Infrastructure Sectors That Boost Growth

 

Apply proven policies in telecom and electricity to rev up the economy.

Shyam Ponappa  |   August 4, 2022 

Does infrastructure spending promote economic growth, or is it the other way around? The arguments go back to questions such as whether building America’s railroads in the 1850s led to growth, or the reverse. While the costs and benefits of building transportation may be contested, partly because of what is measured and what is not, one positive linkage that has emerged is between improvements in information and communications technology and economic growth.

Potentially useful findings are given below.

1. A World Bank study (2021) reviewed the contribution of three categories of infrastructure to growth from 1992-2017: Transport, electricity, and telecommunications. The study covered 87 countries out of 189, because of missing data and to ensure a balanced panel. One finding was that infrastructure, especially electricity generation and telecommunications, significantly affected economic growth. This effect was larger more recently (1992-2017) than before (1970-1991), and developing economies experienced stronger effects than industrialised economies.¹

The researchers considered the contribution of physical capital, human capital, electricity, roads, railways, mobile phones and telephones to gross domestic product (GDP). The first principal component derived from these that explained most of the variation, comprising mainly electricity, mobile phones, and land-line phones, was characterised as the telecommunications and electricity factor. The second principal component, comprising largely roads and railways, was characterised as the transport factor. These factors roughly kept pace with population except mobile phones, which increased very significantly, driving the increase in the first principal component.

The chart of the GDP response to the two principal components demonstrates the effect of the primarily electricity-and-telecommunications principal component PC1, and of the primarily transport principal component PC2. The latter initially reduced output for some years. The implication is a need for policies that prioritise telecommunications, including broadband and internet, and electricity.

2. An Asian Development Bank publication on digitalisation and economic performance in India and China found that the internet and mobile density have a significant impact on economic growth.²

3. A study of factors that drove the surge in India’s service exports by researchers at the Institute of Economic Growth and Symbiosis found that attributes that affect the highest service exports (computers, communication and other services were nearly three times the traditional service exports in 2013), were driven by teledensity, together with financial sector development, human capital, and R&D expenditure (chart 2 ).³

The impact of telecommunications and electricity together with strengths in computers and communications services points to India’s needs: Prioritise enabling policies for telecommunications infrastructure for broadband and internet (integrated with the rest: Electricity and transportation, water and sewerage, logistics/transport, financial support, taxation, and so on). Parallel support is required to develop local ecosystems for equipment, which would have to be imported otherwise.

Effect on Policies 

What matters is how these conclusions affect government’s policies, because policies and regulations permit or constrain what we do and how we live. The solutions required ideally are for overall community needs, and not for what individuals, sectors, or stakeholders might need, as the consideration below indicates.

5G Auction & Prospects

Now that the government has bagged Rs 1.5 trillion from the 5G auction, what are the prospects for growth? If this amount is channelled to support BSNL/MTNL, with more government intervention to make them profitable, consider the probable outcomes.

(a) Things could turn out as planned, resulting in a strong telecommunications sector with four operators propelling growth. BSNL/MTNL certainly need support for their important, widespread services. The issue is whether they can be profitable, given their role. On the one hand are their market position in coverage/saturation and diminished share, while on the other are their responsibilities for essential services for strategic purposes and in difficult, unremunerative locations.

It is unreasonable to expect profitable performance in competition with private operators who can cherry-pick their markets. The very idea that governance through providing essential services must make profits is untenable, as it is for security, defence, or disaster management. Yet, this expectation has led to price cuts that have ended in a race to the bottom. Such pricing is a disservice, because it constrains investment in services, and thereby overall country capacity, to low-quality bottom-feeding. We expect and get low prices, but are saddled with low quality. The sector cannot build high-quality, reliable services, and is falling farther behind global service levels. India cannot possibly compete burdened with such self-imposed handicaps.

(b) Another possible outcome is that there will be unsustainable price cuts as before, with unfair access to spectrum (announced), and unfair competition from corporations. The losses could be perpetual, with the sector and the economy in shambles.

The Alternative for Policymakers 

Instead of continuing with unreasonable and ineffective practices that prevent us from realising our potential, even now, the government can change policies to capitalise on our strengths of being imaginative and resourceful, with the capacity to perform well with good systems and processes.

