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.

Healing Self-Inflicted Wounds

Let's use the smarts for making rational policies

Shyam Ponappa / December 1, 2011

A spate of dysfunctional actions and retrograde developments has led to an unimaginable mess for India. Can the damage to growth prospects be undone? Does it need to be? If so, how? Three areas are discussed below.


Some months ago, the spectre was of consoling ourselves with a reduction of two per cent in growth, from 9.5 to 7.5 per cent. That’s history. What looms ahead is a larger, more serious threat. This ominous tidal-wave-in-the-making comprises many separate currents converging to undermine India’s take-off yet again. The prospect is long-term growth hamstrung by policy stand-offs, foreign direct investment in retail being a case in point, and social tensions fuelled by high unemployment.


Those who think India has arrived should be aware that it will take another decade of eight to nine per cent growth to be able to fund reasonable basic infrastructure and necessities for everyone. Why should it matter if you live in a rich cocoon? At the very least, you’ll be able to go out without stepping into filth or smelling it, or seeing masses of people struggling to survive.


Instead of a high-growth trajectory, we may get six to seven per cent, with luck. These prospects are clouded by wasteful expenditure, such as the perpetuation of an ill-functioning public distribution system and its concomitant, ration-shop-mentality, instead of efficient direct retail subsidies through electronic transfers. The negativity is amplified by fractious social and political tensions, and shoddy infrastructure crippling productivity: power outages, low-speed communications and poor logistics. One can argue (ah, argument) that the tensions are justifiable as an antithesis to increasing levels of corruption from political, bureaucratic and corporate kleptocracy feeding off the land and people, or hardening sectarian interests competing for predatory control. But if there’s one thing we can learn from others’ experience, it is to work together for better outcomes, or suffer; in game theory parlance, collaborate to optimise, or settle for worse.


Undoing Sectarian Alignments


Undoing the fractious underpinnings of sectarian alignments of language, caste and religion is beyond the scope of this article. The unpleasant reality is that unless such structural social impediments are addressed, malfunctions will continue. So we have this reality where, at one level, India is wonderful in the way people stream and swirl together, and at another, it is horrible because our potential is not manifested in living standards, with people fed, clothed and housed properly, and clean streets.


To return to misapplied intelligence in the political economy, consider three areas: interest rates, airlines, and telecommunications.

Interest Rates

It seems only the Reserve Bank of India (RBI) was unaware that the consequences of interest rate hikes since February 2010 would (a) not control inflation (short of an economic collapse), and (b) lead to a severe curtailing of growth. To be fair, some economists aided and abetted with remarks that interest rates must be raised because of high inflation.

By contrast, the accompanying charts for China and Germany (euro zone) show their negative real interest rates.

What we have to do is reduce interest rates, with selective credit controls to ensure that credit for speculation is constrained and costs are high, e.g., in certain real estate, commodities, stocks and derivatives. Implementation, likewise, has to be “intelligent”, with online tracking by exception, and not cumbersome or voluminous weekly or fortnightly reports that are manually compiled and/or analysed, filtered and then presented to committees for decisions.

Airlines

The structural anomalies in India’s taxes on aviation turbine fuel (ATF) and airport charges defy logic. For a decade, there has been talk of cuts in central and state taxes on ATF, but the problems continue. Consider the missed opportunity: India has a large domestic market and is well positioned for airlines to use this for establishing global leadership, as well as ubiquitous domestic services. Instead, the sector is bled for short-term government revenues, giving foreign airlines the advantage. ATF charges in India for international flights cost 16 per cent more than they do abroad, and local airlines pay over 50 per cent more because of taxes and additional charges. Consider the ludicrous stipulation that foreign airlines cannot invest in India, and the irrationality defies imagination. Add the illogic of a government-funded, loss-making airline undercutting private airlines, and we have the mess we are in.

