Scarcity of affordable capital, reliable infrastructure and nutritious food are the supply-side challenges that India has to overcome
As the dust of the world’s largest democratic exercise settles, the focus will shift to the expectations from the new government. With the emergence of a more demanding voter, increased youth involvement, rising income levels and greater urbanisation, this may well be a watershed election for India. In their perpetual effort to portray India’s current challenges as being fundamentally different from what they were 10 or 20 years ago, political parties often forget or underplay the fact that the country’s central challenge has almost always been a scarcity of supply of almost everything that is important for modern economic life. Hence, with every national election, I tend to become optimistic that the new government will tackle India’s supply-side challenges head on.
I see these challenges as having fundamentally three dimensions: A scarcity of affordable capital, a shortage of reliable infrastructure, and a paucity of nutritious food. These three supply-side challenges are the central reason India has moved from being a developing economy with 5 to 6 percent inflation a decade ago (broadly in line with other Asian emerging markets, or EMs) to a country with 10 to 12 percent inflation (almost twice that of other Asian EMs).
Let me begin by addressing the issues around affordable capital. With most Indian corporates paying in excess of 12 to 13 percent for even short-term loans, Ambit Capital’s economists are of the view that Indian companies have the highest cost of capital outside of sub-Saharan Africa. The reason for this is not hard to find. Although India saves just under a third of its national income, more than two-thirds of these savings go into physical assets—primarily gold and real estate. As a result, banks serve as the main mode of financing for the vast majority of Indian businesses. By itself that wouldn’t be a major issue were it not for the fact that the Indian banking system now finds itself in very tricky waters.
An analysis by our banking team indicates that if one makes reasonable assumptions regarding the percentage of the currently stressed assets of the banking system that will have to be written off, and if one factors in incremental Basel III capital requirements over and above that, Indian banks need around $40 billion to regain balance sheet strength. This amounts to 2 percent of India’s GDP. Given that in the July budget India will have to cut its budget deficit further—or risk a sovereign downgrade—it is not clear how this recapitalisation will be financed. Since an economy where the banks are in bad shape can’t really mount a serious recovery, I believe the new government’s first priority should be to address the issues facing the banking system.
On the infrastructure front, our extensive deficits are well known. I see the three central issues in the infrastructure sector as being:
(This story appears in the 30 May, 2014 issue of Forbes India. To visit our Archives, click here.)