Aiming For The High Road

Government's policies can either enable or limit our prosperity.

Shyam Ponappa  May 4, 2023

There are very divergent views about India’s economic prospects.  Some perceive great promise, while others see big government and unclear strategy.
 

The upbeat take is that investors who put substantial capital into China in its early growth phase are finding patterns mirrored in India that encourage their investment (An updated perspective on India, Business Standard, April 17, 2023). These investors are looking to limit or reduce new investments in China, and, among emerging markets, India is promising with the capacity to absorb large investments. Factors such as Apple’s exports of $5 billion in its first year support this, as does recent enthusiasm about India’s building logistics and effecting a digital transformation. The expectation is that annual growth will be over 6 per cent, and that gross domestic product/capita may grow from $2,500 to $5,000 in six to seven years.
 

A more downbeat view is that India has lost opportunities and made misplaced choices with growth coming from government spending and seat-of-the-pants strategies (Rolling the dice on growth, Business Standard, May 3, 2023). This has led to a constrained, uncompetitive private sector hobbled by disabling regulations, inadequate and unreliable infrastructure (notwithstanding high investment, on which more later), limited capital access, tariff barriers, an inappropriate and ineffective educational approach for employability and improving skills, and impoverishment through electoral handouts to much of the population. Instead of structural changes to provide lower cost infrastructure and efficient governance, the government chose corporate tax cuts to spur growth.
 

The fact is that while India is still in a sweet spot because of its economic resilience, momentum, favourable demographics (although largely unutilised), and improving productivity (1), growth in this decade is likely to average under 6 per cent annually. (See chart).

 

India will continue to outpace global average growth rates of real GDP and real per capita GDP from 2023 to 2030
                                                                                                                     (% change y/y)

 

Some data support this view, such as skewed consumer demand and delayed projects. Consumer demand is stronger at the high end, but weak at the lower end. Infrastructure project delays in March 2023 were reportedly the highest since 2004. These include nearly 57 per cent of projects over Rs 150 crore, resulting in cost escalation of over 20 per cent, amounting to half this year’s capital expenditure budget. 

Presumably this problem is reflected in the Gati Shakti National Master Plan. When public access is permitted, it will be interesting to know about the project management and coordination processes for timely execution, given its roots in a Project Management Institute report.

Higher growth of 8 per cent or above requires more structural change. These begin with policies that (a) provide reliable infrastructure that is affordable, (b) improve capital access, and (c) eliminate “tax terrorism”. Facilitating productivity through infrastructure everywhere would enable more people, including more women and young people, to participate and contribute. 

The next level of productivity improvement requires much deeper change. These extend to assuring a sense of security with law and order, access to meaningful education and skill building, deep changes away from “extensive” agriculture to an intensive, informed approach that is productive and sustainable. A critical prerequisite is cohesive, unifying leadership that inspires cooperation and inclusion.  Regarding better infrastructure, the following observations indicate possible ways to improve: 
 

Road Construction: New roads are being built at a furious pace.  However, two problems hamper our logistics despite the enormous sums spent. One is project delays. The other, more serious issue is the rapid deterioration of roads. While heavy rains do aggravate the problem, the underlying reasons are the quality of construction and lack of timely maintenance, made worse by undue emphasis on the value of contracts and quick implementation. Countries with equally severe weather variations build and maintain better roads. An expert with experience in America and India asserts that the reason is not enforcing requisite standards, quoting John F Kennedy that it is the roads that built America’s wealth. (2) This need for adherence to standards extends to many areas, and would transform our quality and competitiveness. It does not, however, lend itself to big targets and bragging rights for electoral purposes.
 

Communications – 4G, 5G and Beyond: If there were fast, reliable 4G-level connectivity countrywide, and if most people got access to these services, there would likely be a productivity revolution.  It would take much more than just connectivity: Development of content, technology choices and organisation are required to increase beneficial use exponentially. For example, content is needed for agricultural transformation to intensive cultivation, workplace skills and manuals, or K-12 education.
 

For the middle-mile and second-last mile, until the current blitz for BSNL 4G wireless, our policies emphasised fibre.  Widespread fibre-to-the-home is unrealistic in India because of the cost. The way out is high-speed wireless for middle-mile and second-last mile (backhaul), and for last-mile (Wi-Fi and cellular). We need enabling policies for these.
 

