Credit guarantees attract investments

Indian infrastructure financing has for long suffered from rating concerns, but recent changes to credit enhancement are helping to plug this gap, enabling investment by foreign insurance and pension companies, and stimulating project exports.

A small refinancing deal in October 2015, followed by a similar one in January 2016, has supplied a critical missing piece, without which Indian infrastructure financing had been stunted for years. If this elusive financial instrument is now consolidated, it will enable infrastructure projects to attract strategic overseas funding as well as make Indian project exports more competitive.

The first transaction, of October 2015, involves power generator ReNew Power Ventures on one side, and the government-owned India Infrastructure Finance Company Ltd (IIFCL) jointly with the Asian Development Bank (ADB) on the other side. In January 2016, another energy company, Hindustan Powerprojects, concluded a similar deal with the IIFCL-ADB combine. Both ReNew and Hindustan Powerprojects have substantial investments in renewable energy projects.[1][2]

Both companies were refinancing existing bank loans with fresh bond issues—ReNew with Rs 451 crores[3] and Hindustan Powerprojects with Rs 380 crores.[4] The bonds were initially rated lower but were able to improve to AA+ due to “credit enhancement” provided jointly by IIFCL-ADB.[5] This enabled the bond issuers to lower their interest costs and, importantly, attract infrastructure-friendly international investors who have stayed away from Indian infrastructure projects because of rating concerns. The IIFCL-ADB’s credit enhancement has made their participation possible.

Credit enhancements (or credit guarantees) resemble insurance policies: a credible financial institution guarantees (for a fee) a bond issuer’s repayments. Such an assurance helps bond issuers obtain a better credit rating. Participation by multilateral institutions—such as ADB’s involvement in IIFCL’s credit enhancement—provides an additional layer of comfort and improves the rating by multiple notches. IIFCL plans to engage with other multilateral institutions (such as the World Bank) for future credit enhancement deals.

This crucial instrument has strategic geo-economic consequences: it can attract long-term overseas financing into fund-starved infrastructure projects as well as sharpen the competitive edge of Indian project exports.

Credit enhancement makes bonds issued by infrastructure companies eligible for investment by overseas insurance companies and pension funds. Both are custodians of long-term funds and thus ideal investors for long-gestation infrastructure projects. This has another advantage: since they invest for the long term, they remain rooted during periods of volatility.

A geo-strategic tool

Most Indian infrastructure projects were unable to tap into the global pool of insurance and pension savings because of rating restrictions. Indian infrastructure projects—public-private partnerships or completely private-owned—are typically executed through a special purpose vehicle (SPV, a separate company set up only to execute the project), with no recourse to the private sector parent’s balance sheet. In short, in times of crisis or default, SPV investors cannot dip into the parent’s resources. With no previous revenue track record, no visible safety net, and an extended project gestation period, SPVs usually got the lowest rating in the investment grade scale.

This deterred insurance and pension funds from investing in such projects. These long-term investors have strict internal regulatory and risk-management parameters, which includes the lowest credit rating that can be allowed for fixed-income investment. In most cases, it is fixed at AA. Incidentally, even Indian pension funds can invest in infrastructure bonds with a minimum AA rating.[6]

There is another collateral benefit arising from the credit enhancement programme. Deprived of long-term financing, most Indian infrastructure projects became dependent on bank financing, which is short-term. This inherent maturity mismatch has affected bank balance sheets adversely and choked off funding for other projects. According to Reserve Bank of India (RBI) data for March 2016, 16.7% of infrastructure loans advanced by banks have turned non-performing.[7] Credit enhancement now allows projects to replace bank loans with cheaper bond proceeds before they turn sticky; this also frees up bank funds for other greenfield/brownfield projects.

The RBI has also allowed commercial banks to provide partial credit enhancement, subject to certain conditions[8] for infrastructure projects that want to refinance their existing bank loans through bonds with lower interest rates. The availability of this facility will again improve the credit rating of the bonds, allowing a wider segment of investors to invest.

Credit enhancements will have the greatest impact on the infrastructure sector where projects have stagnated for want of long-term financing. According to the erstwhile Planning Commission, India needs approximately $1 trillion during 2012-17 to fix its infrastructure deficit.[9] A large chunk of this will be in the form of debt. But given the banking sector’s concerns on maturity mismatches, this debt has to be sourced from long-term investors at home and abroad. Without the rating upgrade mechanism, this was not possible.

Separately, Crisil Risk and Infrastructure Solutions Ltd and ADB have jointly recommended, in a technical assistance report[10] for India’s finance ministry, the creation of a separate bond guarantee fund. This fund’s shareholding pattern and capital structure should be designed with a AAA rating in mind.

A follow-up to their suggestion looks likely: the government-owned Life Insurance Corporation of India (LIC), India’s largest insurer, is planning to create a separate finance company that will provide credit enhancement to infrastructure bonds;[11]

Other kinds of credit guarantees are also falling into place. Project exporters have been able to lower their borrowing costs and improve their competitive appeal with credit guarantees from agencies like ECGC Ltd. Project exports by Indian public sector engineering companies are often guided by India’s geo-strategic considerations. Over time, many private Indian engineering companies have also started focusing on project exports as a revenue source. But since many of these projects were located in risky jurisdictions (for example, in parts of Africa), bank credit for executing these long-term overseas projects became expensive. Such guarantees therefore go a long way in easing such exports.

Exim Bank too has announced12 that it will focus on financing Indian project exports over the next three years. According to Exim Bank, Indian companies have a competitive advantage in project exports over some of their global competitors, such as China. This comes from years of executing large projects in developing and poor countries, which have demanding working conditions, which include rough terrain and fickle political climates.

Clearly a single critical financial instrument—credit enhancement—has the capacity to attract overseas investments as well as propel India’s strategic exports.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

Reference

[1] Homepage, ReNew Power, <http://renewpower.in/>

[2] Homepage, Hindustan Powerprojects, <http://www.hindustanpowerprojects.com/>

[3] Sen, Amiti, ‘IIFCL Launches Renew Wind Energy’s Rs 451-crore “credit-enhanced” infra bonds’, The Hindu Businessline, 23 September 2015, <http://bit.ly/29DSsPs>

[4] Hindustan Powerprojects, ‘Clean Energy Arm of Hindustan Power first to place credit enhanced infrastructure bond’, Hindustan Powerprojects Blog, 5 January 2016, <http://bit.ly/29Di3XH>

[5] Schemes/Products, India Infrastructure Finance Company Ltd, Regular Credit Enhancement Scheme of IIFCL, <http://www.iifcl.co.in/Content/ceps.aspx>

[6] Pension Fund Regulatory and Development Authority, ‘Investment Guidelines for NPS Schemes’, Circular No PFRDA/2015/16/PFM/7, 3 June 2015, <http://www.pfrda.org.in//MyAuth/Admin/showimg.cshtml?ID=705>

[7] Reserve Bank of India, ‘Chart 2.9: Stressed advances ratios of major sub-sectors within industry,’, Financial Stability Report, Issue No 13, June 2016, p 24, <https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/0FSR2316BB76DB39BF964542B9D1EBE2CBC273E7.PDF>

[8] Reserve Bank of India, ‘Partial Credit Enhancement to Corporate Bonds (Notification to all scheduled commercial banks)’, RBI/2015-16/183, DBR.BP.BC.No. 40 /21.04.142/2015-16, September 24, 2015, <https://rbidocs.rbi.org.in/rdocs/notification/PDFs/P183165FFAB186FE4825A0FAD0E95739436F.PDF>