The success of NTP-99 can be repeated, by converting auction payments to revenue-share, this time for spectrum instead of licence fees. The difference is that operator dues can be financed from actual revenues, and not loans on anticipated revenues. This will not only enable immediate investment in networks and services, but as with NTP-99, is likely to result in substantial growth, with much higher government collections, and as a multiplier across sectors.

Legislation can be framed to convert spectrum auction payments to a reasonable percentage of revenues, as for licences. Instead of destabilising markets to favour BSNL/MTNL or corporations, insights can be applied and best-practice regulations can be adapted for our circumstances. The introduction of shared infrastructure through two or more mandatory consortiums led by corporate entities, with BSNL/MTNL as a strategic stakeholder ensuring national security and public interest, will enable even greater leveraging of network assets.

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Shyam (no space) Ponappa at gmail dot com

(1): Timilsina G. et al: https://openknowledge.worldbank.org

(2): D Sahoo et al: https://www.adb.org/publications

(3): Pravakar Sahoo & Ranjan Kumar Dash: "What Drives India's Surge in Service Exports?"

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3620313

Growth, India's Highest Priority

The government must focus on reviving corporate profits and, hence, growth

“…people are starting to question the long-term Indian story… For the time being, people are just giving up on it” — a Moody’s analyst Shyam Ponappa / Jun 07, 2012

With growth in the fourth quarter of 2011-12 at 5.3 per cent, India’s economy is on the brink. If higher growth is not addressed as a priority, we will all lose enormous upside potential. We cannot afford disunity on this issue — neither the government’s arbitrary action nor inaction, nor stalling by the United Progressive Alliance allies, nor the irresponsibility of the Opposition. Continuing discord carries the risk of precipitating our own Greek tragedy.

We need to agree on what the biggest problems are, and how to remedy them. Here is the case for focusing on growth above all, and acting to enable it.

Symptom: Rupee Depreciation

The depreciation of the rupee is the acute symptom. Why has the rupee fallen so precipitously, and why might it get worse? Because of foreign currency outflows. Why the outflows? Declining corporate profits, as explained below.

The drop of over 27 per cent against the dollar since August 2011 is crushing for companies with foreign currency convertible bonds (FCCBs) and external commercial borrowings (ECBs). Estimates of redemptions this year range from $5.5 billion to $7 billion. With growing euro problems and global risk aversion, renewing external debt is possible only for the strongest companies. This problem has to be dealt with, despite the temptation to say, “Let them stew”. That works only if we are not all cooking in the same pot — which we are.

Some counter that an overvalued rupee needed depreciation to help exports. In depressed markets, growing market share is less likely. Some object to actions that protect companies with ECBs as “socialising losses”. While policies can have multiple effects, it is net benefits that matter most: whether losses in energy imports outweigh the export advantage in a global downturn, or companies that escaped high domestic interest rates will create more turmoil if they fail compared with bailing them out. These judgement calls need the objective use (to the extent possible) of financial models, balancing the resistance to creating moral hazard.

Declining Profits

We now face a problem of shrinking profits. With weakening global cues, a slowing economy, and lower capital flows, everyone – policy makers, enterprises and citizens – must seek to alleviate what will otherwise be a slow, difficult recovery. Collectively, concerted efforts are needed to improve profits.

High Interest Costs

Lower revenue growth in 2011-12 with higher raw material costs resulted in lower profit margins. In the fourth quarter, higher interest costs were 31 per cent of net profits, compared with 22 per cent for the previous quarter for 1,066 companies, excluding banks and financial entities. Interest costs for over 2,000 companies rose 38 per cent, following increases in the previous three quarters of 42-50 per cent. High interest costs and an unreconstructed budget triggered a downward spiral in profits. This was made worse by negative sentiment because of government ineffectiveness and capriciousness, epitomised by the Vodafone tax case: attempts to seize what the Supreme Court had annulled.

