There are a few winners right now and many losers in the Indian economy
Jio is a household name in India and now the rest of the world is taking notice. In April, Facebook invested $5.7 billion for a 9.9% stake in the young tech company, which is the digital arm of India’s biggest firm, Reliance Industries. Facebook’s cash was quickly followed by boat loads of cash from other big investors, including Google, Intel, KKR, and Vista as well as the Emirati sovereign wealth funds—Abu Dhabi Investment Authority (ADIA) and Mubadala—and the Saudi sovereign wealth fund, Public Investment Fund (PIF). More money is likely to follow with Microsoft said to be next to invest in Jio.
The investor spending spree could not come at a better time for Reliance Industries. Burdened by a high level of debt—a significant amount of which was used to fund the growth of Jio—Reliance was able to turn the international stage lights on for a national champion and pay its debts in one quick swoop…this type of fundraising (in four months) is not expected in India regardless if the company has a broadband network, almost 400 million mobile subscribers and a selection of retail and financing businesses. Yet, Jio, has raised more than $20 billion in the last several months (which is more than the entire Indian start-up ecosystem in 2019).
The storyline is also a boon for India. The local press is singing Jio’s name like it is the national anthem. And local investors and analysts are joining in the chorus to back it up. Earlier this year (i.e., before the covid-19 pandemic), another Indian conglomerate, Adani Group, sold 25% of its Mumbai power operations for $450 million to the Qatari government while also taking in another $900 million from French oil giant, Total, for 37% of its gas operations. Although big news for India, these pre-covid 19 deals alongside the Jio investment, including the recent purchase of Jio Infratel for $4.3 billion by GIC and Brookfield Asset Management, should not overshadow the economic challenges that are plaguing India today.
Jio is doing well, but the Indian economy is not
Simply put, India’s economy is struggling. The lockdown in the country, which commenced on 25th March and was one of the strictest across the globe, has failed to stop the virus. It took the country more than five months to reach one million cases…it took 21 days to reach the second million and then 16 days to cross three million. There is little data to suggest the numbers will improve as the coronavirus spreads to smaller cities and rural areas and the country reports more new cases daily than any other country. A recent study from the Massachusetts Institute of Technology (MIT) suggested that cases in India could skyrocket to more than 250,000 per day by early 2021 without a vaccine.
Now the country is relaxing lockdown measures to hopefully help the one thing it did stop, i.e. the economy. Public transport is coming back online again this month and schools will follow thereafter. Still the data suggest that the initial uptick in economic activity—like other global economies—quickly plateaus until the public is comfortable and confident in its ability to move freely and socialize. Although there are some economists in the country predicting an economic rebound before the end of the year, local business owners are telling a different story with less foot traffic in commercial areas and industrial production still lagging.
The International Monetary Fund (IMF) predicts India will be the worst hit by the coronavirus pandemic with its economy swinging from a 6.6% forecasted growth at the start of the year to a 4% contraction in 2020…the economy contracted 23.9% last quarter. The Reserve Bank of India (RBI) has been hesitant to quantify the expected contraction and its time frame but rather conspicuously message to the public that the GDP is likely to remain in the doldrums for a while. To be fair to the RBI, it has enough parties too excited to write the demise of India in the short term. Goldman Sachs forecasted a contraction of 5% in the country while some local economists, including Bloomberg Economics’ Abhishek Gupta, estimated a near-11% contraction.
Moody’s and the Economic Bad News
Rating agency, Moody’s, enacted its damage when it cut India’s credit rating at the start of June for the first time in 22 years. Moody’s, in a rather harsh assessment, highlighted the inconsistency between India’s debt level and its credit rating, i.e. how its debt was 30 percentage points higher than the average economy with a similar rating. Moody’s and other rating agencies were willing to forgive the unmistakable reality of India’s debt load when the economy was growing fast but, unless things reverse quickly and growth returns, it is hard to turn a blind eye to the indebtedness going forward, at least, in the short term. Some economists want to claim that Moody’s is bias against the Indian economic model. But those accusations against Moody’s are easily countered by Moody’s (surprising) upgrade to India’s sovereign rating in late 2017 even after an ill-timed demonetization plan and inadequately planned roll-out of the Goods and Services Tax (GST).
Slow growth (and contraction) is the issue for many major economies—the U.S. contracted in the last quarter albeit at a significantly slower pace of 9.1%. That said, the slow pace of economic activity hits hard in a country where many individuals are dependent on daily wages. Some data, specifically that from the National Sample Survey Organization (NSSO) and Planning Commission, suggests that a loss of three months’ income would leave almost half of the country trapped in poverty, which is a stark outlook for a country and economy that has made strident gains since economic liberalization began in the early 1990s. The deteriorating economic situation is compounded by the government’s financial situation. Tax revenues will plummet in the current market and there is little doubt that debt-to-GDP ratio will increase towards 90%. The government accordingly is limited on its ability to spend money to combat the virus let alone to support businesses in the country.
India’s approach to the loan moratorium for borrowers is a perfect example of its limited resources. When the country implemented a strict lockdown in March, the RBI provided borrowers the option to defer loan payments for three months. This moratorium has now been extended another three months. While helping borrowers, officials did not necessarily address the obvious problems that arise for lenders (i.e., the banks) not receiving cash payments. India is not the only country utilizing payment holidays. But it is one of the countries least financially situated to underwrite the moratorium’s effects on greater economy.
At the end of July, the RBI published its financial-stability report, which highlighted that half of all loans went unpaid in April. Nearly two-thirds of the loans made by publicly controlled banks, which hold 70% of the industry’s assets, went unpaid. Whether employing an “opt-in” or “opt-out” approach with borrowers on payment deferrals, the deferral take-up by borrowers has been high. With the plan up for debate again, Indian officials have to take a view, first, on what percent of borrowers will be able to repay debt and, secondly, how much they can fill the cash gap for creditors as result of defaulting borrowers. It comes as no surprise that several banks, including State Bank of India and ICICI, are planning to raise new capital from the market. Although Kotak Mahindra raised $1bn in May, it is unclear how many banks can replicate that capital raise in this market.
Let us not simply blame covid-19
Jio may be overhyping the economic success in India. But covid-19 is overshadowing the greater economic troubles for India. The Indian GDP growth has been gradually slowing with GDP growth of 4.2% for the fiscal year ending March 2020 compared to 6.1% in 2019 and 7.0% in 2018. During the last fiscal year, investment in the country dropped 3%, according to the Word Bank, which was the first decline in nearly two decades. The limited cash resources for the government to invest and spend suggests this investment downward trend may not change, provided you adjust the numbers (i.e., exclude) for the Jio investment. The upward trend for corporate and household debt before covid-19 hit the country further complicates the economic storyline for the country.
To be fair to Prime Minister Narendra Modi, he inherited several problems from the previous administration. Infrastructure projects, which are big drivers of growth in India, were already stalling back in 2014 before Modi came to power. Land acquisitions and transfers were a challenge with lack of inputs for the projects. Although the power sector achieved sufficient capacity, significantly indebted distributors could not make payments. Thus financial stress soon permeated the entire system as producers struggled with their cash flows via the distributors and consumers lost power as a result. The subsidies and bureaucracy within the entire state-controlled system, as is the legacy of the greater economic system in India, have also hampered change and hardened some misaligned incentives within the power sector and the greater infrastructure space.
Being fair again, Modi’s administration cannot escape blame for its mistakes. The GST system remains a mixed bag with its initially poor implementation, constant changes, and general lack of consistency and clarity necessary for business. Furthermore, where Modi’s administration has proved astute in passing the GST legislation, it has struggled to push through other business reforms and public sector reforms critical to unleashing greater economic growth. Kudos is well-deserved for the Insolvency and Bankruptcy Code (IBC) as well as efforts to strengthen tax compliance. But what about banking reforms, including public sector bank boards, land reform, or actions to re-invigorate foreign investment? Don’t let the Jio boon overshadow the challenges in attracting cash across the greater Indian ecosystem.
What can Modi’s administration do now?
First, the country’s power is centralized with the Prime Minister thus most reforms only gain steam and thrive where Modi’s close-knit team is pushing the agenda. This is partly fault of the testy politics in India and partly fault of leadership style in the country. A lack of empowered ministers and organization across the governing coalitions also make policies either poorly designed or poorly implemented. The Make in India initiative is good idea except when the same governing coalition cannot agree on tariffs and taxation throughout the business ecosystem. It is no surprise that Modi has now switched to emphasizing “self-reliance” and making “Local the mantra of [Indian] life” as part of the response to covid-19. Yet the lack of ability to create the right incentives seemingly has confused foreign investors…and it is not clear who is best positioned to effect comprehensive change. At the end of the day, a price tag cannot be put on predictability for investors, but everyone knows it is worth a lot.
Secondly, the government should focus on assisting industries that can unlock value throughout the greater economic system, such as real estate and infrastructure. These sectors are highly indebted and hurting the various non-bank financial institutions (NBFIs) that have poured money into these sectors. Although the government has been quick to apply the IBC to insolvent non-financial institutions, the next step should be to support greater asset quality reviews of the NBFIs. In line with an active government agenda, there will have to be strategic alignment on additional strategies in the short term to help focus sectors with limited financial resources. For example, for real estate, a substantial reduction on circle rates, registration charges, and stamp duties could go far…with tax revenue ideally growing on the other side from a bump to economic activity.
Third, focus on middle income tax relief…yes this is the typical economist line across the globe. But the reality of India is that corporate tax relief may help some corporates, but many are not performing at an economic level to be paying significant taxes. Furthermore, those corporates will not invest capex unless they see potential consumption growth. That consumption growth must be spurred by the middle class (i.e., the affluent in India) who will spend on higher discretionary items, including education, health, and consumer goods. The Indian poor, on the contrary, will mainly use any financial relief on essential products. Nonetheless, supporting the poor to ensure the floor for this economic group remains above the poverty line obviously makes sense…doing so through SME investment, however, may make more sense than handing out cash. Reducing regulatory burdens and costs to operation would be a major first step in buoying the businesses hiring the poor and lower middle class.
The opportunity to create real change
The true reality is that the Indian economy will likely contract this year…that is covid-19 and its negative economic effects. The silver lining of covid-19 is the opportunity to make comprehensive economic reforms—the major economic liberalization reforms of 1990s came after Indian economic growth fell to nearly one percent in 1991. India is in the midst of a “slow(er)” growth period with too much debt for its current economic trajectory. It requires more fiscal flexibility today. This likely means less government spending in the short term. Modi’s administration can choose to do otherwise but they better strongly commit to that path with a teflon mindset because economists and political critics will be attacking Modi’s team as soon as the government spending fails to spur the expected (or the justifying level of) consumption and associated economic growth.
Privatization is an option if properly designed and well-implemented. Though it is hard to see foreign investors being excited today to buy state-controlled assets in India when many of their private sector efforts have been hit or miss. Cleaning up some state-controlled assets will also have a lot of political and social risk (i.e., how do you clean up labor rolls without facing some pushback). Maybe some foreign investors get excited if they can do a deal with a big local partner (i.e., the Jio setup) but there will still be some hesitancy to that deal in this market.
Thus, absent a V-recovery, India is looking at a hard road to recovery on long term growth. The country has a shaky balance sheet of contingent liabilities across its entitlement schemes, including health benefits and bank insurance, because no one knows the true extent of the cost, especially in this pandemic. A forensic examination of India true state of financial affairs is necessary. Then Modi’s administration, with political time on its side before another election, should outline a clear financial strategy for the country and adhere to it. The charismatic and popular prime minister has the energy to jumpstart the process and movement…the question is more so on whether his administration has the fortitude to follow through on its promises in the process.