[9] Planning Commission, ‘Twelfth Five Year Plan (2012-17): Faster, More Inclusive and Sustainable Growth’, Vol. I, Sage Publications India, (2013), p. 18. <http://planningcommission.gov.in/plans/planrel/12thplan/pdf/12fyp_vol1.pdf>

[10] CRISIL Risk and Infrastructure Solutions Ltd and Asian Development Bank, ‘India: Preparing the Bond Guarantee Fund for India; Technical Assistance Consultant’s Report; Project Number: 44447’, Asian Development Bank, August 2014, <http://www.adb.org/sites/default/files/project-document/152971/44447-012-tacr-02.pdf>

[11] Laskar, Anirudh, ‘LIC-led NBFC may offer up to Rs1 trillion credit guarantee’,Mint, July 1, 2016, http://bit.ly/29wm5mX

[12] S, Arun, ‘Exim Bank’s African credit to boost service exports’, The Hindu, 12 June, 2016, <http://www.thehindu.com/business/Economy/exim-banks-african-credit-to-boost-services-exports/article8721312.ece>

A new trajectory for India-Africa ties

India now sees Africa as a promising market for Indian goods, services, and investments. This is evident in the government’s recent concerted focus on the India-Africa relationship—high profile visits by top leaders to African countries, a recasting of India’s development diplomacy, and an attempt to match action to past promises

India’s relationship with Africa has been through an unprecedented intensification in June 2016. In the first week of the month, Vice President Hamid Ansari visited Tunisia and Morocco. In the second week, President Pranab Mukherjee embarked on a tour of western and southern Africa, covering Ghana, Cote d’Ivoire, and Namibia. And in July, Prime Minister Narendra Modi is scheduled to visit Kenya, Mozambique, Tanzania, and South Africa.

The present renewed outreach is also unabashedly about business, and a good example of geo-politics combining with geo-economics. India views Africa as a promising market for Indian goods, services, and investments. So far though, any follow-up on promises had remained anaemic. Now, Indian leaders are seeking out fresh investment opportunities for Indian public and private sector companies in different African countries.

The vice president’s visits to Morocco and Tunisia are crucial because India imports phosphate—a critical raw material for fertiliser production—from these countries. Ansari also inaugurated an India-Morocco Chamber of Commerce during his trip to Rabat.

The president’s three-country tour provided an opportunity to further India’s business interests. At the India-Ghana Business Forum, Mukherjee said: “…the Indian Government would be ready to work with you in key sectors and areas of common interest and encourage Indian private as well as public entrepreneurs to bring more investments into Ghana.”[1] India’s cumulative investments in Ghana are over $1 billion and two-way trade during 2015-16 amounted to $3 billion.[2]

In Cote d’Ivoire, Mukherjee said: “…your country is blessed with fertile soil and abundant agricultural and mineral resources. Our public and private sectors are keen to join you in exploring these resources efficiently and in setting up agro-based industries.”[3]

At the same time, India’s development diplomacy for the continent has been through a strategic shift. Exim Bank, for example, is now likely to focus more on service exports, rather than compete with China for infrastructure projects in Africa.

The bank is looking to disburse close to Rs. 10,000 crores in Africa over the next three years as both commercial and concessional credit.[4] Service exports aim to build on India’s traditional strengths in Africa and will include healthcare, education, and information technology services. Exim inaugurated an office in Cote d’Ivoire during Mukherjee’s visit. The office is expected to widen the bank’s footprint in West Africa.

Exim Bank is also looking to sharpen its focus on another area of India’s traditional exports to Africa: project exports. It has requested the Reserve Bank of India to ease regulatory and compliance guidelines regarding minimum equity capital, leverage (the multiples—3X, 4X or 8X—of share capital that a company can borrow) and the maximum that the bank can lend to a single borrower.[5] These will be necessary if the bank is to make project exports one of its thrust areas.

These actions are in line with promises made during the Third India-Africa Forum Summit (IAFS) in October 2015. The first two editions of the summit—in 2008 and 2011—made numerous pledges but fell short on follow-up and delivery. Both sides were responsible for the indifferent implementation.

The last IAFS, held in October 2015, saw a strategic shift in focus—apart from the usual rhetoric, there was a better alignment of India’s global ambitions (both political and geo-economic) and traditional strengths.[6] [7] Importantly, the third IAFS created a formal monitoring mechanism to regularly review the progress of various projects at different stages of completion.

The summit aimed high—it also sought to create a global alliance of solar-rich countries.[8] Such an alliance will help create goodwill for India among Africa countries, and generate solidarity through collective bargaining when accessing IPR-protected technology from rich countries.

It’s starting with this summit that Modi has been building bridges with different African countries and soliciting support for a host of multilateral initiatives. These include backing for India’s membership of the UN Security Council along with a united front of emerging and poor economies at the World Trade Organisation.

The high-octane official Africa engagements will also help assuage concerns regarding India after recent allegedly racist incidents involving African nationals living in the country. But it is now up to India to ensure that its belated recognition of the critical role Africa can play in our strategic calculus, as well as in India’s trade and investment expansion plans, is not just a temporary spurt.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References
[1] Mukherjee, Pranab, ‘Address at the India-Ghana Business Forum Event’; Speech delivered at Accra, 13 June 2016, <http://presidentofindia.nic.in/speeches-detail.htm?531>

[2] Press Release, Ministry of External Affairs, Government of India, Visit of President to Ghana (June 12-14, 2016), 6 June 2016, <http://www.mea.gov.in/press-releases.htm?dtl/26872/Visit_of_President_to_Ghana_June_1214_2016>

[3] Mukherjee, Pranab, ‘President of India; Speech in response to welcome speech by President of Cote d’Ivoire’ Speech delivered in Abidjan, Ivory Coast, 14 June 2016, <http://presidentofindia.nic.in/speeches-detail.htm?534>

[4] S, Arun, ‘Exim Bank’s African credit to boost service exports’, The Hindu, 12 June, 2016, <http://www.thehindu.com/business/Economy/exim-banks-african-credit-to-boost-services-exports/article8721312.ece>

[5] Lele, Abhijit, ‘Commerce ministry, RBI to review regulatory norms for Exim Bank’Business Standard, 24 May 2016, <http://www.business-standard.com/article/economy-policy/commerce-ministry-rbi-to-review-regulatory-norms-for-exim-bank-116052400042_1.html>

[6] Documents, Third India-Africa Forum Summit, India Africa Framework for Strategic Cooperation, 29 October 2015, <http://www.iafs.in/documents-detail.php?archive_id=323>

[7] Documents, Third India-Africa Forum Summit, Delhi Declaration 2015, 29 October 2015, <http://www.iafs.in/documents-detail.php?archive_id=322>

[8] Speeches, Third India-Africa Forum Summit, Speech by Prime Minister Shri Narendra Modi at the Inaugural Ceremony, 29 October 2015, <http://www.iafs.in/speeches-detail.php?speeches_id=276>

The Legacy: Raghuram Rajan is leaving the battlefield just when he was getting the better of his rivals

India’s debonair central banker, Raghuram Rajan, leaves behind many broken hearts and disappointed souls. Chronicles of his legacy will list many achievements, but will also note that he left the battlefield just when he was getting the better of his rivals; what’s surprising is that the commander-in-chief agreed to his pre-mature withdrawal even though the general’s strategies could be seen bearing fruit.

Equally perplexing will be the choice of his replacement.

