India 2.0 – Delivering to an Aspirational India

What should be the agenda for the great leap from India 1.0 to India 2.0? Undoubtedly, economic stability is a sine qua non. An economy can’t sustain the same speed if it has headwinds in the form of high inflation, weak currency and high debt burden and hence high interest rates.


This might have sounded a bit heavy and idealist to students of a Philadelphia school in an autumn of 2010, even if it came from none other than the US president Barack Obama. But the speech was in a way an inspiring message to all the people of US, the world’s biggest economy and politically the most powerful yet crippled by high government debt and slowdown. That was in 2010. The US economy has since come out of the shackles of recession and is ready to roar.

While Obama’s speech may sound out of place for a developing economy like India especially at a time when the GDP growth is tottering at less than 5 per cent, but it’s time we ask ourselves whether or not the country wants to at least graduate into a “middle income” nation during the next decade. The task of increasing the GDP and the per capita income five times – India’s GDP per capita is now at $1,600 while the average for middle income nations are at $9,000 – is no doubt an uphill task for whichever governments are in power in the next 10 years. But it’s high time for India to “dream big” and “work really hard”. It’s perhaps the wish of 1.2 billion people as well as it voted to power the Modi government with a decisive mandate!

“A middle income country by 2025 propelled by inclusive growth and safe environment for development”

Since the global crisis, inflation rate has stayed high especially for food items for both domestic and international factors – rising global crude oil prices, supply constraints and faulty government policies and responses. Former Prime Minister Manmohan Singh has on many occasions reiterated that inflation is a tax on the poor. But unfortunately, his government failed to remove that “tax” burden from the shoulders of the poor.

“Nothing – absolutely nothing – is beyond your reach so long as you’re willing to dream big, so long as you’re willing to work hard.”

If inflation remains high, it would be naive to assume the RBI will oblige by cutting interest rates aggressively. High interest rates hurt the poor and middle-class borrowers as well as small and medium sized firms the most. In a way, high inflation and borrowing costs are a double-whammy for the vast majority of the population. Needless to say it also erodes the competitiveness of domestic firms in the global market and indirectly weakens the currency as the terms of trade tilts against domestic producers and makes the country hostage to the whims and fancies of foreign institutional investors to fund the trade gap (current account deficit to be precise).

High interest rates hurt the poor and middle class borrowers as well as small and medium sized firms the most. In a way, high inflation and borrowing costs are a double-whammy for the vast majority of the population. Needless to say it also erodes the competitiveness of domestic firms in the global market and indirectly weakens the currency as the terms of trade tilts against domestic producers and makes the country hostage to the whims and fancies of foreign institutional investors to fund the trade gap

With oil imports ($165 billion in FY14) making up more than a third of the import bill $450 billion, a weaker currency puts undue pressure on the exchequer. Not to forget the rise in coal and gold imports until 2012-13. While softening of coal prices in global markets and curbs on gold imports have tempered demand and helped lower the CAD to 1.7 per cent of GDP in 2013-14 from 4.7 per cent in the previous year. But there is no room for complacency as an industrial revival may again push up the CAD this year onwards. CAD is just one part of the problem of twin deficits, the other one – fiscal deficit of the government is still high.

Unless the government mends its finances by cutting down on wasteful expenses, the fiscal deficit can’t be brought down beyond a point, as interest payments, salaries and pension and other such expenditures can’t be curtailed. This incentivised ambitious finance ministers in recent past to cut down on capital expenditure needed to repair and build critical infrastructure and needless to say compromise on social spending for schools, hospitals and public amenities. Not surprising that though the deficit has come down from 6.5 per cent of GDP in 2009-10 to 4.5 per cent last fiscal, the GDP growth has almost halved to 4.7 per cent in FY14 from over 9 per cent in the pre-Lehman era. With a heavy borrowing programme each year, the government also crowds out private borrowers by keeping bond yields and hence interest rates remain high and further choke private investment. The agenda for the new government is to balance the fiscal consolidation process with the growth imperatives. Productive investment from the government could pave the way for revival in the investment. The objective should be to ensure efficient use of capital so that the incremental capital output ratio improves to 4:1 from 6:1, which in turn will be sustaining growth.