Another technology issue is 4G and 5G.  South Korea, leading in 5G, is the exemplar of the “5G fallacy” of getting five-fold speeds after $20 billion in network upgrades, instead of the desired 20 times speeds.  South Korea has nine cities of more than a million people, 42 between 100,000 to 1 million, and 77 between 10,000 to 100,000. They have 215,000 base stations of which only 2 per cent are 28 GHz, covering 45 per cent of their population. India has 48 cities of over 1 million, 405 with 100,000 to 1 million people, and 2,500 with 10,000 to 100,000 people.  We have 102,000 base stations compared to South Korea’s 215,000, and would need many more at unaffordable cost for blanket coverage. What we need instead is high-speed 4G or Wi-Fi, using wireless 60 GHz and 70-80 GHz for the middle-mile, with 6 GHz Wi-Fi for the last mile (in addition to existing Wi-Fi at 2.4 and 5 GHz).
 

One more requirement is technology organisation: Shared networks versus single-operator networks.  Shared neutral host networks (NHNs) are the most efficient, while active sharing by operators costs 70 per cent less per user in an Indian case study. (3) 

It is the government’s choice of policies that can help us on the high road.

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Shyam (no space) Ponappa at gmail dot com

1: For details, see: “Productivity Growth in India: An Empirical Assessment”, RBI Bulletin January 2023.

https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/02ART19012023C2BCA396B632479BBDD5485D89FDEEF4.PDF

and

Page 10: https://www.imf.org/-/media/Files/Publications/WP/2023/English/WPIEA2023082.ashx

 

2: https://www.nbmcw.com/article-report/infrastructure-construction/roads-and-pavements/why-do-many-roads-constructed-in-india-fail-prematurely.html  

Prof. Prithvi Singh Kandhal has drafted standards for the Indian Roads Congress, and was formerly at the National Centre for Asphalt Technology at Auburn University in Alabama.

 

3. https://www.researchgate.net/publication/368772499_Techno-Economic_Assessment_of_5G_Infrastructure_Sharing_Business_Models_in_Rural_Areas

Shruthi K.A. Kumar and Edward J. Oughton

Guns or Butter, Both Need Investments

Our common interest requires building a consensus on cash flows.

"Money, money, money… makes the world go 'round...." This line from a musical set in 1930s' Berlin is inescapable in the commercial, economic, and often the political aspects of reality. While the show emphasised escaping through make-believe, the real-world actually follows closely along.

Take India’s economy: Despite growth, without commensurate profits, employment, and wellbeing, we are marking time. Analysts point out that corporate profits languished since 2008, trending down as a percentage of GDP from 2010, excluding a  minor improvement in 2017. In fact, profits have not grown in real terms despite annual GDP growth of about 7 per cent for 10 years as shown in Chart 1.

In the boom from 2003 to 2008, profits to GDP doubled from 2.8 per cent to 5.5 per cent. Growth was driven by investment and exports as well as by consumption. After the subprime crisis of 2008 and the recession, profits in India slumped, partly because of excess capacity, and the rising costs of additional debt caused by inflation targeting (the components being wages, taxes, corporate profits, interest payments and rents).

Although profits recovered somewhat, they trended downward, and by 2018 were 3 per cent, the same as in 2003. By comparison, US figures (after a low of 4.95 per cent in Q4 2008) ranged from 9 to 11.7 per cent. Gross profit to GDP in the US was 20 per cent in 2015, while in China (2014) it was nearly 30 per cent (Chart 2). Surpluses are essential for investment and development, because neither can happen without them. Only thereafter is a higher wage-share affordable.

Source: https://www.schroders.com/it/sysglobalassets/digital/insights/2017/pdf/em-growth-mirage/gdp-and-earnings-growth-thought-leadership.pdf

Of the decline in India from 2008 to 2018, about nine-tenths happened in four sectors: PSU banks (36 per cent), oil and gas (19), metals (18) and telecom (15). During this period, consumption replaced investment as the driver, with growth in sectors such as automobiles, consumer durables and retail. Some commentators expect these trends to continue, with some optimism on the revival of investment.

The counterfactual is that we haven’t had any required reforms of structure and organisation for surpluses to grow in PSU banks, utilities or telecom. For instance:

• In banking, the NPA crisis remains, but the focus has moved away to elections.

• Reliable electricity supply needs financial sustainability and stable pricing, and neither is available. Coal mine auctions haven’t resolved resource costs and availability, while financial gambits in the form of race-to-the-bottom bids to start projects and sell out early, instead of staying for profits from operations, aggravate problems in pricing and delivery for renewable energy as for conventional fuels. The financial incapacity of state electricity boards has created another set of problems, compounded by continued populism (unsustainable prices).

• In telecom there has been only one major reform for 5 GHz spectrum for WiFi, despite the new National Digital Communications Policy.