Both the government and Rajan personally have been advocates of an alternative global financial architecture. He has also been proposing for a while that it was time for a new Bretton Woods mechanism. And Rajan had taken the battle to the enemy camp. At the April 2016 spring meetings of the International Monetary Fund and the World Bank, Rajan observed how deeply multilateral financial institutions were in thrall of western economic orthodoxies. He even wryly remarked how ideas from emerging economies were dismissed as “crankiness.”

He was prescient about the trans-Atlantic financial crisis. He took on former US Federal Reserve chairman Ben Bernanke when US domestic monetary policy spilled over into the global economy and led to severe volatility in emerging markets. He is unlikely to have fond memories of the period: he had to douse this particular fire soon after his appointment in Sept. 2013.

So, here is question number one: Will his successor have the same zeal about promoting an alternative global financial architecture that is sensitive to emerging economy needs and is not partisan about any particular economic ideology?

Rajan also quits before another crusade could be brought to its logical end. He’s been battening down the hatches that allowed a cosy nexus between large corporate borrowers, bankers, politicians, and bureaucrats, to bleed public sector banks through questionable debt write-offs. Rajan had taken a large broom to bank balance sheets and forced them to take drastic action against defaulters.

Many large—and over-stretched—corporate borrowers have been carping about Rajan’s reluctance to reduce interest rates, which, when lowered, would have certainly helped moderate their interest burden. These same corporates also turned into quack economists on the matter of interest rates: in their collective view, only lower interest rates could bring back high rates of economic growth. This view is oblivious to the fact that the low interest rates in the US, or negative rates in Europe and Japan, have failed to promote any economic growth.

Time for question number two: Will Rajan’s successor have the stomach (or benign sanction from the government) to continue with the clean-up act? Or to hold rates steady when required?

So, what does Rajan’s legacy look like? Apart from the well-documented success in fending off volatility from the US Fed’s tapering in 2013, his tenure will be remembered for three systemic changes he fostered.

One will be the differentiated banking landscape that he designed and left behind. As RBI governor, he grandfathered the emergence of a new breed of universal, small, and payments banks. He was in the process of adding two more categories—custodian banks and wholesale (or long-term) financing banks—to the mix. We will now have to wait and see if his successor has the same enthusiasm for a differentiated banking model.

These new categories come in addition to existing myriad forms of cooperative banks, regional rural banks, local area banks, public sector scheduled commercial banks, State Bank of India group of scheduled commercial banks, old-generation private sector banks, new-generation private sector banks, and foreign banks.

Restive signs mark the payments banks space—three companies which received in-principle approval to launch payments banks (Cholamandalam, Tech Mahindra, and Dilip Shanghvi of Sun Pharma) returned their licences stating that the project was not economically feasible. Undeniably, and in true RBI style, the initial architecture is anti-profit and has flaws in it.

The second marquee item is his strict action against non-performing assets (NPAs) that continue to impair bank balance-sheets. This was viewed as his struggle to end Indian-style crony capitalism: large volumes of loans remain unpaid every year and yet defaulting borrowers manage to get fresh loans unfailingly with some help from politicians, bureaucrats, and complicit bankers.

The staggering amount of NPAs is a direct drain on taxpayers, since loss to state-owned bank balance sheets must be compensated with fresh equity infusion by the largest shareholder—government— every year.

Finally, the outgoing governor will be remembered for installing a new monetary policy framework, which uses inflation-targeting as its driving philosophy. It also includes a monetary policy committee comprising three government representatives and three central bankers, with the RBI governor getting the casting vote. This new structure overhauls the old belief that the economy’s fiscal (the government) and monetary policy (central bank) sides should remain out of each other’s hair.

While the government has been uncomfortable with Rajan’s public comments about governance and broader political economy trends—saying that central bankers should not interfere with the fiscal side—it has not shown the same restraint when trying to influence monetary policy.

It will have to be seen how future central bankers and monetary historians view Rajan’s acquiescence to large government presence in monetary policy making.

The article first appeared in www.qz.com/india and can also be read here.

What does Brexit mean for India?

On June 23, the United Kingdom will vote on whether they wish to remain a part of the European Union through the Brexit vote. The debate surrounding the vote has spurred many a heated and emotional debate. While the Indian government has not declared anything publicly - remaining in the EU would be beneficial to Indian businesses.

The Brexit referendum on June 23 — whether the United Kingdom (U.K.) chooses to stay on in European Union (EU) or to quit the mega regional agreement — has spawned its fair share of heated and emotional debates. Equities, commodities and currency markets have tossed and turned at either prospect. Indian markets have also been agitated at the likely outcomes. An impassive view, though, shows that Indian trade and business interests might benefit from UK staying in.

While the Indian government has not taken a public position on the issue, since it doesn’t want to be seen interfering in another country’s sovereign exercises, newspaper reports says Indian ministers have conveyed to their UK counterparts against exiting.[1]

This stand may have been informed by Indian business’s unambiguous and public support for UK staying on in EU. A statement issued by the Federation of Indian Chambers of Commerce and Industry (FICCI) says unequivocally: “…we firmly believe that leaving the EU, would create considerable uncertainty for Indian businesses engaged with UK and would possibly have an adverse impact on investment and movement of professionals to the UK.”[2] While the other leading industry association, Confederation of Indian Industry, has refrained from issuing any official statements, its representatives have expressed their reservations in different interviews.

There are valid reasons for Indian business concerns.

One, Brexit supporters say the UK will be able to sign new and better trade agreements — free of EU’s restrictive rules — with its strategic partners, such as India and China. They also cite the stalled India-EU trade and investment talks to buttress their argument. However, experience shows negotiating trade and investment pacts takes a long time. For example, the India-Korea Comprehensive Economic Partnership Agreement took five years to finalise[3]. There are concerns over the interim uncertainty for trade and investment flows.

There is another associated hassle. Assuming that Indian business tides over the interim uncertainties, it will still have to adhere to two different standards and rules when trading in the same geography. This entails additional costs.

Two, most Indian businesses use the U.K. as a springboard for their European operations, given India’s historical and cultural affinity with the country. If those favouring exit win, Indian businesses will have to install a parallel set-up on mainland Europe for conducting their operations. For instance, a portion of the Indian foreign direct investment (FDI) into the UK is to access the European markets. Now, Indian companies will have to separate their investments for the two distinct markets. This means additional costs, regulatory wrangles and legal complications. In addition, the complexity of negotiating new tax laws is likely to prove a nightmare.

Three, there are apprehensions that a Brexit success would inspire other EU members to explore a similar option. This would lead to fragmentation and the Indian government would then have to negotiate separate agreements with each country. This will add to the general confusion and add to regulatory and compliance costs for Indian business.

Finally, Brexit might raise myriad central banking problems. First, Reserve Bank of India (RBI) will have to re-calibrate its monetary policies to cope with the currency markets volatility. Additional liquidity measures might have to be implemented to stave off rupee volatility; this might temporarily derail the central’s banks monetary policy objectives for 2016-17.

But more importantly, if Brexit goes through, expect prolonged volatility in the currency markets and a sharp drop in both pound and euro values. This will not only mean a downward revision in valuation of RBI’s currency reserves, it will also require the central bank to re-adjust the composition of its ForEx reserves. Though not substantial, RBI’s volume of euro and sterling pound holdings are also not exactly negligible.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. It can also be read here.