Reforms Redux

Revival of investment will require some hard measures and reforms. Investment follows the simple mantra – money flows where it fetches high returns. For this to happen, rigidities in regulations have to be removed. In World Bank’s language the ease of doing business should improve. Mere increasing of FDI caps won’t help. The government has to convince investors that there will be no retrospective taxation, labour laws will be made congenial and inputs including natural resources are readily available. More than that, the investors are now looking at faster clearances, be it environment and forest or mining or land resources. Finance Minister Arun Jaitley, in his maiden budget, has made several such announcements. But the need of the hour is go beyond mere announcements.

The rise in Incremental Capital Output Ratio (ICOR) in the last three years was primarily because of stalling of projects that locked up capital without raising output. Since 2013, the government has tried to put in place an institutional mechanism in the form of cabinet committee on investment and project monitoring group to expedite clearances for 440-odd stalled projects that made close to Rs 20 trillion of investment unproductive. About 150 projects worth Rs 5.5 trillion have been cleared so far but some of the high profile cases remain unresolved – Posco’s Rs 540 billion steel projects and Tata Sasol’s Rs 6 billion coal-to-liquid project, to name a few.

The government has to convince investors that there will be no retrospective taxation, labour laws will be made congenial and inputs including natural resources are readily available. More than that, investors are now looking at faster clearances, be it environment and forest or mining or land resources

Last year, unavailability of domestic coal through a formal fuel supply linkage from Coal India Ltd had threatened to derail India’s power capacity expansion. After CCI clearance, about 80 power plants, both public and private, with a combined capacity of 70,000 MW got a fresh lease of life. This example is a pointer to another thing – if a PSU cannot deliver, it’s better for the government to open up the sector for competition by allowing entry of private and foreign players through a transparent bidding process. The sooner coal mining is opened up for foreign firms the better for the country. This will not only reduce import dependence but also open up the flood gates for complimentary investment in coal sector.

Demographic Dividend

While growth is an imperative, what is often given a miss is the equitable growth. The high growth during UPA-I era (2004-09) has been highly skewed towards the southern and western parts propelled by corporate investments. Unfortunately, the eastern and some of the northern regions especially Uttar Pradesh, J&K and Uttaranchal have not received adequate attention so far as public investment is concerned.

It’s an irony that if the country has to reap the demographic dividend, policy measures and fund allocations have to factor in the Bimaru states – Bihar, Madhya Pradesh, Rajasthan and UP. These states are economically backward now but they have the youngest population – 90 per cent increase in the working age population is expected in these states by 2050. Surpringly, the contribution from these states to high growth still remains a distant vision.

What is needed is higher plan allocation for education, skilling and training in these states. Much of what is being proposed in labour ministry’s New Employment Policy for skill development fits well with the requirements in these weaker states.

Social Divide

With equitable growth, India needs to redouble its efforts towards inclusive growth. Continued and result oriented government intervention for bottom 33 per cent of the population is the call of the day. While welfare schemes are in abundance, what is needed is accountability and elimination of corruption – if only half of the BPL families are receiving grains under PDS, there is something wrong in the system; if only a tenth of MGNREGA workers have got 100 days of work, the scheme needs a relook. The new government has to stem the rot. It is not an impossible task – one has to look at how Madhya Pradesh has facilitated convergence of all cash transfer schemes and paying the poor families through a proper social security cum debit card.

Welfare schemes do not mean anything if villages don’t have clean drinking water and healthcare schemes as part of their entitlements. Many of the social schemes have fallen flat on their face as there has been some deficiency or the other, in their implementation. And, much of the success depends on the involvement of women, who actually run the households and understand their needs better.