Globally, airlines suffer from gratuitous free-market philosophies, the exceptions being airlines from strategically focused countries, e.g., in West Asia, Southeast Asia (Singapore, Malaysia, Thailand) and, of course, China. Wake up! Surely no one doubts that aviation is an integral aspect of logistics and transportation? The government needs to recognise this and build capacity, with policies like uniform, low state taxes. Also, as in telecommunications, aviation requires an oligopolistic structure with limited competition, which if ignored brings chaos and grief, because nothing else is sustainable.

Telecom & Broadband

The draft National Telecom Policy 2011 promises good things. Yet, like India’s potential, the promise will be realised only with convergent action. This iconic sector, which changed the way the country functions and is perceived, is on the verge of being ruined by dysfunctional intervention. For instance, the regulator and the government seem bent on applying retrospective charges for “excess spectrum”, taking the bottom out of the market. Worse, 3G services are hamstrung by government attempts to restrict services, while operators threaten litigation. Meanwhile, the bastions of “free markets”, the US and the UK, are initiating shared spectrum policies. What good are our brilliant objective statements about excellent, affordable services if the government acts to achieve the opposite? And is it beneficial for India to hound solid companies like Telenor and Qualcomm (unless they commit transgressions), instead of taking a problem-solving approach?

If the confused doublespeak – of punitive charges, restrictive practices, PSUs building state-of-the-art networks, auctions and spectrum sharing, all in the same breath – continues, we may lose a decade or more because of instability and irrational policies. It is time for decisions on pay-for-use, open-access spectrum and networks. Incumbent network companies can be compensated along a downward-sloping power curve to give up their competitive advantage. We must start being reasonable and do things that make sense.

shyamponappa at gmail dot com

Reviving Growth

Reduce interest rates and undertake specific reforms to revive growth

Shyam Ponappa / September 1, 2011

India’s heady economic prospects of a year ago have deteriorated unthinkably. True, the rest of the world is wobbly, too, from America’s unreconstructed and unsustainable headlong decline, to much of Europe’s companion piece. But the possibility of some buffering for India seems to have evaporated. Expectations of better prospects were not so much from decoupling as from our limited dependence on exports, and headroom from activity levels with enormous scope for improvement and expansion — in basic infrastructure, housing, second-order infrastructure like education, sanitation and health care, as well as manufacturing, tourism and retail.

Rising input costs and interest rates started the decline in margins, and self-destructive actions made matters worse, epitomised by the implosion of the scams (2G, the Commonwealth Games, the Karnataka mining scandal, the land scams…). The Reserve Bank of India’s (RBI’s) actions of increasing interest rates when faced with inflation caused by factors beyond its ambit, such as food prices rising because of supply constraints, or energy prices on account of expensive imports, have amplified the negative sentiments.

The Bogey: Growth versus Inflation

The economy is slowing, and earlier estimates of well over nine per cent growth for 2011-2012 have gone overboard. In May, the Federation of Indian Chambers of Commerce and Industry’s estimate was nine per cent; in August, an RBI survey consensus was under eight per cent; Morgan Stanley’s was barely over seven per cent. Yet, policy makers maintain that despite the deleterious effects on growth, raising interest rates to control inflation through monetary policy is paramount.* In absolute terms, the need for controlling inflation is incontestable, but societal needs provide an exigent imperative for making the trade-off in favour of growth. The consideration now needs to be of steps that could alleviate the slowdown, and the likely effects of such actions not only on inflation, but also in collateral damage to economic activity.

Consider India’s shortcomings, namely, insufficient food production and associated storage and distribution, inadequate agricultural extension support services, expensive oil and coal imports, and lack of educational and vocational training facilities for a burgeoning, youth-dominated population. Add another level of inadequacy arising from our continuing lack of infrastructure, from basic sanitation, water and health care, extending through energy, transportation and communications (broadband). These structural bottlenecks exacerbate the negative aspects of our predicament.

The government’s recalcitrance in acting against blatant corruption until the scams erupted had already unsettled markets. Even salutary developments like Anna Hazare’s anti-corruption movement have added to the destabilisation, through attacks on parliamentary processes and the prospect of a breakdown in law and order.

