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A Long and Dark Journey

Our countryís economy is being run aground, and thereís little serious effort to revive it


Letís use a medical analogy for what is happening to our countryís economy. The global financial crisis of 2008 was like an infectious disease that spread rapidly. India was hit too, but we probably had better immunity than many others. On the other hand, Indiaís current economic crisis is like a cancer. Treatment is possible but itís difficult and expensive and has a lot of harmful side effects. But the biggest problem is the doctor himself seems disinterested in the cancer. Instead, he and his assistants seem intent on fighting other incidental symptoms with treatments that will actually make the cancer worse.

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So what happens now? One thing is now clear, things are going to get a lot worse before they get better. Over the last few weeks, the focus has been on the decline of the rupee. The cover story of Wealth Insight's latest issue too identifies a handful of companies that are likely to benefit from the fall of the rupee. You could also identify a (much larger) set of businesses that will be severely harmed by the fall of the rupee. As a tactical approach, thatís fine and as stock investors, thereís no harm in taking such a course.

However, the decline of the rupee is merely one symptom of the underlying disease. The core problems are that on one hand, the governmentís expenditure is out of control and on the other, we are less and less competitive in the world. Thereís a cascade of causes and effects that are interconnected in a web in which we are trapped. Excess government expenditure means huge borrowings. Government borrowing crowds out industry. Massive consumption expenditure by the government drives up inflation. Poor infrastructure and labour quality constraint supply and therefore make inflation out of control. High domestic inflation means that to remain competitive, the rupee must fall.

Exports are constrained by poor productivity and competitive pricing so they donít see an increase despite falling rupee. Imports stay high despite falling rupee because the government doesnít allow pricing signal to pass through to petro-product consumers.

The net result is that the CAD is high and needs massive foreign investments to finance it. These investments are increasingly rare because few foreigners seem to think that India is a good place to invest in any more. In this financial year, India needs at least $25 billion of inflows to finance the gap. In the first quarter, the inflow was matched by the outflow, meaning it was zero. If the inflows donít come, we could be looking at a financial emergency within months. Either the RBI will have to expend a large part of the forex reserves to defend the rupee, or the rupee will fall more. Possibly, a lot more.

How can this be reversed? The steps are simple -- control government expenditure, make the conditions welcome for foreign investors and improve infrastructure. Unfortunately, as someone once said, simple doesnít mean easy. This government has done the exact opposite for nine years and thereís every indication that it will continue to do so. A few days ago, there was yet another Ďbig bang of reformsí with the announcement of higher FDI limits in a whole lot of sectors. And yet, the outcome of previous big bangs -- like multi-brand retail -- are still zero. In the last few days, POSCO and ArcelorMittal have announced suspension of plans to build major steel plants and thereís news that Walmart is having serious second thoughts on India.

The relaxation of FDI limits is based on the notion that low limits are what is holding back investors. This is a fantasy. Poor infrastructure, corruption, red tape and a hostile regulatory and tax environment are the actual problems. If ownership limits were the issue then we wouldnít have seen so many Indian business houses so interested in investing abroad.

Iím sorry for taking such a pessimistic view, but there are only a few silver linings and things will get worse before they get better.



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