Focus on Education and Health

Truly, health and education are inextricable. Regions with poor health facilities cannot generate intelligent people. That’s another reason why children from poor families have lower probability to excel in education especially in higher education. Hard work matters but it has to be supplemented with health.

If India has to supply one-fourth of the global workforce by 2020, it has to step up efforts to increase public investment in education and health so that labour productivity increases. Without that the vast majority of Indian workforce will remain trapped in low productivity jobs and remain within the vicious circle of poverty and that in turn means slower economic development.

With more than 90 per cent of graduates pass-out from state universities not employable, it is not surprising that none of the technical colleges or universities figures among the top 200 globally. The Modi government has to step up efforts in infusing technology, build infrastructure and upgrade skills.

Public health needs a major revamp if it has to benefit the poor. Apart from large-scale technology upgradation, what is needed is 100 per cent coverage of healthcare services. The RSBY programme is a great success and is applauded as the world’s largest public health insurance scheme. The next step would be increasing the benefits. For public healthcare system to succeed, what is needed is replication of the Gujarat model of digitisation and consolidation of hospital records.

Internal Security

Equitable and inclusive growth will remain incomplete unless there is normalcy in life. More than 200 districts are affected by of Left Wing Extremism and more than 10 states affected by terrorism. This is a black spot on our democracy and home security. How to address this? Unless Centre-state relations are strengthened, homeland security cannot be achieved.

Modernisation of intelligence apparatus and intelligence driven action has become a necessity to weed out Naxalism. Lagging implementation of NATGRID and CCTNS only slackens the process.

What states ought to take up on a priority is setting up of dedicated police data centres. There is a dearth of collaboration between city administration and police systems which results in higher casualties in times of terror attacks.

Lack of city surveillance as well as border surveillance only increases the risks to citizens. The problem is aggravated by lax efforts in modernisation of police force. There are not enough police training academies which hamper recruitment of policemen.

Cyber Security

India aspires to become a knowledge society and an IT superpower. Yet, it has one of weakest cyber security system. Nearly 70 per cent cyber attacks are targeted at large firms in India. Electronic systems in defense/military communications can also become prime targets for highly sophisticated cyber-attacks. Already, many of the government websites (even PM’s twitter account) has been hacked. It’s a no-brainer what damage a cyber attack on the country’s booming financial sector can do to the millions of investors.

It’s not just financial markets. Some of the sunrise sectors such as the $13 billion e-commerce market cannot thrive without adequate checks and balances. Online sales of retail goods totaled $1.6 billion in 2013 and are expected to reach $76 billion by 2021. But is it possible if the cyber space is unsafe? Secure transactions and secure payment gateways remain a challenge. Securing financial, market and government databases (from malicious, hacking or phishing activities) is a challenge. Adherence to data security standards worldwide and need for proper data protection and privacy law is a must.

Development Agenda

The development agenda should be reoriented towards infrastructure building especially urban infrastructure. While India needs more power plants, ports and airports, the BJP manifesto rightly targets building of 100 new cities as they can be the engines of growth of the future. As agriculture productivity rises, the rural-urban migration will accelerate and that will put undue pressure on existing urban infrastructure. Unless small towns graduate into big towns and small cities into metros, the country’s development will falter. The upcoming industrial corridors between Delhi-Mumbai, Chennai-Bangalore and dedicate freight corridors connecting the north to east and west presents a strong case to build new cities along these lines. In a way, it will take off the migration pressures from metros and remove regional disparities.

A multipronged development strategy requires convergence and creation of an environment where people come together – skilled people, intellectuals, entrepreneurs and innovators. How will cities come up if you don’t have adequate engineers, town planners? We will also need entrepreneurs who could set up new ventures in these new cities. Also, we need innovators as the future cities will have to be green cities with all the latest technology that optimises power and water consumption, ready with the 4G bandwidth and e-governed.