Foreign outflows triggered by decreasing profits were aggravated by a declining rupee — because of high imports with rising prices, particularly for oil and gold, but also for coal imports, because of local supply shortfalls. The consequent fall in stock prices and unstable tax policies combined to reinforce outflows, increasing downward pressure on the rupee.
There were, of course, other reasons:

• Mismatches between growing demand and constrained supply, leading to persistent inflation. The Reserve Bank of India’s (RBI’s) raising interest rates to tackle this has only compounded the problem of reduced profits and investments, made worse by central and state government failures to augment supply.
• Capriciousness in policies which, like Brazil’s missteps of the ’70s, began with distributing entitlements before assuring growth. Capriciousness now manifests in decisions like the Vodafone tax case.
• Paralysis/incapacity, typified by the failure in the coal supply chain to power plants, unviable electricity distribution agreements and tariffs, new power plants running far below capacity, the unwillingness to take constructive decisions on spectrum and telecom policies fearing populist reactions, or the rollback of foreign direct investment in retail. This is compounded by the rise of populists, many of whom act as if good intentions obviate the need for domain knowledge, competence, organisation, or even simple arithmetic.

Solutions

Two salutary steps are possible immediately. 

- First, cut interest rates, although economists are divided on the merits. What should the RBI do? A big rate cut – 150-200 basis points – can improve profits, capitalising on softening input costs, as well as boost sentiments. Interest as a percentage of profits must be reduced, and sentiment improved to enable increasing investment. Interest rate increases as some suggest, on the other hand, will deplete profits further, accentuating lower growth and exacerbating the decline.

- Second, the government should signal an immediate end to arbitrary tax moves.  

Thereafter, systematic steps are needed to address difficult issues like telecom policy, fuel supplies and land acquisition. Telecom and spectrum reforms are overdue, as are energy reforms addressing the fuel supply-power generation and distribution-sustainable tariffs chain. Then there are all the structural elements affecting productivity – a big mouthful – that can only be addressed in phases.

In terms of sequence, the next significant effort could focus on the poster boy in trouble, the telecom sector. The empowered group of ministers (EGoM) can decisively abandon short-term government revenues in favour of user benefits, leading in time to even more government revenues. A persuasive case needs to be made, for example, to those who favour goals other than functional objectives — like government collections for purposes extraneous to the sector, such as for sanitation or for food. Such confusion in objectives arises from misinformation or incorrect reasoning, because (a) the primary objectives of a sector are its functional purposes; and (b) government collections increase with the prosperity of enterprises paying reasonable taxes. For this iconic sector, including its spectrum and broadband issues, the EGoM should be made aware of the recent report to the US President’s Council of Advisors on Science and Technology on sharing spectrum.*

                                                                                                                  shyamponappa at gmail dot com

* "Presidential Panel Urges More Flexible Use of Spectrum", John Markoff, May 25, 2012, The New York Times:

http://www.nytimes.com/2012/05/26/technology/presidential-panel-urges-better-use-of-spectrum.html?_r=1

Report available at: op.bna.com/der.nsf/r?Open=sbay-8umrn7.ppt

Discussion Board/User Comments (8)

Posted by: Rajesh	June 08 , 2012, 16:39 IST
Sir, when you have identified the right solution ? a big rate cut, why aim for a limited and timid 200 bips rate drop. Why not go the whole hog? This is a time for action and boldness. We must set things right and revive the market. The aim should be to completely unburden the industry from the yoke of the interest burden. Let us follow the West and Japan and bring interest rates in the 0 to 1% range. This restructuring of interest rates will solve a long standing structural problem and unshackle the industry.

  Posted by: SP June 11 , 2012, 17:53 IST
@ Rajesh: 
It's true that we have comparatively much higher borrowing rates. After they try a first cut of 2% and see the benefits, they can move to a bolder balance to maintain NRI remittances...

Posted by: Vivek	June 08 , 2012, 16:11 IST
Are Outflows the result of Declining corporate profits Mr Ponuppa? Outflows and Inflows are determined far more by the Liquidity position in the West than anything which India does. Greece and halting-faltering US recovery decide our "Inflow" fate. Those who benefit from sops, will ofcourse try to use the excuse of a "broken India story" to extract Endless "Inflow" sops, but the wise will realize and flow with the Global Macro context. Grin and wait for the next liquidity cycle.

Posted by: SP June 11 , 2012, 17:56 IST

@Vivek:

True, liquidity is the primary source. But it's exogenous, and we have no control over it, other than taking indirect steps to make investing here more attractive. That's what profits do -- foreigners invest in India for growth, not for safety.