Against this backdrop, we have a slowing economy, now threatened by a global slowdown. In the quarter ending March 2011, a third of the Sensex companies had missed their earnings estimates, while in the last quarter ending June 2011, nearly half of them were below estimates. With offshore revenues estimated to contribute nearly a third of FY12 profits, the threat of a global slowdown is ominous.

Inappropriate Rate Hikes

From this perspective, raising interest rates to combat inflation appears decidedly ill-advised. As expected, interest rate increases have not reduced inflation. The reduction can happen only when economic activity slows so much that demand for essentials falls, a horrific prospect. As for attracting foreign investment, rate hikes do little to induce confidence in foreign investors in skittish times, because they look to India and emerging markets for growth, not for stability. To be a safe haven, India has to be perceived not as a developing economy, but as an equivalent of the Organisation for Economic Co-operation and Development — a long way and many years ahead.

The economy, therefore, needs shoring up. Can the RBI and the government take steps to reverse the decline? Consider the following corrective actions:

(i) Reduce rates to revive growth

In these circumstances, the priority has to be growth. Otherwise, apart from minimal foreign investment, domestic investment also is likely to be curtailed further, and social instability triggered by economic pressures could grab centre stage to devastating effect. International commodity prices are outside India’s control, but the RBI can reduce interest rates. Cutting rates can raise margins and revive consumer demand.

The central bank needs to reverse its repressive stance on rates, no matter what the textbooks say, so that enterprise profits recover to a high-growth trajectory.

An immediate cut in borrowing rates, together with a concerted move to reset positive expectations and sentiments, is an urgent requirement.

(ii) Selective credit controls for asset bubbles

Further, the RBI has avoided instituting selective credit controls to avoid asset bubbles, perhaps because of legacy reasons concerning commodity pricing and the potential for interference in markets. With smart e-governance at hand, this nettle must be grasped in place of the blunt instrument of overall rate increases, to use real-time, targeted additional margins, cash reserves and rate increases to defuse incipient asset bubbles.

(iii) Reforms to build momentum

In tandem, we need reforms to rebuild economic momentum. All sectors need reform, e.g., energy, communications, transport, sanitation/water/health and education. For instance, the energy/power sector sorely needs drastic reforms, but it is so complex, with so many layers that need disentangling, that while initiatives are necessary, they are unlikely to revive growth in a reasonable period. The need, therefore, is to focus on what is practicable with the likelihood of achieving results.

In practical terms, we have to prioritise, and focusing now on communications, specifically broadband, could yield results. Mobile communications grew phenomenally over the last decade. The meteoric rise stalled for a variety of reasons: excessive competition, ultra-low tariffs, saturation in urban markets, limited access to spectrum, no incentives for broadband, restrictive actions against BSNL and MTNL, scandals and policy uncertainties. Yet, if the government initiates appropriate reforms in spectrum policies with incentives for broadband delivery, prospects could revive. If the government can (a) formulate major reforms with a New Telecom Policy 2011 that achieves growth, while(b) resolving problems relating to past irregularities through sound legal processes and judgment, communications could go through another meteoric rise, becoming the growth engine for the economy.

Shyam (no space) Ponappa at gmail dot com

* “The policy dilemma”, C. Rangarajan, Business Standard, August 22, 2011: http://www.business-standard.com/india/news/c-rangarajanpolicy-dilemma/446531/

Cut Interest Rates To Revive Growth

Shyam Ponappa / New Delhi January 1, 2009

Significant interest rate cuts can deliver price cuts and revive growth.

...Avoid calibrated loosening of a noose, giving remedial finance to enterprises after they are half-dead...

...excise cuts, without significant interest rate cuts and sufficient liquidity, are like one-handed clapping: Simply not very effective...

India managed 8.8 percent growth annually for five years. “If it could keep this up, India would be transformed, as China has been,” says The Economist.* Alas, ICRIER’s estimates indicate possibly under 6 percent growth for 2008-09, and under 4 percent for 2009-10.** Perhaps 2 percent below potential (reduced to 8 percent?) by March 2009 and 3-4 percent by March 2010.

