How vulnerable is India to global shocks?

How vulnerable is India to global shocks?

Indian economy is no longer decoupled. It is intricately linked to the global economy, international capital flows and to energy prices. At the World Economic Forum in India, experts Rajat M. Nag, managing director – general at Asian Development Bank, Sandeep A. Naik, MD of General Atlantic, and PR Ramesh, chairman of Deloitte India, discuss if India is inherently strong to deal with any global shocks which may okay out in the near future.

Here is the full transcript of the discussion:

NDTV: As India economy grows, as it becomes stronger, as it climbs up the ladder on global hierarchy, one would think it is less vulnerable and more resilient to global shocks and risks. But is that happening? That is the big topic of discussion here at the WEF with P R Ramesh, chairman of Deloitte India, Rajat M. Nag, managing director – general at Asian Development Bank, and Sandeep A. Naik, MD of General Atlantic. Gentleman, thank you very much. I'll start with you Rajat - tell me, are we decoupled or are we very closely still exposed to global shocks, global risks?

RAJAT M. NAG: Decoupling always was a myth, is a myth, and will remain a myth. You can't have it both ways. You can't say you want the benefits of global integration when things don't go well. No way. As a matter of fact, India is now very integrated with the global economy. But it is now more integrated with, I would say, the Asian economy. It is not as dependent solely on Europe or US as it was before. But it is certainly a part of the global scene, and therefore affected by it for better and for worse.

NDTV: Ramesh, so there is a geo-political risk and a shock that you are exposed to, the economic shock. So let’s go down the economic route first. What is our biggest risk today - our trading patterns or our excessive dependence on oil imports?

PR RAMESH: I would say there are two risks which are significant - one is the risk of inflow of funds not happening at the desired level. We are poised at such a level that we need significant investment capital for growth, whether its infrastructure or any other sector. That’s why all these policy decisions are trying to open up and facilitate investment. The second, as you rightly put, is oil, because energy drives the whole economy and if oil prices go northwards or oil is not available, it would cripple this economy. So these are the two big risks today. Otherwise, I think we are significantly resilient; our financial markets are good; we withstood the global financial crisis.

The third risk if one may say - we are dependent on the Asian economies. In the services' sector, we are dependent on, and particularly in case of the technology services, US and the European markets; more so in the financial services or telecom space. There one saw a decline in all these software companies, which were showcase companies bringing lot of inbound foreign exchange; they are under pressure. However, they are seeing signs of the improvement at this point of time. But as I said, that is again a matured sector that also transmitted a feeling of well-being. If these companies - Infosys, Wipro, TCS - did well, you believed that the country is doing well in the stock market, that India is shining. Therefore, to that extent, there is a third risk.

NDTV: So Sandeep, that was a very important point brought in, and very important from a stock market point of view. From an investment cycle point of view, we are so dependent on foreign capital and FII inflows; does that worry you? Look at the last six months, we have record FII inflows and markets zoom up 16-18 per cent.

SANDEEP A. NAIK: Yeah, let me also address what my fellow panel member just mentioned - are we decoupled? The economies always are coupled; what matters is to what degree. Some economies are coupled to a much bigger degree. If you go back to when the economic crisis took place in 2008, at that time, we convinced ourselves we are decoupled. The reason for that was our economy did not take the same kind of hit that some of the other economies took. It is important to think why that was the case, because even though there were lot of global shocks and macro indicators that were going in the west, our story, from a domestic stand point, was intact. We were still going ahead with the same kind of growth rates that we had; we were still going with everything we had planned to do. As a result, it seemed like we were decoupled, because the story on the ground was intact.

If you fast forward to 2012, what's happened now is that we have managed to upset the story ourselves because of lack of reforms, policy decisions and other issues we have faced with respect to corruption and scams. What happens is we ourselves are uncertain about the things on the ground. You feel that you are much more sensitive to the global shock because the impact of that seems more pronounced now due to the domestic issues. We can put out our domestic issues and get solutions, and put that growth back on track; you'll once again feel that we are less affected by what is happening globally.