References
[1] Watch on Brexit, oil prices; The Telegraph; June 17, 2016;http://www.telegraphindia.com/1160617/jsp/business/story_91646.jsp#.V2TnN-Z96uU

[2] Singh, Dr Didar A; Ficci Secretary General; Ficci Comments on UK Referendum on Brexit; February 24, 2016; http://ficci.in/PressRelease/2293/ficci-press-feb24-uk.pdf

[3] Ahmed, Shahid; India-Korea CEPA: An Assessment; pages 45-98; Korea and the World Economy, Vol. 12, No. 1 (April 2011);http://www.akes.or.kr/akes/downfile/12.1.3_ahmed.pdf

India’s five-cornered trade strategy

Five rather unfavourable trends define India’s trade performance over the past two years; these trends also provide useful pointers as to where India’s future trade strategy can go over the next three years as it deals with a global economic slowdown, the rise of megatrade agreements and a pivot to a more intensive trade relation with the U.S.

The Narendra Modi government’s trade policy has been marked by five noteworthy, but rather unflattering, trends: declining trade volumes, unsuccessful diversification of trade destinations, continuing deadlock in U.S.-India commercial ties, India’s services strength remaining underutilised in trade agreements, and, lack of a national strategy for mega trade agreements.

This then shapes the government’s trade agenda for the next three years.

The first element, the dismal state of India’s trade, impacts Indian industry. In the two years of the current government, exports have contracted by almost 17% — from $314.405 billion in fiscal 2013-14 (April 2013 to March 2014, a couple of months before Modi and his Cabinet were sworn in) to $261.136 billion in 2015-16. Even imports have dipped by a considerable 16% during the same period: from $450.12 billion to $379.6 billion.[1]

To be fair, exogenous factors are behind the drop. The global slowdown has eroded demand for manufactured goods. But, while global trade in 2015 expanded – albeit marginally, by 2.8%[2] — India’s trade shrunk. In addition, lower commodity prices have impacted volumes and values for both exports and imports. However, the fall in imports has another worrisome aspect – it could signify lower demand for raw materials and intermediate products from Indian manufacturing sector. Combined with lower merchandise exports, which also affects broad swathes of industry, contracting trade volumes adversely impact employment, incomes, investment, consumption and economic growth.

                        Exports                                      Imports

2013-14:    $314.405 billion USD        $450.199 billion USD
2014-15:    $310.338 billion USD        $448,033 billion USD
2015-16:    $261.136 billion USD        $379.596 billion USD
Source: Department of Commerce, Ministry of Commerce & Industry

Undoubtedly, trade performance has to be improved urgently. One reason for India’s continuing indifferent trade performance is lack of integration with regional and global supply chains. Foxconn’s decision to set up a handset manufacturing unit in India is an improvement but it will require many similar initiatives to markedly improve India’s trade profile.

This brings up the second aspect. India has been trying for some years to diversify its export destinations, away from the developing countries of North America, Europe and Japan where demand and consumption levels have dropped appreciably. India saw in Africa a key trade and investment partner and fixed a $90-billion trade target for 2015. It finalised similar trade targets with ASEAN, other regional groupings and individual countries. Unfortunately, most of these trade targets remain unattainable.

For example, trade between Indian and Africa fell short of the $90-billion target – two-way trade dropped from $71.5 billion during 2014-15 to $ 56.67 billion by 2015-16. One of the reasons for the shortfall is the steep drop in commodity prices, leading to the oil import bill from Nigeria (India imports about 15% of its oil from that country) shrinking. However, that still does not explain the lack of a concerted thrust at creating alternative markets for Indian goods and services in either Africa or Latin America. It’s not too late, given India’s strategic and civilizational ties in these two continents.

The third facet is a visible pivot over the past two years towards a more intense trade and investment relationship with U.S., though the results are mixed[3].

India’s engagement with U.S. froze under UPA-II regime. However, the past two years have seen considerable energy invested in the relationship. Trade ties between the two nations is conducted through the Trade Policy Forum (TPF, set up in 2005), under the broad rubric of the US-India Strategic and Commercial Dialogue. The forum’s ninth meeting was held in October 2015 and like other previous rounds, the outcome remained wedged between on familiar issues – agriculture market access, intellectual property rights, trade in goods and services. Strategy firm Albright Stonebridge Group comments: “Will the TPF continue to be a talk shop where issues are raised, discussed and shelved for discussion next year…Over the last few years a meeting would be called successful if both sides simply showed up to the meeting at the agreed place and time, discussed the agenda and closed by agreeing to disagree.”[4]

One of the perennial sticking points in the India-U.S trade negotiations is services, the fourth pillar of India’s trade profile and unarguably a competitive advantage. The Economic Survey for 2015-16 states: “WTO data shows that India’s services exports grew from $16.8 billion in 2001 to $155.6 billion — which constitutes 7.5% of the GDP — in 2014, making the country the eighth largest services exporter in the world. The share of India’s services exports in global services exports at 3.2% in 2014, is nearly double its share of merchandise exports in global merchandise exports at 1.7%.”[5]

But, India has failed to utilise this competitive trade advantage, specifically cross-border movement of professionals, in various trade agreements.

For instance, India signed a Free Trade Agreement (FTA) with ASEAN for goods first, and then followed it up five years later with a FTA on services. In the interim, India suffered a negative trade balance given the SE Asian region’s superior manufacturing capability and integration with global supply chains. Strategically, if India had signed an FTA for both goods and services simultaneously, the outcome might have been different.

The past lessons seem to have been learnt and, in various FTA talks, India is now insisting on inclusion of freer movement of professionals in return for demands to lower customs tariffs.

The fifth corner of India’s future trade strategy relates to mega trade agreements. The largest – Trans Pacific Partnership – promises to change how trade is conducted. India and China are noticeably absent from the pact; in fact, if the other mega agreement under discussion (Transatlantic Trade and Investment Partnership, between USA and Europe) is finalised, India and China could find themselves in trade hibernation.

Opinion is divided[6] [7] on whether India should join TPP, even though scholars are unanimous that such mega agreements will definitely result in trade diversion for India. Excluded by both TPP and TTIP, India has now set its eyes on completing the Regional Comprehensive Economic Partnership (RCEP), a trade and investment agreement between ASEAN members plus India, China, Japan, South Korea, Australia and New Zealand. Simultaneously, President Obama is pushing for India’s membership in Asia Pacific Economic Cooperation, a 21-country regional economic forum. In fact, APEC membership is a stepping stone for TPP inclusion.

India’s strategy on mega agreements should be to first conclude RCEP without compromising on its strengths. Alongside, India should also try and finalise FTAs with individual states, such as Australia. At the same time, the government must initiate a broader public discussion on India’s trade strategy, specifically to clarify the country’s stand on TPP and its focus on “beyond-border” issues, such as domestic labour laws or environment rules.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. It can be read here also
References

[1] India’s Foreign Trade: March 2016; Ministry of Commerce and Industry, Govt of India; April 18, 2016; http://pib.nic.in/newsite/erelease.aspx?relid=0

[2] Trade Statistics and Outlook: Trade growth to remain subdued in 2016 as uncertainties weigh on global demand; Press Release No Press/768; World Trade Organisation; April 7, 2016; https://www.wto.org/english/news_e/pres16_e/pr768_e.pdf

[3] Elliot, Mark and Linda Dempsey; Stalled Progress on U.S.-Indian Trade; The Washington Times; January 12, 2016;www.washingtontimes.com/news/2016/jan/12/mark-elliot-linda-dempsey-stalled-progress-on-us-i/print/

[4] India Newsletter; Determining Success or Failure of United States-India Trade Policy Forum; October 28, 2015; Albright Stonebridge Group;http://www.albrightstonebridge.com/news/determining-success-or-failure-united-states-india-trade-policy-forum

[5] Page 158, Services Sector (Chapter 7), Economic Survey 2015-16, Vol 2, Ministry of Finance, Govt of India