Meanwhile, electoral wrangling threatens to further deplete the treasury, whereas the problem is the opposite: Lack of surpluses (profits, and ultimately, cash). Profits have been stagnant for a decade starting from UPA-II, partly because of the excess capacity of the boom. This has constrained development spending, because low surpluses have kept investments down. By contrast, investments and exports were strong from 2003-2008.

Several other social forces add to the downdraft.

• One is a political system that encourages splintering and divergence. As large parties have established hierarchies, it’s easier to start anew to get and control funding for splinter parties around divergent special interest groups.

• Another is incomplete or dysfunctional design, whereas expenditure must produce surpluses. For example, a new metro service in one part of the National Capital Region does not connect with the Delhi Metro. What’s more, the interchange is separated by several kilometres, and is reportedly designed to end ultimately with a gap of 350 metres at street level. A ‘rapid transit’ system that slows you down? If this were designed by enemy action to tie up resources and make people unproductive, they could not have done better. Similar problems assail the design of communications systems that often don’t ‘connect the pipes’ all the way through, such as spectrum regulations that hinder communications, hastily applied GST regulations, or expressways with bottlenecks.

• A third is behavioural acts of omission or commission that increase costs and reduce surpluses. Ignoring laws, rules and regulations, whether it’s driving down the wrong side, lane indiscipline, jumping traffic lights, breaking queues, littering, polluting, and such other lapses, including government agencies not paying bills.

• Yet another is accepting mediocrity, ignoring standards and protocols required for quality outcomes, products or services.

If we are to achieve surpluses, we will have to build a consensus focused on cash flows. The building blocks are ‘trainable’ virtues, with appropriate structures, processes, and behaviour. Social disciplines such as a sense of responsibility for and a desire to maintain good order, working logically, cooperatively, to plan — an ‘objective oriented, project management approach’ for individual and group gain — needs to be taught, ideally from the cradle, and reinforced in our activities, provided the connectivity and content are built to support this. These values can also be introduced at any level. Playing for group stakes and open, direct communication can be habituated through practice, by educational, economic and political systems treating them as worthy of inculcation and reward.

A necessary adjunct is to embrace long-horizon plans and group gains through multipartisan activity. For example, export initiatives are needed using digital technologies that feed into a digitally informed foreign trade policy (DIFTP). Such initiatives require diligent collective effort, recognising that short cuts are at the cost of larger gains. Until we practice such convergent, national-gain behaviour, we are unlikely to generate the surpluses we wish for.

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Shyam (no space) Ponappa at gmail dot com

1: “Corporate profit to GDP: Analyzing growth across cycles - 2018 mirroring 2003 bottom”: https://www.motilaloswal.com/site/rreports/636840041276772228.pdf

2: https://thewire.in/political-economy/what-explains-india-incs-corporate-earnings-conundrum

3: https://www.researchgate.net/profile/RASHMI_BANGA/publication/330824656_Is_India_Digitally
_Prepared_for_International_Trade

Domestic High-Tech Manufacturing Needs Access To Markets

Breaking into the closed circle - Domestic high-tech manufacturers need help to break into a closed circle and gain market access.

Shyam Ponappa  August 1, 2013

The deferral of India's preferential market access (PMA) policy for locally manufactured high-tech products indicates some lack of clarity and/or confusion in the government. There are compelling reasons for supporting domestic manufacturing capacity in India, and high-tech products deserve high priority. Examining the elements of the proposition for developing our high-tech manufacturing and the state of its capacity may help clarify where and how policies should be heading. If domestic electronics production does not increase significantly, India's electronics requirements will be choked by high imports in excess of even oil imports.

The Bogey of Protectionism

The aim of the PMA policy is to give technically qualified domestic manufacturers access to otherwise closed domestic markets. It only provides an opening, and does not provide any protection or price preference. The notification states explicitly that technically qualified domestic manufacturers are eligible only if they match the lowest bid; if there are no qualified local manufacturers, or if qualified vendors don't match the lowest bid, entire orders may be awarded to the lowest-priced vendor/s (from abroad). Perhaps there is some confusion arising from the nomenclature, as "PMA" usually refers to international vendor access to domestic markets. The notion that the PMA is protectionist and shields domestic suppliers from competition is incorrect.

Deferring PMA to Assess Domestic Capabilities

The government's deferral of the PMA pending assessment of domestic manufacturing capabilities appears unreasonable, as there are already qualified manufacturers in India, several of them transnationals, producing high-tech products for global markets. The top 10 global fabless design companies and the top 25 semiconductor companies operate in India. In 2010, revenues were estimated at $7.5 billion, and in 2012, over $10 billion. India is reportedly among the top countries for fabless design skills, and has the critical ingredients for the growth of fabless companies as start-ups slow in the West: design service companies, design engineering expertise and innovation, returning entrepreneurs, and educational facilities. What they need for scale is local market access, equity funding, good logistics, and effective infrastructure. These are the areas where the government can facilitate matters. Deferring access to local companies at a time of rapid growth in networks will entrench foreign products, providing them with an undue advantage against local producers. Instead, we should be capitalising on our domestic strengths.