RAJAT M. NAG: In 2008, we had much more space; we had much more fiscal space, policy space; we could bring in investments. In 2012 we didn't have that much fiscal space. The point is that Indian economy is a very large economy; external factors will always matter. Domestic issues, high inflation, delayed monsoon, issues on the reforms or the lack of it, would all play in this. This is why, I think, the issue is not that we are decoupled; we never will be. But that doesn't mean we will only be dependent on the external sector, because the domestic market is very important.

NDTV: Our resilience has gone down. If you look at the BRICS nations - in a study done a couple of years ago, India and Russia still came about as the highest risk countries. That was simply because they said lack of governance, lack of reforms and lack of internal strength exposes us to higher risk. Would you not agree?

RAJAT M. NAG: Hopefully the reforms, which have now been announced and hopefully implemented, will increase the resilience. So, I think, we just have to think of it in a very integrated eco-system. We can't sort of push one or the other.

SANDEEP A. NAIK: I will take you back to Davos this year for the WEF. Someone came up to me and said, you don't need an incredible India story; you just need a credible India story.

NDTV: I think they put it very well.

SANDEEP A. NAIK: That is very important. The investors and the people sitting out of India are saying - just show us a credible India story; we will believe in everything you say and we will come back in a big way. So when you talk about the fact that the inflow and the FDI worry you, I would say it worries me in the short term. I know that we as a country also, when we are pushed to a corner, we come back.

NDTV: We still have that belief and hope?

SANDEEP A. NAIK: Structurally, I don't think much has changed. We still have all the structural positives that were intact in 2008. There are a couple of things that need to happen; we need to tackle the deficit issue that we have; we need to push through more reforms; we need to improve the investment cycle because for investors like us, the investment cycle really tells us the shape of the growth curve. Going forward, that is what investors will come and try to bank on; I think that's what is currently missing.

NDTV: I am very skeptical about the investment cycle. I know everybody says 5.5 per cent growth is very good compared to what the rest of the world is showing you, but Ramesh, we are talking about a huge young population which will need jobs; we are talking about slowing investment cycle. So, I am not so confident. What about you?

PR RAMESH: Well, I have a short-term optimism but a long term fear, if I may put it. Let’s take 3 elements to it - one is the tangible part, the second is the financial part and the third is the policy part of it. In the tangible part - the fact of the matter is, we have 17 per cent of the world's population, but less than 5 per cent of the world's resources. Whichever way you look at it, that can't be changed by infusion of finance in anyway, and that would perhaps lead to a policy issue. Do we have a plan in place to deploy 400-500 million working age population which we will be having? If so, in which sectors? Is investment happening in those sectors?

Currently, we are all judging our performance by the fiscal performance and if fiscal deficit is within control or not within control. We are also looking at whether services sector is contributing a large part, or is agriculture contributing a large part. But we are clouded by short-term inflows of foreign currency or the confidence level. We need to address the long term issue of 400-500 million working age population - skill development for them, and deployment in the right sectors. The second one, clearly yes. Money will come in, but money will not transform itself into a growth story unless you address the first one.

The third one is that the policy is creating an environment for money to be appropriately utilized, and for all the actions to happen, you need to have the right policy environment, and that is where I have a concern.

Today all our problems seem to be self-created; we have a political logjam; we have policy paralysis, though a bit of announcements have been made; thirdly, are we a united India today? Our problem today is, we are the largest democracy, but it would have been great if we had a two-party democracy - like in the US; it makes a huge difference.

RAJAT M. NAG: I think if you had said about policy paralysis a year back or even a month back, I would have agreed with you; we have talked about it. But I think it is not fair. I think, the government has announced some very very far reaching reforms and the political commitment has also become evident by the rally we saw, a very important one. I think we are all very good at taking the contrarian view; I think we have got to now look at this in a positive way. These policy reforms are good if implemented.

But the other thing Sandeep alluded to, let me bring that thing. India has a huge infrastructure deficit and a governance deficit. Now the two are related. I think we have to address infrastructure deficit, which ties into the investment and the large number of projects which have been held up. The PM setting up the National Investment Board, the FM talking about blocking some of those - I think they are all very positive. I won't be as negative as you. But I think the growth story is plausible, not pre-ordained. What I find is, either people are euphoric or people are down. I think the truth is always somewhere in between. I think India can make it; we see some evidence of it. A growth rate of 5.6 per cent, which is what we focus this year, is far below India's potential, but not bad and next year, we are projecting it to grow to 6.7 per cent, which again is nothing to scoff at. But the tragedy is that it is much below potential.