[6] Banga, Rashmi & Pritish Kumar Sahu; Trans-Pacific Partnership Agreement (TPPA): Implications for India’s Trade and Investments; Working Paper CWS/WP/200/24; October 2015; Centre for WTO Studies; http://wtocentre.iift.ac.in/workingpaper/Trans%20Pacific%20Partnership%20Agreement_Implications%20for%20India.pdf

[7] Bergsten, Fred C; India’s Trade Gains From Joining An APEC-Wide TPP; September 18, 2015; Peterson Institute for International Economics;https://piie.com/research/piie-charts/indias-trade-gains-joining-apec-wide-tpp

India-Nepal Ties Back on an Even Keel

Nepal and India are trying to even out recent crimps in their decades-old relationship by focusing on areas of cooperation – such as, energy, trade, investment and infrastructure – with the bilateral cooperation agenda also including a public diplomacy programme

Cultural, historical and religious affinity often masks the ordinary Nepali’s simmering political discontent against India. It erupts and manifests itself sharply during any internal crisis in Nepal. This deep-seated antagonism towards India was further stoked by Nepal government’s insinuations (corroborated by Nepal’s media) that India was blocking supply of essential goods into Nepal during the recent Madhesi agitation. In a break with tradition, Nepal Prime Minister K P Sharma Oli proposed a visit to China for his maiden foreign tour.

There were numerous missteps by India also, including delays in using alternate supply routes to provide essential goods to Nepal. This intensified Nepal’s economic suffering during the Madhesi agitation.

However, it seems pragmatism and better sense has prevailed on both sides. PM Oli visited New Delhi in February 2016 (before visiting China in March) and signed a bunch of MoUs with Prime Minister Modi. Nepal has also commenced a public diplomacy initiative to improve communication, as well as to inform and engage Indian civil society on multiple areas of bilateral cooperation. As part of the exercise, an inaugural discussion on “Nepal’s Reconstruction Agenda – Opportunities and Challenges” was held in New Delhi on April 13, 2016. Stakeholder inputs from the discussion will be used for commissioning further research.

The discussions centred on participation of the international community in reconstruction efforts, the economics of a drawn-out reconstruction exercise, areas of collaboration between India and Nepal, and, how to incorporate efficiencies into India’s monetary and non-monetary support to Nepal. There was a common thread running through the deliberations: the centrality, or importance, of local knowledge and indigenous technologies to the reconstruction efforts. To that extent, there was emphasis that international aid agencies should desist from super-imposing global disaster-management solutions that are divorced from Nepal’s cultural, social and architectural inheritance.

The public diplomacy programme comes at the right time. Nepal’s political and social stability is in India’s interest, given the long and porous border between both countries. Nepal faces enormous challenges in its post-disaster reconstruction and rehabilitation programme, which is estimated to cost around $7 billion. India has pledged $1 billion as reconstruction aid, 40% of which is in the form of grants and the balance as soft loans. Another $1 billion was promised during PM Modi’s visit in April 2015 through Lines of Credit (LOCs, concessional loans for projects identified by Nepal, disbursed by Exim Bank of India and guaranteed by both the governments). Many of these lines will probably get allocated for quake-related infrastructure works.

This is the third LOC sanctioned by India, with two earlier tranches totalling $350 million. Many projects under the earlier tranche have been delayed due to either capacity deficits, or bureaucratic hurdles, on both sides. The discussion focused on how the new $1-billion LOC tranche could be used expeditiously and efficiently – using lessons learnt from earlier LOCs — for re-building both physical and social infrastructure.

Physical infrastructure – especially roads and power generation and distribution — is critical for the reconstruction of the quake-affected areas. While the Madhesi agitation forced the Nepal government to explore alternate supply routes, and Oli signed agreements with China to allow Nepal to export and import through Chinese ports, it will be some time before Nepal can seriously think of using China as a trade corridor. There was unanimity during the talks that transporting petro-products across the China border is uneconomic, given that the challenging terrain of the Himalayan range impedes smooth movement of large oil tankers. India, on the other hand, has deployed Vishakhapatnam as an additional transit port for Nepal’s foreign trade. Currently, Nepal’s imports transit through Kolkata port only.

Participants at the public diplomacy forum were also informed that the Oli government has started addressing domestic misgivings over Nepal-India power trade. A 132-kv line from Muzaffarpur, India, has already started supplying 80MW of power to Nepal; this capacity is expected to be upgraded to allow for transmission of 600MW by 2017. The transmission lines being laid for this project will be used by Nepal for both export and import of power, especially once the hydro-electrical projects are completed.

India and Nepal not only share a 1750-km long, porous border but also a unique people-to-people relationship (many Nepali citizens, for example, own land and property in India). India is also Nepal’s largest trade partner and contributor of foreign direct investment. Political gamesmanship often vitiates this deep association. It is unfortunate that egregious, short-term political objectives have now necessitated a public diplomacy programme on a bilateral relationship that is so intricately inter-twined.

This blog was exclusively written for Gateway House: Indian Council on Global Relations. You can find it here.

Remembering Water...

In this hot and fractious season of water shortages, cricketing villains and simmering public anger, I was reminded of an Op-Ed I wrote for The Economic Times on August 9, 2006. It was titled "Water of Love, Deep in the Ground". Is it coming true? Here it is:

With the government unwilling to act, except to frame effete policy, and the sharks devouring public assets by tacit political consent, it won’t be long before water becomes the incendiary fuel for public strife, warns Rajrishi Singhal

STOCKS are jejune, gold is passe and land is old-fashioned. So, what’s the next big asset class, which will allow investors to get in on the ground floor before every other punter in the land wisens up to it? I asked this question to a couple of my senior colleagues and pat came the reply: “Water”! Certainly not what I was expecting to hear, but the more one thought about it, the more convincing and compelling the idea seemed. In fact, as a commodity and an asset class, water has already triggered wars between nations in Africa and the Middle East and, closer home, strained relations between Tamil Nadu and Karnataka. It also plays a vital role in determining property rates in almost all the major cities — Mumbai, Chennai, Delhi definitely being the main ones. 

The query came up in connection with the unabashed land grab that’s going on in the name of every conceivable enterprise — SEZs, shopping malls, educational institutes, highway projects. What’s more, every major metro has seen the emergence of land sharks who have been cornering large swathes of land — mostly at rock-bottom prices by threatening owners and using the shield of political clout. The modus operandi usually involves bending a few rules here, paying off a few politicians there. But it’s all kosher as long as there’s a profit at the end of the transaction. So, don’t be surprised if you see the same sharks — or at least sharks with similar intentions — taking to water before you can spell aqualung. 

This raises a basic issue — what is an asset? Can water be called one? An asset can, loosely, be defined as an investment that generates cash flow, whether it is a machine owned by a company or a fixed deposit owned by an individual. There is huge opposition from certain quarters to water being termed either as an asset or a commodity since it is part of the “commons”. The argument certainly does have an element of logic to it but does not entirely do justice to ground reality. In fact, various policy documents from the government — including the last National Water Policy of 2002 — also curiously maintain a studied silence on the issue, leaving it not only open to interpretation but to subsequent bending of rules. 

The reason for considering water as an asset is pretty obvious. It is getting increasingly scarce and its supplies have started carrying a premium. In fact, certain members of the conspiracy theory camp even ascribe the current conflict in Lebanon to Israel’s growing thirst for water resources and yearning to control the Litani river basin. Agreed, this probably sounds a bit outlandish, especially given the Iran-sponsored Hezbollah’s involvement in the conflagration, but water is irrefutably a flashpoint in West Asia and Africa. British journalist and author Adel Darwish said in a conference way back in 1994: "Most borders have been set, oil fields mapped and reserves accurately estimated — unlike the water resources, which are still often unknown. Water is taking over from oil as the likeliest cause of conflict in the Middle East." 

In India, the problem is not over availability of water, though that might soon become the issue. Inadequate and corrupt service delivery standards crimp the pipeline. However, given that water supply is largely in the domain of state governments and urban local bodies (ULBs), their inherent inefficiencies and embedded corrupt practices are bound to create opportunities for private sector investment. In a 1996 survey by the Indian government, in 241 towns with populations between 50,000 to 100,000, more than one-third ULBs could not provide more than 100 litres per capita per day. 

SO, THERE does exist a gap between demand (which is growing, with rising population and urbanisation) and supply, which the government bodies seem incapable of addressing. Given this, there does exist an investment opportunity which will certainly be exploited by the sharks, unless the central and state governments, along with the private sector, jointly pursue rigorous structural reforms in the management and delivery of water resources. In fact, at the risk of being labelled a neo-liberal, it must be said that a large part of the responsibility might have to be shouldered by the private sector. 

Involving the private sector in water has many detractors, but the choices are limited. Given the huge investment outlay required to provide water to every Indian, a World Bank document observed: “On the ‘supply side’ there are ultimately only two sources of financing — tax revenues and user charges — and both are falling.” Also, the government has proved to be entirely incapable of delivering the required services at economic rates. Therefore, if we assume that the private sector will play a larger role, it might as well sharply define which areas work and which do not. For instance, building physical infrastructure might not be feasible for all private sector enterprises, given the long payback period and the system allergy towards paying user charges. Some private companies might find it useful to invest in bottled water, given the phenomenal growth rate in the sector (an annual growth rate of over 50%) and the fragmented nature of the industry structure (200 brands with 80% local brands). 

There could be opportunities in other areas that have already seen the emergence of water sharks — water tankers. A lot has been written about them and their unshakeable grip over water supply in metros as well as smaller towns. These sharks have close links with politicians, or have been indirectly promoted by them, prevent the ULBs from investing in the supply infrastructure and then supply to the deprived neighbourhoods at exorbitant prices. Tanker sharks have today become ubiquitous in both metros as well as smaller towns. 

This signifies only one thing: even though the NWP is silent about water markets and the Maharashtra Water Resource Regulatory Authority Act of 2005 wants a water market in the state, a parallel and unregulated water market has already sprung up and is thriving under the official tutelage of the political class. And with the government unwilling to act, except to frame banal and effete policy documents, and the sharks devouring public assets by tacit political consent, it won’t be long before water becomes the incendiary fuel for public strife.

Going Global? Study Tata Steel First

All Indian companies planning to go global should closely follow the saga of Tata Steel’s UK plants; it’s a masterclass on how intimately business is intertwined with geopolitics and geoeconomics

An epochal event, that should resonate for every globalised Indian business, brought down the curtains on an eventful 2015-16. In the last fortnight of March, Tata Steel declared[1] that it will sell off or mothball its U.K. steel plants. The event contains a lesson for every Indian business aspiring to go global; it also has immense geo-economic and geo-political repercussions.

Tata Steel’s momentous decision is in keeping with the general trend of Indian companies selling off overseas assets to either repay debt or exit low-yielding assets. Tata Steel’s decision seems to be a combination of both. Here are some other examples of Indian companies selling overseas assets:

* Reliance Industries sold its Eagle Ford shale oil field in the U.S.A. for $1.07 billion in June 2015.

* In October 2015, Bharti Airtel sold telecom tower assets – close to 8,300 towers — in seven of the 13 countries from its African operations. The proceeds: $1.7 billion.

* Suzlon sold German subsidiary Senvion (earlier known as Repower) to private equity company Centerbridge Partners for Rs 7,200 crore in January 2015.

* GMR Group sold three overseas operations during 2013: in March it sold a 70% stake in GMR Energy (Singapore) Pte Ltd for $520 million; in December it offloaded its 40% stake in Istanbul airport and another airline services company f0r a combined $305 million.

* Avantha Group’s Crompton Greaves has been selling its overseas power equipment assets.

* Healthcare company Fortis sold five overseas healthcare assets between 2013 and 2015

This is just an indicative list but does underline India Inc’s troubled liaison with globalisation. Economic reforms and competitive pressures forced many Indian companies to expand operations overseas through acquisitions with either (or a combination) of three objectives in mind – to acquire competitive supply chains, to access consumer markets, to buy into developed technology and intellectual property. However, the fault was not in going global but seemingly, in the timing.

But it also begs the question: how did Indian companies end up borrowing so much that it would subsequently force them to jettison their cherished global desires?1And, how come they never saw the approaching storm, because most of the loans were contracted either just before the crisis or during the slowdown?

Tata Steel’s UK outing is an example that provides an answer. It acquired British company Corus in April 2007, subsequently renaming it Tata Steel Europe. Tata paid over $12 billion for the purchase, most of it debt. Around the same time, the sub-prime mortgage crisis had started undermining global markets, leading to the cataclysmic closure of Lehman Brothers in September 2008 and the subsequent global financial crisis.

The economic slowdown and continuing weakness in European markets affected sales. What exacerbated matters were structural factors — global steel oversupply, increase in third-country exports into Europe, high manufacturing and environmental costs, continued weakness in domestic steel demand and a volatile currency.

Many other Indian companies with ambitions of acquiring a global footprint similarly borrowed heavily either in 2007 or, bizarrely, during 2011-12. A bloated appetite for foreign currency loans was fuelled by historically low interest rates in developed markets. There was also an element of hubris – a mistaken feeling that growth would continue unhindered, unaffected and untouched by global turmoil.

Unfortunately, this also reveals India Inc’s lack of strategic intent and a bewildering ignorance of geo-economic currents. The absence of an in-house risk-mitigating treasury process is exposed in numerous speeches by various Reserve Bank of India governors: most companies that borrowed overseas to finance acquisitions, left their foreign currency exposures unhedged. Consequently, the rupee’s depreciation since 2013 increased their loan-servicing burden.

Tata Steel’s woes, though, could have an additional set of triggers, which could include UK’s geo-political snuggling-up to China, or even the country’s vexed relationship with the European Union (EU).

China has been dumping cheaper steel in Europe after other large markets – including U.S.A. and India – increased tariff barriers. This has resulted in demands within Europe to increase import tariffs as well.

In a February 4, 2016 news release to disclose results for the quarter ending December 2015, Karl-Ulrich Köhler, MD & CEO of Tata Steel in Europe, stated: “Chinese steel shipments into Europe leapt more than 50% last year, while imports from Russia and South Korea jumped 25% and 30% respectively. The European steel association has identified that Chinese steel is being exported at prices below the cost of production…”[2]

In a separate statement, Roy Rickhuss, general secretary of the steelworkers’ trade union Community, said: “I would like to see evidence of the Prime Minister’s claims that they have increased procurement of British steel or tackled Chinese dumping of steel in Europe…The UK is one of the member states opposing the end of the lesser duty rule in Europe, which currently prevents higher tariffs being imposed.”[3]

But Europe is wary of jeopardising its relationship with China – it is the EU’s second-largest export market, and fourth-largest FDI destination.

The EU and the UK dithered on imposing higher import duties on steel because of apprehensions that it might render end-user industries uncompetitive. Higher tariffs present another predicament for the current Conservative government: weighing the cost-benefit of saving the 15,000 jobs at the Tata Steel works versus antagonising new-found friend China.

Tata Steel now involuntarily finds itself inserted into the Brexit campaign. Advocates of Britain’s exit (Brexit) from the EU are arguing that exiting the Union will allow the Cameron government to bail out the Tata Steel plants and save those 15,000 jobs. Currently, EU’s state-aid and procurement rules restrict state-sponsored lifelines to industry, which have been bolstered by two recent rulings[4].

A face-saving formula – which keeps Tata Steel and its workers, Britain, EU, and China happy — might still be in the works. EU Trade Commissioner Cecilia Malmstrom[5] ’s speech at a recent trade conference provided some clues to such a compromise.

Whatever the fate of Tata Steel plants and jobs, there is a learning in this for Indian companies which are looking abroad: before investing in any jurisdiction, India Inc must do well its homework about a country’s potential geo-economic tripwires – specifically, its bilateral and multilateral trade and investment agreements – and geo-political risks. This will require corporate India to develop a new strategic temper and a broader perspective, one that thinks more like a multinational leader with global – not just Western – ambitions, rather than rely only on the template advice proffered by international bankers and management consultants.

References

[1] Press Release, BSE Limited, Review of European Portfolio of Tata Steel, 29 March 2016, <http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/EB0CC117_DBF1_47E0_8753_5DEA119FE8B6_082546.pdf>

[2] News Release, TATA Steel, Tata Steel reports Consolidated Financial Results for the third quarter and nine-months ended December 31, 2015, 4 February 2016, <http://www.tatasteel.com/investors/pdf/Q3-FY15-16.pdf>

[3] News & Views, Community, Community responds to Prime Minister’s statement on steel,31 March 2016, <http://www.community-tu.org/community-responds-prime-ministers-statement-steel/>

[4] Other news, European Commission, Vestager announces EU State aid decisions: Belgium and Italy, 20 January 2016, <http://ec.europa.eu/ireland/press_office/news_of_the_day/vestager-announces-eu-state-aid-decisions-belgium-and-italy_en.htm>

[5] Malmstrom, Cecilia, ‘Trade Defence and China: Taking a Careful Decision’, European Commission Trade defence Conference, 17 March 2016, <http://trade.ec.europa.eu/doclib/docs/2016/march/tradoc_154363.pdf>


This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can find the article here.

What’s In The Bag?

For all intents and purposes, the Budget is in the right direction. Except, it could use a plan to achieve its ambitious goals

From the moment finance minister Arun Jaitley began reading his career’s third Budget speech, all the way till the very end, the stock market’s bellwether index, the BSE Sensitive Index, oscillated wildly. Social media comments too reflected the mood in the bourses — swinging between complimentary and scathing, to downright snarky and fulsome praise. 

One tweet even claimed (without furnishing any proof) that though the Budget speech was read out by Jaitley, its key architect was Prime Minister Narendra Modi. Another, snidely claimed the Budget seemed to have UPA-III’s imprint, given its emphasis on rural and farm sectors. There were other similar tweets. While you can’t really expect a proper analysis in 140 characters, it’s true that the tenor and content of Budget 2016 has left experts confounded and desperate to find the one thread that ties up the whole package of measures.

Indeed, there are multiple strands to Budget 2016, each striving to provide a specific solution. The question is: do all these cohere to form a meaningful tapestry? Does it make sense? It might be worthwhile to examine some of the overarching themes in Budget 2016.

Let’s consider the first charge: Budget 2016 is a political document. To be fair, Jaitley had little choice. Economic policy-making cannot be conducted in a political vacuum. With key states (Assam, West Bengal and Tamil Nadu) going to polls this year, followed by Uttar Pradesh and Punjab next year, it might be naive to expect that Budget 2016 will be bereft of any political grandstanding. 

That might also explain this Budget’s exaggerated emphasis on playing Robin Hood: imposing a slew of additional taxes on the wealthy, under the heading “Additional resource mobilisation for agriculture, rural economy and clean environment”, without bothering to specify whether these taxes will indeed be sequestered for the specified objective, or even caring to explain what happened to taxes collected under similar heads over the years. Ironically, Jaitley has himself provided the counter-point: pensioners withdrawing life savings from pension funds will now have to pay tax on 60 per cent of the accumulated corpus, if it is not invested in an annuity. As a wag observed drily, Thomas Piketty’s whistle-stop tour through India has left economic administrators with fleeting notions of inequality.

Two other broad themes dominate Budget 2016: a stimulus package to spur rural consumption and enhanced outlay to speed up investment in infrastructure. As argued in these pages a few weeks ago (http://goo.gl/GvFnbP), Jaitley was faced with a binary choice: either ramp up public investment to derive economic growth, or stick to the fiscal straight-and-narrow. A spirited public debate ensued with growth adherents advocating a temporary slippage in fiscal deficit. Fiscal hardliners argued it would be foolhardy to relax vigil during these trying times of global turmoil; a downgrade by credit rating agencies would scupper even incipient growth impulses.

In the end, the minister has chosen both options. How he achieves both ends will have to be seen. While his public investment outlay is up 15.5 per cent over previous year’s estimates, he has also set aside large amounts for the rural and farm sectors. Jaitley stated capital expenditure on railways and roads will alone account for Rs 2,18,000 crore this year. Additional outlays have been announced for investment in power generation, ports and waterways. It is interesting to note that even in infrastructure investment, the emphasis is on the rural sector: investing in expanding the coverage of irrigation (to reduce Indian farmers’ vulnerability to fickle monsoons) and investing in rural roads and rural electrification. Connecting unconnected villages will help farmers get their produce to markets. 

In the midst of this enhanced spending, the FM has also promised to adhere to the fiscal deficit target: 3.5 per cent of gross domestic product. A lot will depend on the revenues he manages to raise — Rs 19,610 crore of additional tax revenue (some of it from soaking the rich) and a 25 per cent increase in non-tax revenues. One large chunk of non-tax revenues (Rs 98,995 crore, compared with last year’s Rs 56,034 crore) is expected to come from telecom spectrum auctions. The other source of non-tax revenue is a leap of faith: the government expects Rs 56,500 crore from disinvestments. In this fiscal year, the government managed only Rs 25,312 crore against a target of Rs 69,500 crore.

Undoubtedly, the agricultural sector needs additional resources: it is not only hobbled by numerous structural deficiencies but poor monsoons over the past two years have caused deep distress in the sector. The Budget wants to double farmer incomes by 2022, by facilitating easier access to markets for inputs and finished products, higher credit allocation and better infrastructure. But, the text lacks details of how this will be achieved; there is no mention of a roadmap.

A massive allotment of Rs 2.87 lakh crore — in the form of grant-in-aid — has been made to village panchayats and municipal bodies. Again, there is lack of clarity about the end-objective of this fund flow. Will it be used for local infrastructure? How will the money be spent — in one year or five years?

The FM’s intentions seem honourable and generally aimed in the right direction. The economy needs higher public investment in the absence of private sector capital expenditure; there are deep structural flaws in the farm and rural sector that need urgent corrective action; fiscal discipline is non-negotiable. What’s lacking is clarity, or the nuts and bolts of how the FM intends to achieve these objectives. There are some other unanswered questions in the Budget:

Monetary Policy and Monetary Policy Committee have now acquired a statutory basis. Details on the committee’s composition are absent. While it has been clarified that there will be equal representation from both the government and the central bank (with RBI governor getting the casting vote), it is not known whether the original plan of appointing a senior bureaucrat on the committee as an ex-officio member still exists. The bureaucrat’s status as an observer is to report to the ministry on the voting pattern of the committee members. I am sure you get the picture.