The fall in the Index of Industrial Production leaves policymakers no room for false optimism (see diagram).


Source: The Economist

Add dismal advance tax collections in December, a limp stock market as FIIs pull out and local demand stalls, unresponsive consumers, new hires plummeting, and funds raised through public offers at a five-year low. The airline sector dying again and with it, prospects for tourism gains. Airlines will be gutted unless taxes are cut to reduce our inordinately expensive aviation fuel (ATF), enabling price cuts. Lower pricing is more critical for ATF than for petrol for cars, because capital-intensive airlines cannot simply cut back on travel as individuals can, and capital costs will compel failure if the cost structure is unviable.

This is a hard landing for India. Growth so far short of potential means huge opportunity losses for very many people. The spillover in social consequences is another cost with devastating effects, from deteriorating law and order to divisive short-term realpolitik. Time to stop tinkering and take big steps.

Bungled Policies: One-Handed Clapping

Responses from the RBI and the government have been mixed. After a good start, there’s been a letdown. A solid excise cut in the first week of December from 14 percent to 10 percent, after-trial 1 percent cuts in the repo and reverse-repo rates, and reclassification of some real estate lending as priority sector. Markets stirred warily, and banks strove to devise creative solutions, restructuring and lowering rates on some home loans. And then? Nothing — fooled again.

Have the RBI and the government done enough? Consider:

• Consumer demand revived only slightly. This is to be expected with a rate cut of only 1 percent. Interest rates are very high in India, affecting prices, consumer finance, and sentiment (a negative wealth effect — see next item).

• Despite good fundamentals, the Sensex is volatile around 10,000. Some think a forward P/E multiple of 10 is reasonable. But with India’s upside potential, the Sensex could be at much higher multiples with strong foreign and domestic investments, if it were not constrained. These constraints are: Depressed earnings because of expensive or unavailable finance and sagging demand, negative sentiment, and uncertainty. Remedial measures can increase earnings, critical for investment, and revive sentiments. Otherwise, growth will be constrained by limited bank finances, further circumscribed by concerns about excessive credit growth (which aggravated the liquidity constraints to begin with).

• The RBI says there is adequate liquidity, but banks have deposits of around Rs 29,000 crore at the risk-free reverse-repo rate. Meanwhile, trade credit has dried up and the securities markets are dead, with funds raised from the public at a little over a third of the previous year, at Rs 16,927 crore in 2008 against Rs 45,137 crore.

• Additionally, contradictory moves, eg, a railway freight hike, resulted in cement companies not reducing prices sufficiently, crippling revival possibilities.

With India’s potential, why isn’t growth higher? Because excise cuts, without significant interest rate cuts and sufficient liquidity, are like one-handed clapping: Simply not very effective.


Reviving Growth

The ‘solutions’ are straightforward:

Liquidity: Abundant liquidity, with signals of continued availability — not calibrated loosening of a noose, giving remedial finance to enterprises after they are half-dead — will convince lenders that funds are available, and businesses that they can realistically consider investments. The need is for a further CRR cut of 2 percent.

Repo Rate Cut To 4.5 percent: The cost of funds must fall for lending rates to drop. One way to induce this is a sharp reduction in the repo rate — the rate at which banks borrow from the RBI — by 2 percent, to 4.5 percent, combined with a reverse-repo cut (next item).

Reverse-Repo Rate Cut To 3 per cent: A simultaneous cut in the risk-free rate of investment for banks by 2 percent will encourage lending. Also, these cuts will change the economics of many good enterprise activities and projects, making them viable, providing opportunities for banks to lend. Initially, banks short of funds will borrow to lend at lower rates. Call rates will drop with adequate liquidity, ensuring a significant fall in lending rates.

Limits on Investment in Government Securities: There need to be limits on banks’ investments in government securities to discourage this risk-free alternative.

NRI Remittances: NRI remittances require a level of safety, and thereafter, returns. Returns are driven by FCNR rates, which can be set separately from other policy rates, as has been done before.

