Posted by: qmaxim | August 29, 2019

Growth and jobs – what can be done?

PM Modi in the second term has set ambitious targets  for the country on GDP growth, job creation and increasing  income.  First target is increasing size of Indian economy to $ 5 trillion in 5 years, from  roughly $ 2 trillion at present.  Infrastructure investment of  Rs 100 lakh  crore in 5 years is  one of the  things  being considered to achieve this. As per calculation of some experts , GDP growth has to accelerate  to  8-8.5%  (from current 6.7-7.2%) to achieve this. This along with other large  handouts for weaker sections  is a very large sum of  money to be raised.
Where is the money going to come from?   It is going to be challenging task considering the  state many  financial institutions are in.

Financial sector  crisis

Some of  the banks  (particularly public sector banks ) and  finance institutions  are  going through a  crisis. Large loans given to  many  companies  have turned into non-performing assets (NPA).  This has come into open due to tighter scrutiny of financial sector by RBI and implementation of   Insolvency and bankruptcy code (IBC) introduced in 2016.  This  has resulted in forcing promoters of  companies out of their companies  or  in some instances  companies going into liquidation. Some of the reasons for  NPAs are:

  • Lousy due diligence : in many cases  banks have lent large amounts without doing even basic due diligence. There are instances in which  loans were repeatedly  given to companies even when their  registered address was bogus. Recently, a large housing society received eviction notice from a bank only to be hastily withdrawn.
    It emerged that builder had hypothecated the buildings after selling them!
  • Fraud : Many tactics were used –  promoters took massive loans then gave ‘loans’  to related parties or  shell companies and didn’t return the loans ( turned them into sick companies), got phony orders from foreign entities owned by them,  made purchases at highly inflated prices, made sham  purchases, diverted funds to unrelated businesses, evergreening of loans to show that companies are  healthy.  Lenders  and auditors failed to detect such frauds for years. Diamond  merchant  Nirav  Modi’s  companies are one such example and fraud is said   to be about  1.4 B dollars. Lead banker  was Punjab National bank.
    Weak legal system has allowed borrowers to escape jail and many of the scamsters have fled the country.
  • Changed economic circumstances or competitive landscape:  Due to changed circumstances, once profitable companies  have  started making massive losses.  Companies in telecom sector is one such example.  After entry of new player  Jio with  superior technology, better offerings and ample  funding,  incumbent players started making huge  losses due to catastrophic loss of market share. Some of them  merged with other players at deep discount, others  went bankrupt thus sinking large sums of money.

Fix  finances first  then raise money

Before ambitious targets are achieved financial sector should be  put in order, tax system should be straightened out, exiting funds should be utilized efficiently. These are some of the things which should happen.