Closed Circle of Buyers & Sellers

In high-technology procurement, large international vendors, of whom there are relatively few, form long-term relationships with the relatively few large buyers in oligopolistic markets in telecommunications or electricity. This holds whether the buyers are government entities, state-owned enterprises, or private sector companies. Often, the international vendors have strong home government support. This is why domestic manufacturers need mandatory access to break into a closed circle. There is no ambiguity in this, nor is it protectionist, and there are no price preferences - in contrast to the 15 per cent allowed by the World Bank, or 10 per cent for minority-owned businesses in the United States.

Markets & Demand

Of the many reasons for developing electronics manufacturing capabilities in India, a compelling one is our level of demand for electronics. A task force comprising government and industry participants estimated in 2009 that demand in 2009-10 was around $45 billion, going up to $70 billion in 2012, and projected at $400 billion by 2020 (see chart), with government's share being 40 per cent.

Source: http://deity.gov.in/hindi/sites/upload_files/dithindi/files/Task_Force_Report-new_21211.pdf

Domestic production was at $20 billion in the financial year 2009 while imports were $25 billion, projected to rise to over $300 billion by 2020 if domestic production maintained its trend to reach $104 billion. However, with appropriate policies including the PMA for local manufacturers, in the best case, domestic electronics manufacturing was estimated to increase to over $300 billion. If this could be achieved, India's electronics imports would amount to about $100 billion. Without it, imports of $300 billion may be needed, exceeding even estimated oil imports.

Security Screening/Auditing of Imports

High-security applications in the US, Japan, Israel and China are procured from trusted domestic manufacturers. The US Congress monitors high-tech imports for strategic reasons. The UK is conducting an investigation into whether its broadband networks have been compromised by foreign suppliers, although malware is very difficult to detect, and can be downloaded after security audits. High-tech supplies need to be from trusted sources.

Domestic Producers vs Other Lobbies

In effect, it would seem that the operators and foreign vendors have railroaded the government into perpetuating the status quo of foreign-dominated electronics suppliers in India. Facilitating access to local markets for domestic manufacturers is the kind of support that many governments provide. Take the case of the "Buy American" provisions of the American Recovery and Reinvestment Act of 2009. Recovery Act funds used for the construction, alteration, maintenance or repair of public buildings and public works must procure all iron, steel and manufactured goods produced only in the US, with a price preference of 25 per cent. The exceptions are non-availability, prices of over 25 per cent, or where applying the provisions is against the public interest. The objectives were to save and create jobs, to give relief to those affected by the recession, and to invest in infrastructure, education, health and renewable energy. The estimated cost is $831 billion between 2009 and 2019.

Remedial Action

What's needed is for the government to take unequivocal action without delay on enabling policies for domestic high-tech producers. The sooner this is done, and the more sustained support that is provided, the better. Too many confused signals are being sent out on investments.

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Shyam Ponappa at gmail dot com

FX Reserves & Infrastructure

Shyam Ponappa / June 16, 2005

The most important criterion for investments is cash flow.


The proposal to use India’s mounting foreign exchange reserves for investing in infrastructure or in capital goods seems to have been given up.

Should it be revived as an attractive idea? Maybe, but this is where we need hard-nosed financial management and not reliance on broad-brush economics. The difference is the emphasis on cash flow, execution, and sustainability.

There is an impression that reserves represent government funds that are available for the asking, regardless of a sustainable yield. Understanding the nature of reserves, infrastructure needs and project returns is a good place to start.

First, foreign exchange reserves are not all India’s own capital: they also represent money that the Reserve Bank of India (RBI) owes investors abroad, parked temporarily with us as the equivalent rupees are invested in India through the primary or secondary markets, in corporate and individual accounts, or in assets such as real estate.

Second, from a financial perspective, investing reserves is all right provided (a) cash outflow needs are met, (b) the value of the invested capital is retained, and (c) the returns are reasonable.

Taken together, this amounts to investors seeing their capital not only preserved but enhanced in what they view as a reasonable timeframe: dicey for equity in infrastructure.

Third, there is no doubt that improving infrastructure to excellent standards improves both productivity and the quality of life, and India is at present very far below these standards.

The problem with investments in roads or airports, however, is that the payback period can be very long: instead of three to six years, it may take 20 to 30 years, or more. This is untenable for most investors, who want returns much sooner.

