Thirty years ago, India endured its last big financial crisis when it had to send gold held in the central bank’s vaults over to London to borrow hard currency from the Bank of England. Luckily, the flights landed safely, and so did India.
The turnaround in economic thinking triggered by that balance-of-payments humiliation saw the state shed controls on production and imports. The emergence of a globally attuned software services industry as well as vibrant capital markets — which India opened up to the world faster than China — helped spawn entrepreneurship and create a middle class. Hundreds of millions were lifted out of poverty; the 1990-91 crisis became the starting point of two decades of rising prosperity.
All that progress is now at risk because of a very different failure. Growth is crashing. Jobs have gotten scarce. Investments have cratered. Profits have vanished. Tax collections are low; government deficits high. Debt has surged, but there isn’t enough loss-absorbing cushion either on corporate balance sheets or with financial intermediaries to allow orderly deleveraging. India isn’t in the midst of an external crisis. It’s grappling with a vicious internal cycle of defaults.
More crucially, what’s missing is the national determination of the 1991 reforms. Economist Manmohan Singh, then a newly appointed finance minister who later became premier, invoked Victor Hugo in his budget speech: “No power on earth can stop an idea whose time has come… the emergence of India as a major economic power in the world happens to be one such idea.”
Unlike Singh, current Prime Minister Narendra Modi is a career politician who won a resounding popular mandate in 2019 for a second five-year term. There’s no dearth of slogans and goals — such as a $5 trillion economy by 2024 from under $3 trillion now. Yet except for a recent move to make India a low-tax enclave for manufacturing units fleeing the U.S.-China trade war, there isn’t much of a plan in place. It’s not even clear if a search for enduring solutions will get under way in 2020, or if the economy will just muddle through.
Today’s problems result from past successes. In a withering critique of what he calls a “finance-construction growth model,” Princeton University economist Ashoka Mody has rightly blamed India for ignoring labor-intensive manufacturing. The country has shortchanged its blue-collar workers, especially women, whose participation rate in the workforce has swooned. A nation of 1.3 billion people is producing only what 150 million affluent customers want.
*First, India must reinvent infrastructure financing. The sudden collapse of highly rated infrastructure operator-financier-owner IL&FS Group in September 2018 was the last straw. The nation was already reeling under a disastrous 2016 ban on 86% of the currency in circulation. Modi’s demonetization failed in its goal of freezing out ill-gotten wealth: It depressed consumption and pauperized farmers and tiny businesses instead. Then came a botched-up goods and services tax in 2017. After IL&FS went under, the economy gave up.
*IL&FS was a monster. To ensure a cash-strapped government never again allows another cabal to exploit India’s hunger for roads, power plants and sewage disposal units for private riches, the country should adopt the Australian model of asset recycling. This means privatizing existing infrastructure, including power grids, government land, roads and commercial real estate, with an explicit promise to use the proceeds to build new public assets. That will make privatization politically palatable.
*Tap long-term money. Rather than being stuck with defaulted bonds of IL&FS, India’s Employee Provident Fund should be owning revenue-generating domestic hard assets alongside the likes of AustralianSuper Pty and the Ontario Teachers’ Pension Plan, and India’s own fledgling National Investment and Infrastructure Fund Ltd.
*Having enough public funds to invest means being able to employ the private sector as contractors. Partnerships, in which the private sector shares the risk of building new assets, don’t have a great track record in India. They lead to inflated costs, corruption, and disputes. As a high court judge noted about an IL&FS-backed water supply project: “Water started flowing (or trickling down) to the common users, both industrial and domestic, in May 2005. What flowed thereafter appears to be only litigation.”
A new model for infrastructure, supported by more flexibility to companies when it comes to acquiring land or engaging labor, would give India a shot at large-scale manufacturing — for domestic markets as well as exports.
However, there’s a shortage of income and savings. Channeling meager resources to productive activity via deposit-taking banks may have been the only way after India disbanded its development finance institutions. That didn’t work well, as is clear from the $200 billion-plus pile of dud corporate loans on banks’ books. Nor did switching credit delivery to nonbanks — which rely on wholesale funding — produce desired results. Shadow financiers gave too many loans to developers for homes that never got built. Capital markets became casinos where brokers lure day-traders with additional leverage on already-leveraged derivative products.
Not many of India’s one dozen state-run banks will survive. Technology will render their deposit-taking privilege obsolete over the coming decade. A lender’s expertise will lie in using big data to find customers with stable cash flows, originating credit against those cash flows, and selling to investors. This is the model that shadow financiers, caught napping making loans for long-term assets using short-term borrowings, are gravitating toward. India should give them a nudge.
The part of India’s finance-construction growth that survives will be worth saving. It may be no less important to the country’s future than the software firms of the 1990s that had honed their skills on domestic projects like computerization of railway tickets. They hit the global scene once the Y2K millennium-change scare stoked demand.
Coming out of the current crisis is priority. But without trying to pick winners, India should also be getting its financial industry ready for the opportunities the 2020s may have in store.