  • Poor state of financial institutions: Punjab national bank which lost huge amount of money  in Nirav  Modi scam is a typical example. Audits by multiple agencies ( external auditor, internal auditor, IT auditor, SEBI, RBI, vigilance ) failed to detect the fraud for many years.  Govt has spent 1000s of crores in re-capitalizing  banks with no end in sight. Unless banks skill sets related to — risk assessment , customer orientation, lending profitably, audits improve,  
    –losses and  scams will recur.
    A complete overhaul of audit process is called for.
  • Same goes for corporate audits-  they are found wanting. Recast of audit mechanism is need of the hour including stringent punishment for scamsters.
  • High tax rate: Less than 2% of the population pays income and other taxes. People having  legally earned income end up paying large percent of their income as taxes.   For example, income tax  rate is 20% for a  person earning Rs 5 lakhs/year. Assuming GST rate of  18%  for a  purchase, he has to shell out about Rs 1400 for a item costing Rs 1000. This severely curtails their purchasing power thus reducing overall demand for goods. Taxation structure should be tweaked to increase demand for locally produced goods.
  • Reduce subsidy : Most of the population (98%) don’t pay taxes. Farm income is totally tax free.  In addition, irrespective of income,  farmers receive handouts and are entitled to highly subsidized inputs (e.g. electricity, water, fertilizer , pesticide) for farming.   Many  people convert  their ill-gotten wealth to  farm income to escape taxes.  Excessive amounts of  grains are produced for which demand is low or price is low.  Taxing farmers is a political hot potato. Not all the farmers are poor or need support. Clever ways can be found to tax them. Money spent on subsidies can be reduced, for example, by  reducing extent of subsidy depending on value of purchase.
  • Fix GST :  Even though GST has lead to greatly simplifying tax payment throughout the country many anomalies exist. For example, commonly used items like    biscuit   are taxed at 18%, cement at 28% and issues with input credit.    
  • Use foreign exchange reserves:  India has accumulated $ 438 B foreign exchange reserves, 8th highest in the world.  But this is not due to trade surplus unlike other countries which are export champions. This money is stashed away with foreign  banks or in US govt. bonds earning almost nothing.  Instead, money can be lent to  high quality borrowers to setup manufacturing facilities or  infrastructure. Some experts think that  $200 B in reserves is sufficient. But RBI can start small lending say $20 B/year.
  • Improve data collection: As of now sectorwise data with sufficient granularity, detail and accuracy does not exist. A good system should be setup for periodic collection, analysis and reporting. This should in fact be the  top priority.Use foreign exchange reserves:  India has accumulated $ 438 B foreign exchange reserves, 8th highest in the world.  But this is not due to trade surplus unlike other countries which are export champions. This money is stashed away with foreign  banks or in US govt. bonds earning almost nothing.  Instead, money can be lent to  high quality borrowers to setup manufacturing facilities or  infrastructure. Some experts think that  $200 B in reserves is sufficient. RBI can start small by lending say $20 B/year.Poor state of financial institutions: Punjab national bank which lost huge amount of money  in Nirav  Modi scam is a typical example. Audits by multiple agencies ( external auditor, internal auditor, IT auditor, SEBI, RBI, vigilance ) failed to detect the fraud for many years.  Govt has spent 1000s of crores in re-capitalizing  banks with no end in sight. Unless banks skill sets related to — risk assessment , customer orientation, lending profitably, audits improve,  
    –losses and  scams will recur.
    A complete overhaul of audit process is called for.
  • Same goes for corporate audits-  they are found wanting. Recast of audit mechanism is need of the hour including stringent punishment for scamsters.
  • High tax rate: Less than 2% of the population pays income and other taxes. People having  legally earned income end up paying large percent of their income as taxes.   For example, income tax  rate is 20% for a  person earning Rs 5 lakhs/year. Assuming GST rate of  18%  for a  purchase, he has to shell out about Rs 1400 for a item costing Rs 1000. This severely curtails their purchasing power thus reducing overall demand for goods. Taxation structure should be tweaked to increase demand for locally produced goods.
  • Reduce subsidy : Most of the population (98%) don’t pay taxes. Farm income is totally tax free.  In addition, irrespective of income,  farmers receive handouts and are entitled to highly subsidized inputs (e.g. electricity, water, fertilizer , pesticide) for farming.   Many  people convert  their ill-gotten wealth to  farm income to escape taxes.  Excessive amounts of  grains are produced for which demand is low or price is low.  Taxing farmers is a political hot potato. Not all the farmers are poor or need support. Clever ways can be found to tax them. Money spent on subsidies can be reduced, for example, by  reducing extent of subsidy depending on value of purchase.
  • Fix GST :  Even though GST has lead to greatly simplifying tax payment throughout the country many anomalies exist. For example, commonly used items like    biscuit   are taxed at 18%, cement at 28% and issues with input credit.    
  • Use foreign exchange reserves:  India has accumulated $ 438 B foreign exchange reserves, 8th highest in the world.  But this is not due to trade surplus unlike other countries which are export champions. This money is stashed away with foreign  banks or in US govt. bonds earning almost nothing.  Instead, money can be lent to  high quality borrowers to setup manufacturing facilities or  infrastructure. Some experts think that  $200 B in reserves is sufficient. But RBI can start small lending say $20 B/year.
  • Improve data collection: As of now sectorwise data with sufficient granularity, detail and accuracy does not exist. A good system should be setup for periodic collection, analysis and reporting. This should in fact be the  top priority.

Way forward for  growth and job creation

Following are some of the reasons for slowing growth rate and relatively low job creation.

  • Poor export performance:  Notwithstanding  IT and few other items, India has failed as a exporting nation. China with 5 times India’s GDP exports 8 times as much as  India. There is tremendous potential for  exporting commonly used items such as garments in which India has natural advantage being largest producer of Cotton. Even Bangladesh exports more. Persistently overvalued Rupee exchange rate is one of the  reasons. High supply chain  cost, taxation, inflexible labour laws are the other reasons. Many countries put invisible trade barriers.  A coherent export/ import policy is need of the hour. Limited number of items should be prioritised for creating large export markets.  Areas in which India has natural advantage should be the focus  to start with.
  • Too much imports : In many cases importing goods is cheaper than local production. For example, cooking oil imports for many years was over $ 1B. Even tomato purée in large quantities   was imported to manufacture ketchup. Last year imports of Agarbatti (incense stick) was Rs 800 crore. Recently I purchased a laptop bag – nothing fancy – was surprised  to find it was made in  a far eastern country. It is possible to import even common use goods duty free or at low duties due to agreements (such as with  Asian countries , WTO)  India has signed many years ago. Almost all countries have trade surplus with India- for example- China had yearly  trade surplus of  $ 50-70 B in the last few years.   Some of these agreements have to be renegotiated. India’s trading partners should be encouraged to buy more.
  • Imports are lucrative for government: Imports like gold, petrol are taxed heavily and they   play a large part in meeting short term tax collection targets. Hence, policy makers may  not be  keen on giving incentives for local manufacture.  Long term interests should be balanced with short term revenue targets.
  • Pubic sector: Due to the same reason, pubic sector companies are forced give large dividends and do  share backs.  Consequently, most of them have been laggards in investments over the years. With some exceptions, since opening up of economy in 1991,  most of the investments have come from private sector.

5  trillion dollar GDP  and 100 lakh crores investments  are good targets to have. But more importantly, funds should be deployed in a meaningful way.  Following should be basis: goods/service created should have sufficient demand, there should be  enough  people capable of buying these goods, should lead to  growth of  real income, support ‘make in India’ & job creation. Priority should be given to investments   which can earn adequate returns

Of course,  achieving  $5 trillion depends on Rupee to Dollar exchange rate weaker Rupee  is not necessarily bad thing.


I will be pleased to hear your views

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

Categories

%d bloggers like this: