate of return on a newly commissioned solar project to fall below its cost of debt.
Government departments that settle bills on time will alleviate a $ 27 billion backlog, improving private sector cash flow and its ability to take on new projects. Just doing this will not create the eight to 10 million jobs the country needs each year. India has to persuade investors to put aside its reputation as a difficult place to do business. Only then will supply deepen and demand strengthen.
Approximately 10% of Modi’s financial incentives go to drug manufacturers. That’s fine. Being able to supply a Covid vaccine to its own population and to other developing countries could give a confidence boost to its manufacturing sector and the wider economy. Hopefully, both today and tomorrow will look better.
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