The economists’ argument is that some portion of a (large) reserve will remain as a stable deposit, like the portion of aggregated savings that stays in the banking system, and can be used for long-term investments. The problem with this reasoning is that such assumptions fail in a crisis.

No stable base can be assumed, and money that flowed in because of perceived opportunities can as easily flow out again in a rush, like a run on a bank, while inflows dry up because of a changed perception of heightened risk.

Invest Reserves In Good Projects And Stop Subsidising US Consumers

So where can reserves be invested, other than in supporting US consumer spending through investment in US treasury instruments? The latter, unfortunately, is what many countries, including Japan, Taiwan, China, and India, have tended to do.

The answer: in productive investments that (a) yield good returns and (b) are of reasonable risk, measured by expected cash flows and their perceived certainty.

A number of country funds do this: search for sound opportunities, not necessarily in their own countries, and invest in them. Their criteria are the soundness of the enterprise, and the capacity to repay with returns. Examples are country funds of Kuwait, Singapore, Norway, Finland, the Netherlands, and of course, China.

How To Fund Infrastructure Without Using Forex Reserves

So how should infrastructure projects be funded if not by reserves? By using available capital (preferably not reserves) to structure attractive opportunities for participation by external capital.

This means augmenting available capital by sourcing capital from third parties who are attracted by the intrinsic project attributes, and encouraged by equity invested by the government or state-owned enterprises.

The effective but difficult way to do this is by setting the terms for each sector, i.e. the framework of (a) policies, (b) laws [primary, secondary, etc.], (c) regulations, (d) rules and procedures, (e) institutions, and (f) customary practices, which effect successful project execution, so that investors (foreign and domestic) find it advantageous not only in theory to invest, but profitable in practice.

Even with perfect hindsight, it must appear to have been a good decision. Investors and prospective investors should feel (a) they can get their money back (b) with satisfactory returns (c) in a time frame that they consider reasonable.

For foreign investors, it is perhaps 5-6 years for India; it is preferable if they invest for a longer period, but this is not something one can persuade investors to do by argument. People who have worked with/for serious investors in India (like me) must be able to conclude after an objective assessment, not tricky wordplay, that the rules are transparent, and that the chances of success are high for projects with good attributes.

Ground Rules

Build the policy framework right from inception

The odds of success in a sector can be improved by setting the policies, processes, and practices, so that good projects ordinarily succeed.

This means rebuilding the policy framework in each sector (except IT) from scratch, using unconventional methods for India: the government working with expert consultants AND industry, as in many well-run countries, in a collaborative mode.

No ivory-tower pronouncements by one or more luminaries, and no special-interest-induced distortions. Otherwise we will get a reprise of the 1990s, with investments of hundreds of millions of dollars in power and telecommunications mired in our muddled policies, with the resulting fall-off.

As for the pernicious practice of road shows to invite investment when the ground rules are at best muddled or dysfunctional, and no objective assessment is possible to indicate reasonable chances of success, what could be more counter-productive than to waste resources on “luring investment” by government and industry bodies? Far better to focus our resources instead on setting the right objectives [see (a) below], and then the ground rules [see (b) below]. Then, investment will follow.

(a) Setting the right objectives: To set proper ground rules for any sector, we must start with clear and reasonable objectives in the context of our history and circumstances [see (b) below].

Our essential need is to achieve and balance markets that function well (because they are open and competitive?) with the policy goals of social equity, environmental sustainability, and security (energy, food, and of the political economy as a whole).

These could be reasonable objectives for us as a nation. For example, in the power sector, the objective could be: reliable and adequate supply at reasonable prices for all users.

(b) Institutions, systems, and procedures—legacies versus building anew: We have inherited a colonial administration that is ill-suited to the pursuit of nation building with a good quality of life. Once we accept this, two things can follow.

One is that the traditional, adversarial—often predatory—stance of the government towards citizens, with its legacy of emphasis on collecting taxes, can be cast off.

Instead of maximising tax collections, the government can concentrate on (a) nurturing long-term capacity and (b) conserving/building the quality of life for citizens—attributes that together may be termed as “the public interest”.

Second, we can start devising constructive policies, institutions, and practices in earnest, instead of ad hoc efforts to bypass our administrative architecture (the “baad mein dekha jayega” [we’ll-see-later] approach).

This is best done with experienced advisors (e.g. for telecom, a firm like Squire Sanders and Dempsey, which has done extensive good work in this area) working with the government and with good domestic consultants, over 18-24 months, aiming at stabilisation over several years. There are no short cuts.


Shyam Ponappa