NDTV: Lets also now look at a global environment. We do know we need a lot of fixing, and if intentions roll out in terms of reforms and fiscal deficit containment, I think India would be alright and resilient when it comes to domestic economy. But now let’s look at the global factors little bit - Europe and America. US is showing signs of recovery; there are a huge number of businesses depended on it and there is also Europe. Do you think it all played out Sandeep or they'll pretty much figure out their problems whatever it is and work it out? It’s not a threat anymore to the global markets or Indian markets.

SANDEEP A. NAIK: I don't think there is any economist in the world who can tell you what's going to happen, and if he does I would love to meet him. But I think, with what's happening and what's playing out, the Euro crisis is seen more like a political crisis than economic crisis, of really trying to get all the governments together to come up with solution. The economic solution on paper is clear; the question is, would they want to take the pain in order to do that, and really austerise Greek as a result, and figure out what the repercussions are? So we don't know what's going to happen and I don't think that’s going to be the end of the world. I don't think we should worry about it too much at this point. In the US, starting January 1, you are going to see the US fiscal cliff, as Ben Bernanke put it, which is all the tax relief and all the spending cuts that were pulled back. Starting January 1, you are going to see taxes go up; you are going to see the spending cuts happen. As a result, we may get into a double dip recession in the US and that’s probably the biggest question that president Obama would face once he settles down for his next term. Should that worry us? To a certain extent, yes, because these are global economic issues that may hurt investor confidence, not only in those countries. People would want to keep the dollars back and not bring it into emerging economies. These are things that we cannot control, but what we can definitely control is how do put ourselves back on the growth track, and as you have heard the other panel members speak, 5.6 per cent growth is nothing to shy away from; it is still better than many other economies and I am very optimistic that we'll get back to the 7-8 per cent by doing some of the very basic things that we need to do. The government needs to first focus on fiscal consolidation, GST, DTC, making sure that there is fiscal consolidation, disinvestments by all the PSUs and then, they need to focus on incentivising investments to happen - be it simplifying the land acquisition, or taking care of the coal issues, making sure that you help companies invest more in the manufacturing.

NDTV: A large reason why reforms have also been stuck is simply because there is no political consensus on it. We are facing this situation Ramesh, coming back to the point you made, where you have a deepening political environment, but also more fractured politics. How do you get out of that logjam? Will just GST take up growth by 2 per cent? That’s what the economists are saying. Transparency in governance, will that add another 1 per cent to GDP? It all seems very fair, doable, but it is not happening.

PR RAMESH: Currently if you look at our country, there are certain pockets where growth is happening. There are some states that are doing well and that raises the question - are these national issues really holding up development across or do we have clearly regional issues which is causing growth not to happen? We had good states in the past, whether it is Karnataka, Tamil Nadu, Andhra Pradesh, Maharashtra, Gujarat and bad states earlier like Bihar. Bihar has turned around; Gujarat is doing well; Maharashtra is static in a way; Andhra has its own problems of unstable government and with the political issue of Telangana and AP, no new investment will happen and there are huge power issues there, as is with Tamil Nadu.

NDTV: Are you saying that you don't need even at a state level; if the governance is sorted out you will see growth?

PR RAMESH: If states have, even these good states which already have reasonable good infrastructure. if the political lack there is remedied, I think even with 10 good states we will still be able to do well.

NDTV: Is it also not worrying you that we are still so dependent on international capital and domestic savings aren't coming to productive use? It is something that needs correction, doesn't it, Sandeep?

SANDEEP A. NAIK: What do you mean by that?

NDTV: Money doesn't come to equity markets, it all gets funneled into real estate and it gets funneled into gold, which is an unproductive asset.

RAJAT M. NAG: Absolutely. But it doesn't come in because we don't have a very advanced or sophisticated capital market. Most of our financial market is still bank dominated. I think India is still working on local currency bond market, for example, we have to work on the capital market deeply, and most of the debt market actually doesn't quite exist or is not developed, which I think we will have to work at.

