Â Part I of this article is here: No Wizard of Oz For Indian Economy. Here is the concluding part.
Irrespective of uncertainties of Greece or Euro-zone, both would recover. However without capacity creation, India seems to be going nowhere. And that job of creating the huge shortfall of capacity increasingly gets difficult. Economic turmoils elsewhere, as in US post-2008, could be resolved through monetary or fiscal policies. However, no policy makes up for huge and persistentÂ capacity shortfall in economy.
No denying that there is a policy-paralysis itself in New Delhi. However, a coalition government cannot be an excuse for not creating capacity by government itself. No political party would say we do not want the roads built, or the facilities to come up.Â The obvious problem, one may say, is financial resources. Key point is, financing infrastructure with deficit is always a better choice than not having infrastructure itself, when there is huge demand for the infrastructure.
The best example and case is Indian Railways. It is surprising that this economy is still growing by more than 5% (as per whatever quality of data). A close look at capacity created by Indian Railways over last twenty years, and its financials tellÂ us the real ‘Indian Growth Story’.
Point is simple. You allow private investment in healthcare, education, roads, drinking water â€“ or anywhere. Make that private investment as attractive as you can, but even then, in case the capacity created by private investments still falls short of the huge domestic demand, what do we do? Wait for someone to create that capacity sometime in future, when millions of citizens fail to get basic medical facilities, due to accessibility and/or affordability? Leave it to luck and assume, because your terms of investment are so attractive (assumedly), that sooner or later, someone would create that capacity? And demand continues to grow in the interim period, and citizens suffer. And that someone barely creates a fraction of the needed capacity, and the gap widens, with a young and highly populated nation,Â as India is.
And in between supply side constraints pushes your inflation rate high, forcing you to raise interest rates. And monetary tightening achieves less in controlling inflation in such Â situations, as it rather acts as a negative feed-back loop, as investments to create capacity from private sector slows (projects become unviable with increased cost of capital), as well as it leaves government itself with less money as more is spent in servicing its own debt. Indiaâ€™s 70% debt to GDP ratio, when placed with debt-servicing costs, are equivalent to Japanâ€™s 700% debt-to-GDP ratio, when Japan actually has little more than 200% debt-to-GDP ratio. Â It further increases our consumable imports, thereby increasing trade deficits and current account deficits, furtherÂ putting pressure onÂ the currency, and thereby further making India unattractive for FDIs.
Having higher debts to finance those capacities is better, thereby managing inflation better, and having lower interest rates where overall debt-servicing improves.
The imported inflation due to the oil-import is just another aspect of it with a weakening rupee. It is a vicious cycle. Only capacity can break it. Huge capacity, and not an incremental approach to it, as has been observed in last twenty years. As China did.
A stable period of low-inflation low interest rate is a must to create enormous capacities that India needs. Since long, we have been hearing that India needs trillions of dollars of investments in infrastructure and in basic commodities supply side; but we never made a small progress in making that investment happen. The gap only widens, with each passing day. And in between, capital too has become scarcer. And the world has not waited for India; China alone has created capacity in last ten years in almost all sectors that India has not created till date.
What have we been trying to achieve by reforms or subsequent rounds of reforms, or by absence of it, anyway you take it? Reform or no reform, capacity creation is a must. China happens to be a clear example â€“ where reforms, tremendous FDIs, private investments were not enough to create the capacity China needed. The state played its role in that process of reforms by adding up capacity, in an unparalleled level.Â State, when it creates capacity, is not necessarily competing with private sector aone; it just provides for the stable economic environment to last so that capacity short-falls do not push inflation up, and thereby hampering private investments too.
The answer can be found easily by looking at private investments that China received in last ten years, vis-Ã -vis that of India. In spite of huge state investments in capacity creation, China received and continues to receive much higher FDIs/FIIs.
No nation can ever dream of becoming an economic power by constantly devaluing its currency, through market forces or through policy-actions. Even Indian glorified IT companies would be making loss had Indian rupee exhibited the same strength that China’s renminbi did, over last twenty years. Without constant devaluation of currency, the IT model (and thereby being services capital of the world) is not sustainable.
Point is, in India, reform means different things to different people. To Government and to a group of misguided policy-makers to journalists to industry lobbyists, it means one simple thing: Government must not create capacity, and it must further sell-off whatever small capacity it has. There is no problem with government privatizing its facilities, provided adequate capacities are created first.
To me, capacity creation is the objective. Reform is a way to achieve that better, as any Government anywhere has financial constraints. In India, we have thrown capacity creation out of this whole equation of reform. It is not akin to throwing the baby with the bath-water; it is much worse. It is throwing the baby but retaining the bathwater; because Government now has relegated its responsibility of creating capacity, and reforms have neither achieved it. To be more accurate, it has achieved a fraction of needed capacity. When the capacity created is high, it automatically increases domestic consumption through higher competition and better affordability; and surplus capacity competes for the export market, thereby ensures exports pick up faster than imports.
Inflation in India had always been a supply-side problem. There was steady denial of that realization until recently. Realization or no realization, there is been no action till date to create that capacity. Most still believe paper-based policies and reform alone would solve the problem. But it wonâ€™t. Many a bumper monsoon has come and gone, food inflation has not come down, when same food grains are wasted across FCI go-downs due to shortage of capacity, and poor-people starve with high malnutrition rates. So create storage capacity. The private sector power plants, whatever small capacities added, are not getting coal, so create capacity (price of that coal needs to be competitive, not subsidized!) in coal mining. Examples are aplenty and from all sectors.
A nation like India, with almost lowest per-capita consumption in all commodities, has no time to be engaged in hypothetical economic debates on what comes first: chicken-or-egg, or in this context, demand comes first or supply. Incremental capacity additions, as done by private sectors, are not the solution. The myth that Indian manufacturers are competitive should have been bulldozed long back with constantly higher trade deficit figures. If our private sector is uncompetitive in the global market due to other reasons beyond their operational control (lack of port, transportation, competitive power, etc.), itÂ is also due to capacity mismatch, where government must act, beyond making policies alone.
In spite of investment-led bubble and overcapacity fear in China since last one decade or so, there has been no slowdown in either investments or capacity creations. If our policy makers just look at the capacities China have been creating every year, year-after-year, and try to match half of that; our economic turmoil would be over. Be there reform or no reform â€“ create half of the capacity created by China. In my opinion, we donâ€™t create one-fifth of that capacity; and then there are people in India who compare India with China. Or alternatively wish, that by some miracle, inflation would slow down.
Every nation wants to grow at a higher growth rate. But before we demand so, as if that is our legitimacy, we must ask whether we deserve to grow at a higher growth rate, in a sustainable manner. Unfortunately in India, couple of years of abnormal growth rates has created a â€˜new normalâ€™ in our expectations. India deserves to grow at 8-10% growth rate has become the mantra for many.
But no one is asking why.
Without Dorothy, that is an impossible task. Or else, without creating capacity, by whomever, which is difficult, but still possible.
Â Prof. Ranjit Goswami works as theÂ Director of School of Management of RK University. Opinion expressed in this article is personal. HeÂ invites you to visit his blog,Â Wondering ManÂ (or take a look at his book, Wondering Man, Money & Go(l)d). You are also invited to join him onÂ Twitter.Â