Posted by: Calling a Spade	June 08 , 2012, 15:28 IST
Nature of Subsidies - This world is not an island. Subsidies to the poor also help corporates by increasing their buying power and generating demand. Subsidies to the rich corporates (fiscal stimulus export subsidies debt restructuring tax cuts, etc)may trickle down to the poor in the form of cheaper products and employment. However, there is no guarantee of that!! But the greedy selfishness of the corporates can be turned from a social hazard into a social virtue and result in public good! Not through regulation but ONLY if competitive pressures balance this greed and direct vast entrepreneurial energies into customer service. Witness the benefits of low rates which have accrued to customers in telecom sector. It is not spectrum subsidies but the new entrants and greater market competition which has created the telecom revolution.

       Posted by: SP    June 12, 2012,  11:03 IST

@Calling a Spade:

Infrastructure sectors such as telecommunications/broadband have attributes of network economics and cannot sustain unlimited competition, because of  problems arising from an "empty core" (game theory).  Please see article titled, "Competition, open skies ...and bust?", August 4, 2005 (http://organizing-india.blogspot.com/2008/04/competition-open-skies-and-bust.html).  The article is about airlines, but the same principles apply to communications.

The likely consequence of unregulated competition is "robber baron" outcomes of the Gilded Age.  

Posted by: Gopi	June 07 , 2012, 07:54 IST
Sir, opposition, esp BJP, has been accused of being irresponsible / destructive by Cong's bhompus in our media - eg, edit pages of BS, IE, Telegraph, HT, ToI, ET etc as also many leading commentators - for last 8 years. So, my question to you, sir, is: how did we achieve high growth rate during first 6+ years of UPA Raj?

  Posted by: SP June 11 , 2012, 18:02 IST

@Gopi: 

There's no doubt the NDA prepared a good platform for growth. But as mentioned in the article, this was squandered by premature giveaways, restrictive monetary policy, and -- what is not mentioned, but is perhaps most important -- lack of constructive leadership in championing growth. However, the fact is that the Opposition and allies appear to be equally heedless and opportunistic.

Posted by: ashok	June 06 , 2012, 22:45 IST
New private power projects should be allowed ( compelled ? ), making use of open access, to sell directly to consumers, bypassing the broke SEBs completely. No need for competitive bidding, leading to unviable tariffs, dodgy allotments of captive coal mines and leaning on Coal India to help out. This will also have the effect of fracking the SEBs, whose reform is long overdue.

Interest Rates, Living Standards & Inflation

Shyam Ponappa / New Delhi June 7, 2007

What the right aims and strategies could do for India's living standards.

We must try to get these few major goals right in India: low interest rates, and a systematic policy framework for basic infrastructure (and systematic approaches to everything, including a simple, low-tax regime).

Low Long-Term Interest Rates

Imagine this scenario: a long spell of low interest rates, initiating a period of domestic expansion with sizeable construction and property development for a decade or more. With low interest rates, this could happen in India. Imagine the corporate champions that could grow exponentially, as companies build their game locally, then expand globally … in banking and financial services, telecommunications, energy, metals, construction, textiles, automotive products, manufacturing, chemicals, leather and fashion … “swashbuckling their way around the world in search of booty”, as the Economist puts it. Wishful thinking? Not entirely. This is what happened in Spain, more or less, over the last 14 years.*

I have taken some liberties, grafting elements of what-might-be for India on to what-has-happened for Spain: Santander in banking, Metrovacesa in property—a subsidiary acquired HSBC’s Canary Wharf headquarters in Britain’s biggest property deal, Ferrovial in construction, Mango and Zara in fashion. India’s special circumstance is that it is entering a phase of manufacturing competence. Manufacturing could be a growth engine if we got basic infrastructure (power, transportation and communications at least, with basic education, healthcare and sanitation, then access to distance education & training …). This may be fanciful, as we display little comprehension of the need for an integrated policy framework, but if it happens, add manufacturing to India’s potential for growth and employment.

We could consider Japan, except that inexplicably, many in India reflect the Western view that Japan is in some doghouse because of the long recession following the property bust over a decade ago. But what a plush doghouse! Look closely, and you will find that Japan has been a member of the OECD, the rich-countries club, all along. It is hard to explain Japan’s living standards to those who have not experienced it…

There’s Korea, the newest member of the OECD. Korea too went through a long period of tremendous growth built on low, stable interest rates. After achieving living standards comparable to OECD countries, there was a partial collapse during the Asian crisis of 1997, followed by structural problems relating to costs and overextended credit. However, that should not obscure the high living standards in Korea today, as is evident from Table 1. The same story applies to China, the US, Australia, Thailand …

Table 1: GDP per capita and final adjusted indicator, 2004

International Comparisons of Living Standards by Equivalent Incomes, Marc Fleurbaey & Guillaume Gaulier, January 2007: www.cepii.fr/anglaisgraph/workpap/pdf/2007/wp07-03.pdf.