FII Investment in Debt: As of October 15, 2008, FIIs had invested $2.4 billion in corporate bonds and about $3.25 billion in government bonds. Some argue that if India’s interest rates fall, these investments will pull out. While foreign investors do seek higher returns, one issue is the limited extent of these investments, as India is not viewed as a true safe haven (having recently made it to investment grade, and now in danger of slipping). Another is the relative merits of strong growth with low interest rates, with two associated developments:

• A strengthening currency, and

• provided there are the right policy initiatives, a strong debt market.

Benefits from these developments are likely to far exceed a weak position ‘defended’ with higher rates. A third factor is low returns elsewhere.


Real-Time Management: The RBI also needs to implement a loan monitoring system covering: (1) Priority sector loans and rates, (2) Capital-intensive manufacturing and services such as airlines with domestic market potential, and (3) Higher margin requirements and provisioning for activities such as second-and-subsequent property loans, to discourage asset bubbles.


Cutting rates is easily practicable. If there are doubts, sound out bankers who understand cash flows, and have a sense of actual supply and demand. If there are problems, raising rates will correct for many of them.


shyamponappa@gmail.com

* ‘An elephant, not a tiger’, The Economist, December 13, 2008.

** ‘The global crisis and India’s growth rate’, BS December 3, 2008: http://www.business-standard.com/india/news/the-global-crisisindias-growth-rate/16/13/342081/





See:

Do more than you think is needed: Bimal Jalan

STATE OF THE ECONOMY (A TURN-OF-THE-YEAR SERIES)

BS Reporter / New Delhi January 01, 2009

Breaking the Mould: India's Own Growth Path

Shyam Ponappa / April 06, 2006

Services as the locomotive for growth, & not always letting markets dictate prices

Some pundits rue that services have grown in India while manufacturing lags, and that manufacturing has been more capital-intensive than not. The facts are that a confluence of events and circumstances over decades—capital-intensive manufacturing, high-end education, a flair for creative problem solving, an impending millennium bug, and the gradual build-up of a critical mass of successful Indian immigrants elsewhere, especially in America, and the gradual, cumulative effects of steady growth by stealth of a potentially large economy—have made for a transformation in India’s positioning.

Instead of ruing the facts, perhaps we could learn to capitalise on them. Make necessity a virtue, as in two other examples of unconventional development: China’s air transportation, and Brazil’s production and use of ethanol.

Services vis-à-vis Manufacturing: Two Vignettes and a Deduction

One “false note” in a post-budget interview on NDTV: Asked why he did not focus on strengthening services (i.e. strengthen the champions instead of trying to turn weaklings into pahelwans), Finance Minister Chidambaram said services were doing well enough, so the government did not need to do any more for them.

A recent IMF report on the different pace of development in the advancing versus lagging areas in India concludes that the latter “will have to follow a more traditional path of growth, focusing on labor-intensive manufacturing.”*

This is where India must break the mould. Services need not be only for external markets/outsourcing. Services for hospitality, biofuels/floriculture/ “smart” agriculture and logistics could provide excellent employment. With adequate infrastructure, there could be far higher volumes of local and foreign tourism (little Thailand gets 12 million!) and travel, generating immense local services demand. India needs infrastructure that enables and facilitates learning and work, whether for services—in IT, hospitality, agriculture, floriculture or logistics, or for manufacturing. There could be much more productive uses of land and people, e.g., travel and leisure facilities, as well as biofuels, floriculture, vegetables, etc. All these need infrastructure just as much as manufacturing. Once they are there, with appropriate training and organisation, there could be growth in services as well as better manufacturing.

Make Necessity a Virtue: China’s airlines, Brazil’s Ethanol

China’s airlines, operating primarily in domestic markets, have the kind of problem we might wish for. They carried 138 million passengers in 2005 (India had about 40 million), and expect to double that in five years. China has 130 airports, handling over a million passengers each annually, with another 55 international airports planned by 2020. Airbus and Boeing are gleeful at prospects for aircraft sales over the foreseeable future. The Economist, however, finds a worm in the apple: despite impressive growth, many airlines show negligible profits.**

The article cites rapid growth as one reason for this, and also cites administered pricing for depriving them of “the sophisticated yield management of their western peers”. Also, like India, China’s government exercises a jet-fuel monopoly, and so fuel costs comprise an average 40 per cent instead of the 24 per cent for airlines worldwide.

