The Modi government finds itself in a chakravyuh it is unable to fight its way out.
One of the few talking points of the Narendra Modi government is that India’s foreign exchange reserves have scaled $400 billion. It is seventh in global ranking — China being the biggest foreign reserves holder, with $3 trillion, a trillion dollars down from its high point of $4 trillion in 2015; followed by Japan ($1.25 trillion) and Switzerland ($800 billion), mostly due to other people’s money in its banks. The other four ahead of India — Saudi Arabia, Taiwan, Russia and Hong Kong — are in the $400-500 billion range.
Despite this, the Indian economy is not at a place where it wants to be. The Modi government finds itself in a chakravyuh it is unable to fight its way out. The government is unable to make or attract the investment needed to make the economy buoyant again. India enjoyed a decade of unprecedented growth from 2004-14 that seemed to have lost steam in the past year. For the sceptics, India’s average economic growth rose to 7.7 per cent in the 10-year UPA government, compared with 6.2 per cent in the previous decade.
The slowdown of the last two UPA years was largely due to a huge decline in the proportion of capital investment expenditure. That unfortunately still continues in the Modi era. Growth in India still largely depends on government investment. The decline in its investment is not because it lacks ideas, but because it lacks cash. The Modi government has continued with the UPA’s high subsidies and was further hit by a 23 per cent increase (Rs 1.03 lakh crores) in salaries following the Seventh Pay Commission recommendations.
The Modi promise was that he would set right this trend and again begin a new cycle with government-led investment. He promised us 100 new cities, a nationwide grid of high-speed rail networks, a national river-linking programme and many other transformational projects. A hundred new cities have now become 100 smart cities, which means little more than free wi-fi networks. The nationwide grid of fast trains has now become an exorbitant and apparently uneconomical single bullet train linking Ahmedabad and Mumbai. Similarly, all other feasible and exciting promises are now mere caricatures of what were promised. The picture thus remains bleak.
Then came the twin black swan events. Demonetisation was a body blow to the daily wage unorganised sector that makes up 40 per cent of India’s GDP. The unorganised sector also accounts for 90 per cent of the total employment of around 450 million. The loss of jobs due to demonetisation and the hasty implementation of GST is still not empirically confirmed. Estimates vary. The construction and food retail sectors seem to have taken a massive hit and the ballpark estimation of loss of jobs is at around 20-30 million.
GST’s hasty implementation forced companies to reduce production in the run-up to its July 1 implementation as dealers reduced inventory. The announcement of rates was hasty and the many mismatches between input and output rates compounded the confusion. Of the Rs 95,000 crores collected in the first month, as much as Rs 65,000 is due to be refunded. The government doesn’t seem to have the cash to do so.
In a belated effort to reverse these trends, the government plans to loosen its fiscal deficit target of 3.2 per cent of GDP to enable it to spend up to Rs 50,000 crores. This is a tiny sum for an economy of over Rs 150 lakh crores. What we need is a huge cash infusion to boost investment. The option of meaningfully slashing subsidies, with Mr Modi’s term on the slope towards elections, is not politically feasible.
There is that old saying that when the going gets tough, the tough get going. Mr Modi should now show toughness and imagination, tempered with realism. He must revive the national mood and generate optimism. He now needs a plan to drive investment. He doesn’t have to go far to find the money to fund this plan.
The government is sitting with foreign reserves of over $400 billion, with around $135 billion alone sitting in US banks earning next to nothing. These reserves are equal to about 80 per cent of our foreign debt. Even after providing a quarter of reserves to cover the expensive short-term hot money of NRI investors, each taking a pound of flesh for mostly foreign bank-financed investment in their mother country, we will have $300 billion in hand. How much can be freed from the other $300 billion for investment is now the big question. Kaushik Basu of the World Bank says India’s foreign reserves needn’t be more than the current account deficit (CAD), or about $80 billion.
Just holding enough reserves to cover CAD or exports for a few months would be about enough. This nonsense of holding reserves to at least cover six months’ imports is plain arbitrary and concocted by those who devised the Washington Consensus. This “consensus” assures New York banks plenty of cheap money to finance American domestic consumption and extravagances. The Chinese have now realised the stupidity of financing the US cheaply with their reserves and have run it down by about $1 trillion.
Clearly, running them down by around $100 or Rs 6.5 lakh crores can be contemplated. The government could establish an India Infrastructure Investment Fund and start shifting meaningful fractions from the foreign reserves into this fund. Think of it as a Indian Sovereign Fund investing in India. A board of well-regarded experts, who can allocate investments on merit to prevent the usual leakages and political misuse, could administer the fund. This fund must also mandate the minimum level of local procurement and investment to boost Make in India. It is probably our best hope to revive the investment spirit to get the economy out of the hole it finds itself in. And Mr Modi too.
The writer, a policy analyst studying economic and security issues, held senior positions in government and industry. He also specialises in the Chinese economy.