Financial inclusion does not mean just banking operations. Insurance penetration and coverage has to increase exponentially as the poor households are vulnerable to risks more than anyone else – life, health, crops, cattle, farm equipments and dwelling units should all be covered preferably through a simple and a single product

All of these will help create an eco system that will stimulate economic activity and increase employment in high productivity jobs. Even while we embark on this developmental agenda, one can’t lose sight of the inclusive growth agenda. A restructured societal setup and coordinated participation in economic development from villages to cities is required. Creating a system of interdependent development of rural and urban areas should be the hallmark of the new developmental process.

Why are Governance, Growth and Financial Sector Joined at the Hip?

While the roadmap for development is laid out, the problem is of financing. Typically, infrastructure development will require at least $1 trillion (Rs 65 trillion) during the 12th Plan (April 2012 to March 2017) and half of it has to come from the private sector. Of the private sector funding, a major portion (about $250 billion) has to come from debt and the rest from equity. So far, the Indian experience has been highly skewed towards bank financing of the debt portion. It is a challenge to garner the equity financing as neither do India Inc has the risk appetite nor has the financial sector offered innovative methods

Non-financial corporate sector dependent on bank credit, e.g., 2012 net bank credit to industrial sector was 2.9 per cent of GDP, capital from the markets was 1.3 per cent of GDP. The ratio of credit between banking system and markets – roughly 85:15 in comparison to 50:50 in developed markets. Even in the case of debt financing, the requirement is close to Rs 15 trillion which should come from the bond market, which unfortunately is practically non-existent. If the government is raising over Rs 5 trillion from the bond market, it leaves little scope for corporate sector especially medium sized firms and infrastructure SPVs of large firms to tap the market. The IIFCL had tied up with ADB and PFC to offer credit guarantee to infra companies eager to raise money from bond market but it has not taken off.

Even for the banking system is hamstrung in extending loans beyond 10 years due to the asset-liability mismatch. Over 80 per cent of the bank financing is below 5 years and are not allowed to raise deposits over 10 years. Only a handful of institutions such as IIFCL, PFC, REC, IDFC, IFCI and RFCL are not allowed to raise money up to 25 years. Even their tax-free bonds, which have appetite among retail investors, are limited to Rs 60,000 per annum.

Going forward, even bank financing of long-gestation projects is going to be more difficult due to the additional dimension of Basel III compliance. Banks will need to reserve nearly Rs 5 trillion of additional complaince capital. Already, the capital needs of PSU banks are impinging on the government finances The annual budgetary provision for recapitalisation for 27 PSU banks is about Rs 150 billion, far less than what it should be to sustain a 30 per cent credit growth. Some of the banks including SBI can’t even tap the equity market to a great extent as the previous government had capped its shareholding at 58 per cent.

Unless the government takes a proactive view on its shareholding and recapitalisation of PSU banks, debt financing from this channel will remain a mirage. Unless capital market reforms are expedited and new financing instruments come up, India Inc. will have to rely on foreign funds or costly bank loans to invest in mega projects. Whichever way you look at it, infra financing is clearly non-viable from day one except for a handful of corporate houses having huge unutilised reserves. Even some of the cash-rich PSUs like Coal India, which has reserves of Rs 600 billion, have been dragging their feet due to the legacy of cost over-runs and stalling of projects.

The new government has to implement the Deepak Parekh committee report on various measures to spur infra financing including deepening of the bond market and supportive steps to augur equity financing. Governance of financial sector has to be fortified to convince investors that their money is protected. Innovative and alternative financial products are a need of the day to garner long term funds.

What are we trying to drive?

Whatever has been achieved so far is no mean feat. But one has to think out-of-the-box to reboot the economy. The traditional ways have all being tried. What is needed now is resourcing growth.

