EVEN the biggest supporter of the Modi government finds it difficult to defend the regime when it comes to the economy. On almost every economic metric — GDP, employment, investment rate, industrial output, exports, building of assets — the Modi sarkar’s performance is worse than that of the UPA. This is especially galling for Modi-backers, because the PM came to power on the promise of taking India out of the economic mess supposedly created by the UPA’s policy paralysis.
In a recent video that has gone viral in liberal circles, PM Modi’s former Chief Economic Advisor Arvind Subramanian, has admitted that the Modi government failed to fix the economy and probably even made things worse. Although Subramanian traces the turning point in India’s growth story to the
Global Financial Crisis of 2008-09 that affected every country, he argues that India slipped more than the others. And since then, various kinds of policy mismanagement — what he calls ‘aborted structural transformation’ — have exacerbated the situation.
Underlying Subramanian’s thesis is the idea that India had got things mostly right in the first decade of this millennium. It was on track to beat China to become the fastest growing economy in the world. It had an enviable investment rate, was building assets at a record pace, and was gradually capturing a larger share of global trade, especially in IT services and pharmaceuticals.
But what if this very ‘boom’, between 2002-11, is to blame for India’s economic slowdown over the next decade? I will take a cue from Subramanian’s own speech to argue my point. Subramanian says that one of the biggest failures of the Modi government is its inability to fix the ‘twin balance sheets’ problem: On the one side, the
large number of bankrupt companies who don’t earn enough to service the huge loans they have taken, and on the other, public sector banks who are saddled with bad loans on their books.
This indeed is the secret sauce of India’s boom years. The cycle began in the capital markets. There was so much money sloshing around in the world, that excuses were invented to justify fabulous stock prices, especially of real estate, infrastructure, steel and power companies. These companies first raised money through over-valued IPOs, and then used their shares as collateral to raise money from banks.
Flush with funds, they launched projects that could only make economic sense if India’s domestic demand expanded at a very fast rate. And that is precisely the rosy picture that was being painted by the UPA government, professional economists, commentators and business news media. In hindsight, it is clear that private sector banks did not buy into this story of perpetual growth. An overwhelming majority of the loans given to these companies came from public sector banks, most likely because of political pressure and corruption.
I will call this the ‘twin bubble’ problem. The first bubble was a financial one, caused by overheated stock markets and an unregulated and irresponsible credit growth. The second bubble was in capital formation — homes, power plants, airports, roads, steel and cement plants — that were built without any concern for who would pay for their use.
If power plants had to sell electricity to state electricity boards, those boards had to be able to charge more money to their consumers. That would have required higher income for a wider section of India’s people. That, in turn, could only have been possible if India’s economy had been able to create more jobs during this ‘boom’period. But employment grew by just 1.2% per year between 2002-11, just about half of the 2.3% annual growth of India’s working age population between 2001 and 2011. Much of this growth took place in low-paying jobs like retail trade and construction. So, it is clear that India’s output was growing at a much faster rate compared to what its people could sustain through domestic demand.
This ‘capital formation bubble’is not easily understandable, because it is a bubble made of solid, visible assets. But that is what empty unsold homes, factories running on half capacity, and power plants that don’t generate any electricity, ultimately mean. On the face of it, it gives a real sense of economic growth, especially when buildings, factories, roads, power plants and airports are being built. It is a ‘boom’ that can be seen and felt, in the form of brick, mortar and steel. But it is a bubble nevertheless, however ‘concrete’ it might be.
In fact, the signs of a demand stress were visible well before the Global Financial Crisis. The real estate sector, for instance, was already seeing a growth slowdown and prices begin to plateau by early 2007. Road projects were running into trouble over toll rates. Construction companies that had got ‘build-operate-transfer’ contracts, found to their dismay, that Indians didn’t have enough money to pay the toll rates that would give them decent returns on their investments.
Some heterodox economists had been warning of this for a long time. They had said that investment in infrastructure without generating good jobs will make them unsustainable. They were also pointing to the growing income inequality in the country that was shifting commodity production to cater only to the top 10% of India’s consumers. These were all clear signs that a collapse was about to come. The Global Financial Crisis accelerated the process, but its conditions were already present.
The only reason why India’s economy appeared to recover after the global crisis of 2008-09, with just one year of slowdown, was because of huge stimulus packages announced by the Manmohan Singh government for the next two years. The fiscal deficit was allowed to balloon to stimulate demand, and that sustained the output. But once the fisc was tightened, the economy folded once again.
We are now sitting on huge capacities built during the ‘capital formation bubble’, without any commensurate demand. The private sector has no reason to invest when capacity utilisation is so low. It is only the government which can invest and employ people to revive growth. But that is unlikely to happen.
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