Lars Joar Hognestad, India områdestudier, IKOS, UiO
The Economic and Political Weekly recently released a special report on the struggling manufacturing industry in India (Bhattacharjee, Chakrabarti). This topic has been in debate since the liberation of India and it is much suspected that it will continue to be a debate until the day India has the largest manufacturing economy in the world. In short progress has been slow, much slower than expected.
As EPW write in their special report the modern roots of these problems are often accounted to the failed policies of the 1970’s and its socialist policies and then further to the slow liberalisation of the economy towards 1991 and its continuation, but this as they point out is not enough to explain why the rate of growth has been so modest. They identify four factors which other economic authorities have pointed out as limiting factors of the Indian economy.
- Inadequate development of physical infrastructure
- Labour market rigidities
- Ignorance of demand factors
- Credit constraints
#4 is perhaps the most discussed alternative for a scapegoat in India at the moment. It is a particularly enticing idea as it seems to be a problem which is easily solved by a willing government at minimal cost. All a government would have to do is perform changes to the credit market according to economic pundits and the will of opposing parties and it would all be fixed. The reality of this of course is not as simple as the opposition believes it to be or leads the public to believe they believe it to be. EPW as others find that it must be the instruments of credit which are at fault and are preventing Indian manufacturing from dominating the globe.
EPW’s article reflects opinions of a frustrated and impatient nature which is found among economists in India that liberalisation has not been effective enough for the Indian economy and that the problems which are faced are not merely short run problems due to a lack of familiarisation with the liberal market system in India but that the instruments found in India today are not effective enough to solve the problem.
They do a comparative study of the rationale vs the reality of liberalisation and without using any examples from India they are able to pick their examples of economies who were unsuccessful at liberalisation. However some of their examples fail to recognize the later success of those countries while quoting articles from the 1990’s as a reference. Taking their point of reference when it comes to these examples and you would have to go back to a time where business computers were more common than home computers. Mexico is clearly a successful newly industrialised country today and functioning quite well economically. Though they have a decent point that internal national factors must be considered when looking at the prospective results of liberalisation they fail to do so convincingly with their examples.
When analysing the relationship between external sources of funds and investments EPW treat the time period from 1991 until today as their should be a linear relationship between liberalisation and usage of external sources of funds in a private limited company. When they find that there has been a decrease in usage of external sources of funds they investigate no further into why this is but conclude that liberalisation as a mechanism for obtaining increased external funding thus far in India has failed. In their own analysis it would seem they find that the dismantling of the DFI are the cause of this increase in the cost of credit.This would be the wrong conclusion and surely the do not mean it so. Clearly since the dismantlement of the DFI’s more companies have been established and the pressure for credit has increased many fold. Moreover they focus on how the domestic credit market is risk averse and the Indian population savings oriented. “..the Indian manufacturing sector that was mainly credit-centric in the earlier years experienced a signiﬁcant decline in the availability of loanable funds in the post-liberalisation period mainly due to the risk averse behaviour of the banking sector and the gradual withdrawal of the DFIs. Moreover, increased risk aversion of the saving class and the highly skewed transaction of the equity market failed to reduce the cost of equity capital. The combined effect was a rise in the external ﬁnance premium that made ﬁrms face severe ﬁnancing constraints in the post-liberalisation period.”
Their concluding observations are refreshing comparatively to the rest of the article which at times seems as if it wishes India could go back to a pre-1991 world, and I do believe it was necessary for them to underline that this is not what they wished to achieve.
They recommend further creation of Derivative Instruments better known for regular people as hedge funds which spread the risk of credit. Further they want to further develop and strengthen the corporate debt market hoping to shift its investment base away from banks and insurance companies and into more inclusive corporate investment base. Their key to failed liberalisation is more liberalisation suggesting further access to India from foreign investors and capital. They suggest a build up of the mutual funds industry in India as means of relieving the Indian credit crunch in the Indian manufacturing industry. As a final recommendation they suggest an improvement of corporate governance and accounting standards and a further opening of markets to foreign direct investment.
So what does this mean and should we believe that this might work for India?
Many public figures blamed hedge funds for the 2007 financial crisis due to hedge funds ability to mask the risk in an investment as one hedges several credit projects into one bond. Hedge funds might still need a while before the general public feels ready to trust them entirely and so as a mechanism for increasing the access to credit in the short run it might be ineffective. However its a great prospect for the long run in India. Changing the corporate make up of the bond market might require restructuring the tax laws of the Indian stock and bond market. Such an act might upset large populations of voters in India and would seem fairly greedy by the middle and upper middle class but such a restructuring would be beneficial for Indian credit market. A mutual funds industry would be a good idea, but as hedge funds they seem scary to many people as it is hard to know exactly what you are buying and the more such products become available to more difficult making a decision on which to invest becomes and the risk avert population might just end up saving their money anyway.
Better corporate governance is something which hard to control and difficult to balance out with the right amount of freedom so that minor entrepreneurs are able to enter the market which is the same for accounting standards. But clearly accounting standards and governance for medium and larger companies must improve in order to be able to attract FDI. Opening their markets for FDI is risky for a country which has been outside of the global markets for as long as India and they must make sure that they keep their currency in check. But as the new retail law on FDI allowing 51% FDI on retailers was approved in December of 2012, India is well on its way towards a more liberal approach towards foreign capital.