NDTV: What about the banking system? I mean in 2008, Sandeep mentioned that it was the robust banking system which was actually saw us through. This time around banks don't seem to be in that comfortable a position. I mean, NPAs are rising. There are no alarm bells being sounded, but there are more concerns today with the quality of assets that our banks carry.

PR RAMESH: True. Typically, banks mirror the state of the economy. If the economy is booming, banks do well; there is really no issue there. What you are seeing currently today is banks' exposure to certain sectors. Why we feel that our country is not doing well is because of the issues in telecom; because of our issues in mining; because of the issue in aviation. Now all of these three sectors are significantly funded by debt and banks are exposed to it. The fourth one is power. Because of all the coal issues related to Indonesia, banks have stopped funding coal projects. But they do have significant exposure already. Now, that is what is being reflected today in the banking sector. As a system, I would say, our banking system is very good; It has a conservative regulator; we don't have very aggressive banking; we don't allow products in the banking space to be marketed. The regulator too is very careful in avoiding two things - one is pro-cyclicality and the second is sectorial shocks in a way, where for example, if real estate sector is over heated, the regulator comes up with capital adequacy norms or risk weightage of assets.

NDTV: You think the Central Bank – RBI – is fairly vigilant and there will not be a shock. I think we are far away from that. We have got that piece extremely right and we have got it right as a country. Just have one last question here, Rajat. Yes intentions have been announced for reforms, but fiscal consolidation still remains a big question, and if that ain't happening, I don't think Subbarao is going to blink and bring the rates down in January. What do you think?

RAJAT M. NAG: The fiscal deficit is one issue but also the inflation. India has about 8.2 per cent inflation this year, and that may be moderating a bit to 7 next year. But it is still a major concern. So I think we have got to recognise that there are inflationary pressures which we have to deal with as well.

NDTV: Again that's a chicken and an egg situation. What do you do for the supply side situation? Subbarao is trying to dampen demand; he is trying to bring government to task and say cut down your fiscal expenditure, otherwise I am not going to cut down rates. But what do you want from them?

SANDEEP A. NAIK: I was sitting outside and not been a part of this. You can see two institutions really going at it, and I think I would probably be of the opinion that what the Central Bank is suggesting to the government is that - show us some more progress on fiscal consolidation, and once we show that we will start bringing down the interest rates. As an investor, I always look at the inflation-growth mix and that’s what gives us the investors the confidence to come in. The intentions are right by the government in some of the things like GST and DTC; they need parliamentary approvals; the question is will this really go through, given the coalition government that we have? If it does go through, you will see the central bank immediately responding to that and making sure that the interest rates come down, and then we will have investment cycle, which will fuel growth, and by 2014, we will see it back on the 7-7.5 per cent track, which would be great for everyone. But the key question is, are we going to be able to push through these parliamentary reforms in a way which bring the economy back in track?

NDTV: So, what are the bets on whether we are going to have a functioning winter session of the parliament, Ramesh?

PR RAMESH:  Human nature is to extrapolate the most recent, and if I extrapolate the most recent and look at what's happening, there are stones being thrown at the BJP and then the BJP throws stones at the Congress; I am not seeing that settlement happening in a way. So that'll now perhaps happen within the parliament and I am not too confident that it'll settle down. What would have helped settle down if there were no new issues coming up. So, media is playing a big role in bringing out things, which are actually causing this.

NDTV: I think we should black out television channels for a while.

RAJAT M. NAG: No, I won't do that.

NDTV: So, what is not very concerned about India's external shocks right now is internal domestic resilience, which we need to work on.

RAJAT M. NAG: It is a mix and I think there are some issues, which need parliamentary approval, but there are others, which can be done by executives and that is being done. I think it is a mix.

NDTV: I think that is moving ahead, and the FM has decided, he's going to go ahead. Alright, gentlemen thank you very much; a very interesting discussion. Of course, no easy answers to that. As we say, if you grow well, if you get stronger, then you have the ability to resist any shock and be far more resilient than ever before. Thank you.