Low interest rates bring the benefits of broad growth that is widely distributed in SMEs and entrepreneurial ventures (provided funding is accessible, not tucked away in government bonds or restricted to blue-chips who don’t need it), as well as in larger enterprises. The resulting lower costs sweep away many ills motivated by high interest rates, e.g., excess liquidity, the Yen carry trade, much of today’s external commercial borrowings (the reverse-rupee-carry-trade), and deals like Japanese leveraged leases (a structure arising from low interest rates with low tax rates), which will disappear with the dismantling of their rationale. Not only will low rates cut off a root cause of excess liquidity, they will help to move the locus of transactions to a local ambit, enabling the development of financial depth and higher-order capabilities in local markets.

Figure 1 shows how GDP varied inversely with lagged real interest rates in the 1990s in the emerging economies of Argentina, Brazil, and Mexico, and the new OECD member Korea.

Figure 1: Real Interest Rates & GDP in Emerging Economies

Source: Business Cycles in Emerging Economies: The Role of Interest Rates, Pablo A. Neumeyer & Fabrizio Perri: http://www.nber.org/papers/W10387

Living Standards

What do we aim for? What living standards should we aspire to, given the option? One measure is GDP per capita, but should we really aim for this, with its implied per capita consumption of, say, 32 kg of aluminium (US) or 6.5 kg (China), or “x” gallons of water, or “y” automobiles? Apart from making our surroundings unlivable, we could surely have more balanced aspirations, just as a life of the mind is worth cultivating despite scores of TV channels spewing inane trivia.

Living standards are measured in various other ways, such as the UN’s Index of Human Development, Osberg & Sharpe’s Index of Economic Well-being, or Bhutan’s Gross National Happiness. Alternatively, GDP per capita can be adjusted to compensate for non-income attributes of a society’s choosing, such as better healthcare, less unemployment or pollution, or more leisure, to arrive at an adjusted “equivalent income”, by determining how much a population is willing to pay for a reference level of a non-income dimension.

Figure 2 from a report by France’s Institute for Research on the International Economy (CEPII) shows GDP per capita for OECD countries, with adjusted “equivalent income” for several factors. According to this, Spain, Japan and Korea enjoy better living standards than their GDP per capita reflects, as do many OECD countries. The lesson for India: define relevant dimensions and desirable levels, then strategise and work to attain them.

Figure 2: Living Standards - GDP per capita ($) Adjusted Equivalent Income, 2004

Source: International Comparisons of Living Standards by Equivalent Incomes, Marc Fleurbaey & Guillaume Gaulier, January 2007: http://www.cepii.fr/anglaisgraph/workpap/pdf/2007/wp07-03.pdf

What should be our “acceptable” inflation rate? The risk in mentioning inflation is that the high priests of one persuasion or the other hijack all discourse, with knee-jerk reactions from anti-inflationary ideologues as well as proponents of inflation-tolerance. Arguments for both sides are entrenched in ideology, preempting understanding and multidisciplinary action for the practical management of such problems.

Consider a question I will address in my next article: what inflation rate should we—and the government and the RBI—wish for?

Before fielding Sukhamoy Chakravarty’s proposed 4 per cent, then RBI Governor Rangarajan’s 5-6 per cent, and FM Chidambaram’s 4-4.5 per cent, please consider:

- At a time of high growth, why nurture high “acceptable inflation”, i.e. expectations of rising prices? Why not 1-2 per cent?

- Do facts contradict the conclusion that high prices follow high interest rates (Thomas Tooke)?**

- How desirable—imperative?—is it to coordinate fiscal and monetary policy (and public-private initiatives) to achieve low interest rates and inflation in an emerging economy?

shyamponappa@gmail.com

* See The Economist, May 3, 2007: ‘Conquistadors On The Beach’ and ‘Plain Sailing No Longer’.

** On Interest and Profit: Thomas Tooke’s major legacy to economics, Matthew Smith:

http://cpe.oxfordjournals.org/cgi/content/short/25/1/1.