There is an overall increase in the incidence of cesses and surcharges. One example is the Krishi Kalyan Cess, which will levy an additional 0.5 per cent on all taxable services. When combined with a consumption upsurge, due to Pay Commission arrears and a fillip to rural demand, the after-effects are most likely to be felt on the price line. What happens to inflation targeting then?

PM Narendra Modi’s ambitious Make In India programme suffers from domestic industry’s negative propensity to invest. Industry, in turn, complains that bank credit is not forthcoming. Banks, on the other hand, carp that their ability to lend is seriously impaired by mounting bad loans. In short, banks need fresh capital to start the lending process once again. Against this background, Jaitley’s allocation of only Rs 25,000 crore towards bank recapitalisation is underwhelming. FM Jaitley also mentioned consolidation; is he proposing public sector bank mergers as a way of reducing the drain on the Central exchequer?

The fiscal deficit target for 2016-17 — 3.5 per cent of GDP — is premised on GDP growing at 11 per cent. Given the global headwinds, and exports contracting for 14 months consecutively, slippage in the 11 per cent target will not be very surprising. Hopefully, the government’s resource transfers will keep the growth trajectory along expected lines.

A lot of Jaitley’s wishes are riding on revenue estimates delivering. He collected an additional Rs 54,334 crore of indirect taxes over the budgeted estimate during 2015-16 by increasing taxes on petro products, at a time when oil prices were crashing globally. Gross tax revenues are expected to grow by 11.73 per cent during 2016-17, at the same rate as India’s GDP. He is expecting tax on luxury consumption and a plethora of cesses and surcharges to fill the gap. It might be a bit of a tall ask.

There are too many imponderables in this well-intentioned Budget. Hopefully, some clarity will emerge in the coming weeks.

This article was published as cover story in Businessworld magazine (issue dated 'March 21, 2016) as part of the publication's special Budget package, titled 'Budget 2016 Split Verdict'.

The story can be found here.

Silver Lining to India’s Trade Blues

India’s merchandise exports have now contracted for 13 months in a row, reflecting the global slowdown and impact of China’s economic recalibration. But, therein lay new opportunities and challenges for India’s economic diplomacy

India’s exports of goods have now shrunk for 13 months in a row. Even as this presents a threat to the government’s “Make in India” programme, it also provides some clues to future focus areas for India’s economic diplomacy.

Data for December 2015[i] shows merchandise exports at $22.29 billion, 14.75% lower than exports booked in December 2014. Cumulative exports for the first nine months of 2015-16 (April-December 2015) amounted to $196.6 billion, down 18% over the comparable period of 2014-15. There is one silver lining though: the trade deficit for the first nine months of 2015-16 ($99.2 billion) is lower than the deficit in 2014-15 ($111.68 billion). This is primarily due to lower oil prices.

There are two ways of slicing this data to understand incipient trends; locating the geographical source of this demand compression and looking at performance of specific commodities.

According to Commerce Ministry’s database on exports by region[ii], in dollar terms, the three destinations showing maximum contraction in Indian exports (or areas that are buying much less from India than in the previous year) are Latin America (down by 36.73%), Commonwealth of Independent States (CIS) & Baltic region (down 32.4%) and Africa (25.59%). Clearly, India’s foreign policy practice and economic diplomacy needs to expend greater energy on these areas.

Granulated regional data provides better insights. In Asia, for instance, the sharpest fall in absolute terms has been in exports to the West Asian countries that are members of the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates). The second largest drop in absolute terms has been exports to the ASEAN countries, followed by North East Asia (which includes China). While the GCC phenomenon can be ascribed to shrinking oil revenues, leading to diminution of demand for Indian goods, it is the slowing of the Chinese economy that explains the North East Asian drop and a second round impact leading to dwindling of ASEAN demand.

Examining trade data through the lens of performance of specific commodities highlights stasis in India’s manufacturing industry and the need for providing stimulus. This can be either through “Make In India” initiative or through additional investments. The data clearly shows slowing demand overseas for agricultural (rice, other cereals, oil cakes and oil seeds) and oil-related commodities. However, more importantly, import data shows a huge spike in purchases of pulses, gold and silver–indicating higher consumption–but demand for fuel, mineral ores and metals, machinery and equipment remained in negative zone, reflecting static industrial and manufacturing demand.

Yet, there are some oases of optimism— India’s trade in services for the first eight months of 2015-16 (April-November) showed a positive balance of $48.047 billion. In fact, this is one area in which India not only fares better than China (which has traditionally suffered a negative trade balance in services) but has also been able to stave off the China slowdown factor more effectively that merchandise trade.

This, then, points to another focus area for India’s future economic diplomacy, including its bilateral engagements with China or European Union (EU) and regional arrangements like Association of Southeast Asian Nations (ASEAN) or Regional Comprehensive Economic Partnership (RCEP).

The India and China example are instructive. India and China have multiple grounds for disagreement which occasionally drives a wedge between the two countries in multilateral negotiating forums. China’s overwhelming trade surplus with India and the festering border dispute are some of the legacy issues. Thesehave been joined by new contentions, such as India’s lack of response to China’s generous offer of building critical infrastructure.

But a common grouse should be uniting both countries’ interests at global negotiating platforms: services exports. This is because multilateral trade negotiations — such as those under World Trade Organisation (WTO) — or regional trade arrangements (examples being RCEP) and even bilateral agreements focus overly on goods trade. This is disadvantageous for India, which has competitive advantage in services but is denied level playing field in trade negotiations. China is likely to be in a similar situation when contracting exports of manufactured products forces its hand to provide a greater thrust to service exports.

India’s service sector has been a saviour for both domestic economic growth and for overall balance of payments. China’s trade in services is in negative zone because it’s a net spender on tourism and education: its trade balance was a negative $159.9 billion in 2014. This is ripe for change — a Chinese government policy document released in February 2015 set a target of $1 trillion of services trade by 2020, including accelerating services exports[iii] [iv].

With China expected to refocus economic efforts on strengthening its services sector and increasing its share in exports, both India and China need to coordinate their strategies and act in concert during multilateral trade and investment negotiations.

In fact, the UNCTAD Handbook of Statistics 2015, released recently[v] by the United Nations Conference on Trade and Development (UNCTAD), shows that services bailed out global trade during 2014. Data also shows the criticality of services exports for India, and its negative impact on China’s balance of payments. Given this strategic importance of services for both countries trade, and the continuing slowdown in demand for goods, overall global trade patterns are pointing towards the need for greater India-China cooperation in services trade.

References
[i] Department of Commerce, Ministry of Commerce and Industry, Government of India, India’s Foreign Trade (Merchandise): December, 2015;; <http://commerce.nic.in/tradestats/PressRelease.pdf>

[ii] Department of Commerce, Ministry of Commerce and Industry, Government of India, December, 2015;<http://commerce.nic.in/ftpa/rgn.asp>

[iii] The State Council; The People’s Republic of China, New guideline on boosting trade in services, ; 15 February, 2015; <http://english.gov.cn/policies/latest_releases/2015/02/15/content_281475056101818.htm>

[iv] Gerry Shih; China’s economic planners aim to boost service exports; Reuters, 14 February, 2015<http://www.reuters.com/article/china-exports-idUSL1N0VO09W20150214>

[v] UNCTAD;,International trade in services was main driver of growth in global trade in 2014 ; <http://unctad.org/en/pages/newsdetails.aspx?OriginalVersionID=1149&Sitemap_x0020_Taxonomy=UNCTAD%20Home>

Courtesy: Gateway House (http://goo.gl/cXKJYO)