Is this really so bad, considering China’s gains? After all, where has sophisticated yield management led western airlines besides overcapacity, unsustainable price-cutting, and bankruptcy (see “Competition, open skies ...and bust?”, Business Standard, August 4, 2005: http://organizing-india.blogspot.com/2008/04/competition-open-skies-and-bust.html).

The Economist compares China’s airlines with Cathay Pacific and Singapore Airlines. This is inappropriate because the latter operate internationally, while the Chinese airlines operate primarily in domestic markets. Second, we are left with the question in China’s context: is profitability the sole criterion? Put differently, would China benefit more from airlines making impressive profits, or from their maximising passenger- and freight-miles while maintaining viability and quality? A cost-benefit analysis could provide some illuminating, counter-intuitive answers.

The article acknowledges that “China has done wonders to mobilise the country”, praising its airport infrastructure. Yet its overall assessment is negative because of its bottom line preoccupation. Assessed by benefits, however, China has broken the mould. As India, much of Asia and the rest of the developing world must do, as they seek prosperity. Just as Brazil, desperate in the mid-70s to be less dependent on then-imported fossil fuels, succeeded after years of effort at ethanol production and use. Production costs are now down to $7.50/Giga Joule, competitive with oil at $35 a barrel.*** Brazil is less dependent on fossil fuels and less polluted, and exports ethanol to North America and Europe. Impossible, if Brazil had focused on profitability, instead of policies such as compulsory blending, support prices, user subsidies, and cheap, easy credit despite inflation. (Much we could learn and adapt, supplemented by initiatives such as Teri’s jatropha project with BP in Andhra, given India’s land/water constraints for sugarcane.)

Letting markets set prices in affluent countries is different from doing so in developing countries. In China’s case, the benefits of mobilisation, the efficiencies in production and delivery, could not have happened so quickly if the airlines were essentially profit-driven. China’s policies have resulted in cheap transport with the headlong growth of travel and productivity through efficient logistics. These gains are not reflected in any one airline’s profits; nor is another significant benefit, the convenience for users and their beneficiaries.

Services: India's Locomotive for Growth

India’s precocious services growth with limited manufacturing has likewise stumped orthodox expectations. While we must certainly strive to build productive activities of every sort—manufacturing, surely, but also more efficient agriculture and horticulture, extending to oilseeds and biofuels, fruit, vegetables and flowers, wood products, greening the land in strategic ways to yield net social, environmental and economic benefits … But most emphatically, we must build services as a locomotive for the Indian economy. IT/BPO/KPO services, already doing well, would benefit tremendously from better infrastructure, as would manufacturing. And hospitality services in India are like gold waiting to be mined, provided the infrastructure facilitates millions of tourists, and the training and capability of service providers. Not everyone can be trained to manufacture, whereas many more people can be trained to provide services for tourism and travel than can become skilled machinists, welders, IT jocks, or biochemists. Broadband Internet as a multiplier and delivery mechanism for training and facilitation is a no-brainer; it just needs to be done effectively, not merely claimed to be available. (How to achieve that requires a combination of planning-and-execution that we apparently haven’t quite figured out.)

* “India’s Pattern of Development: What Happened, What Follows?” IMF Working Paper WP/06/22 of January 2006, Kalpana Kochhar, Utsav Kumar, Raghuram Rajan, Arvind Subramanian, and Ioannis Tokatlidis.

** “Chinese aviation: On a wing and a prayer”, The Economist, February 23, 2006.

*** Seminar: An International Market for Biofuels? “The Brazilian Perspective”, December 9, 2005: http://www.clingendael.nl/ciep/events/20051209/20051209_CIEP_Moreira.pdf


Shyam Ponappa