Indian finance is in need of reforms updated for 2020s

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.

Long and Winding Road
More crucially, what’s missing is the national determination of 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 US-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.
With rampant automation, a bulging low-cost labour force isn’t the advantage it once was. Even in software exports, cloud computing and digital technologies have diminished value of work done by Infosys and Tata Consultancy Services engineers in maintaining bulky enterprise software for global corporations.
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 demonetisation 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.

India Needs $1 Trillion
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 privatising 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 privatisation politically palatable.

The Race Is On
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 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.
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.
— Bloomberg

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services