Financial inclusion and deepening should not be looked as a mere social objective but as a business proposition to raise resources. The very fact that the non-banking sector including chit funds have raised and are raising huge deposits from the hinterland is proof enough that people have the appetite for savings. If the formal banking sector reaches out to these strata, deposit mobilisation will be much higher, credit growth will be faster and going by the recovery rate of micro-finance institutions, NPAs will also slide. Financial inclusion does not mean just banking operations. Insurance penetration and coverage has to increase exponentially as the poor households are vulnerable to risks more than anyone else – life, health, crops, cattle, farm equipments and dwelling units should all be covered preferably through a simple and a single product. If this is taken care of much of the indebtedness will vanish overnight as it is an established fact that losses of crops, destruction to property due to natural calamities or illnesses have been one of main reasons why the poor households fail to come out of the vicious cycle of poverty.

Infrastructure financing can’t be successful without some decisive reforms in the banking sector and capital market. Allowing banks to raise deposits over 10 years will go a long way in mitigating the asset-liability problem. The government along with RBI and SEBI must now replicate the success of equity market in rejuvenating the debt market. If a retail investor can buy a share worth `10 and trade it freely in a bourse, why can’t it be possible for a corporate and government bond. If banks are facing A-L mismatches, one has to redouble efforts on take-out financing. Redefining priority sector lending (PSL) to include Infrastructure, MSME, tourism and affordable housing in one stroke can resolve much of the funding problems of the relevant sectors.

Much of the workings in the government can be improved if industry and global experiences are intertwined into public policies. Infosys has successfully innovated a green initiative to cut power usage especially ACs in its offices. Can government replicate it? Surely it can

Since much of the infra financing has to come from overseas, the government on its part can remove the anomalies in taxation of external commercial borrowing, FII investment in infra and non-infra debt papers. The withholding tax rates should be uniform at 5 per cent for all or should be abolished altogether.

In the next few years, all efforts should be made to revive investment by efficient use of capital and hence lowering the ICOR to 4:1 or less. This will not just instill confidence of investors but further accelerate the investment flows into Asia’s third largest economy.

The government, through its budget, is aiming to secure a stable fiscal regime. The Shome committee report has shown the way forward for better tax administration. While abolishing the post of Revenue Secretary or merging CBDT and CBEC could still be debated, there should not be any doubt that tax department has to be more service oriented and taxpayers should not be hassled.

Governance must improve in all spheres – from tax administration to project clearance to allocation of scarce resources. Modi’s mantra – Minimum Government, Maximum Governance – should be implemented across all segments of government and local bodies. Already, the prime minister has directed his ministers and bureaucrats to leverage technology to improve governance. Online processing and approvals for environment, forest and mining clearances are underway. It should be replicated in other spheres as well including direct cash transfers to poor. Eliminating the human interventions and discretions will help curb graft and increase service delivery.

Some of the key areas that need attention are education, health, tourism and energy. While Sarva Shiksha Abhiyan has served the purpose, the next step will be to improve the quality of education at the primary levels as without a strong foundation stone, the architecture of higher education cannot stand its strength. RSBY has been a success but the call of the day is to improve the public healthcare system and make it of some standard. Tourism can be a great employment generator and revenue and forex earner, which should now be leveraged to attain the goals of faster services sector growth. The energy sector has to be efficient and output has to be scaled up in order to sustain high economic growth. A favourable decision on gas pricing, opening up of coal sector and completion of state power sector restructuring has to be completed within a year in order to attain energy security in the next decade.

Cities are the engines of growth and hence urban infrastructure development must be a priority. Revamp of the JNNURM empowering the local bodies has become an imperative. Some of municipal bodies of China have tapped the global markets for expansion while not one of the Indian counterparts has gone at the doorsteps of BSE or NSE. Why? Is it just lack of governance or lack of foresight on the part of local bodies?

Securing financial, market and government databases (from malicious, hacking or phishing activities) is a challenge. Adherence to data security standards worldwide and need for proper data protection and privacy law is a must

Re-architecting social sector schemes has become necessary to reduce wastages and make such schemes effective. The twin objective will not just help alleviate poverty but also reduce the&

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