There is a treasure chest Modi government can unlock and use for investment: Foreign reserves

Clearly, the Indian economy is not at a place where it wants to be. Despite the PM’s brave show of defence of his economic policies at the Institute of Company Secretaries of India on Wednesday, the Narendra Modi government finds itself in a chakravyuh that it is unable to fight its way out of. The government is just not being able to attract or make the investments needed to make the economy buoyant again.

India enjoyed a decade of unprecedented growth during 2004-14 that seemed to have lost steam over the last year. The slide was largely caused by a huge decline in the proportion of capital investment expenditure. Despite the growth of the private and foreign investment, the Indian economy is still largely dependent on government investment. The prime minister had made a promise that he was going to set this trend right and once again begin a new cycle with government-led investment.

He promised the country a hundred new cities, a nationwide grid of high-speed rail networks, a national river-linking programme and so many other major nationally transformational projects.

A hundred new cities have now become a hundred ‘smart cities’, which means little more than more free Wi-Fi networks. The nationwide fast trains grid has now become an exorbitant and apparently uneconomical single bullet train joining Ahmedabad and Mumbai. Similarly, all other feasible and exciting promises made are now mere caricatures of what were promised.

The Modi government has simply been unable to free the economy from its high subsidy burden and public sector utilities black hole, where the oil and power companies alone earn aprofit due to administered pricing. Consequently, the picture continues to be bleak. Output of capital goods contracted 1 per cent in July against growth of 8.8 per cent a year ago. Production of consumer durable goods shrank 1.3 per cent against a nominal increase of 0.2 per cent a year earlier.

Then came the twin black swan events: demonetisation and the hasty implementation of the goods and services tax (GST).

Demonetisation came as a body blow to the cash-dependent unorganised sector that makes up 40 per cent of India’s GDP. The unorganised sector also accounts for 90 per cent of employment of around 450 million.

Job Loss
The loss of jobs due to demonetisation and the hasty implementation of GST is still not empirically confirmed. Estimates vary. The construction and vegetable and fruit retail sectors took a massive hit and the ballpark estimation of the loss of jobs is at about 25-30 million. These sectors mostly employ rural landless labour with few skills and, hence, they were forced into taking up daily wage and earnings sustenance.

The implementation of GST forced companies to reduce production in the run-up to its July 1 implementation, as dealers reduced inventory. The inadequate training and preparation was abundantly evident. The announcement of rates was hasty and the many mismatches between input and output rates compounded the confusion.

In a belated effort to reverse these trends, the government is planning to loosen its fiscal deficit target of 3.2 per cent of GDP to enable it to spend up to Rs 50,000 crore. This is a piddly sum for an economy whose GDP is over Rs 150 lakh crore now.

Right now, India has a net outflow of foreign investment. What it needs is a huge dollop of cash infusion to boost investment. Loosening fiscal deficit norms will help. But meaningfully slashing subsidies when Modi’s term is on the slope to elections is not politically feasible.

There is that old saying that when the going gets tough, the tough get going. Modi should now show toughness and imagination that is tempered with realism. He needs to revive the national mood and generate optimism over the economy. 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 reserves of nearly $400 billion, with about $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 the reserves to cover short-term hot money of NRI investors, each taking a pound of flesh for mostly foreign bank-financed investment in their ‘mother country’, India will still have $300 billion in hand.

How much money can be freed from the other $300 billion for investment is the big question now. Economist Kaushik Basu has said that India’s foreign reserves need not be more than the current account deficit of about $80 billion. Others are more cautious.

Infrastructure Fund Clearly, freeing up $100-120 billion (Rs 6.5-8 lakh crore) can be contemplated. The government could establish an India Infrastructure Investment Fund and start shifting meaningful fractions from the foreign reserves into this fund. A board of well-regarded experts, who can allocate investments on merits to prevent the usual leakages and political misuse, could administer the fund. The fund must also mandate the minimum level of local procurement and investment to boost ‘Make in India’.

Slow growth and no new jobs are Narendra Modi’s twin Achilles heels. He is vulnerable on both counts. He must seize the moment with both hands and start running with both legs.