Safeguarding India’s growth prospects: A macrofinance perspective

India might still be bustling, but without fresh thinking its economy is at risk of grinding to a halt
The business-friendly results of India’s election earlier this year were clearly a mandate for economic-growth, offering a renewed opportunity for the world’s largest democracy to propel itself into the top league of the world’s leading economies.

It augurs well that the initial coordinated framework to drive infrastructure investment and projects is being aggressively put in place by the new government. The recent budget took the first tentative steps in this regard, with the liberalization of foreign direct investment in infrastructure and defence production, though it stopped short of a far reaching system revamp.

The budget is the beginning of a long list of initiatives aimed at rebooting GDP growth.

Looking at what support the financial sector might offer, we suggest here three additional measures and practices that would act as multipliers to these initiatives and strengthen India’s economic revival. The potential results of these measures would be an organic boost to GDP from reduced costs of borrowing for corporate India, as much as for the government, propelling investment and helping to drive further growth.

Measure I:  Controlling Cost-Push Inflation

rupees280The RBI has been forced to raise interest rates to try to dampening a spike in inflationIndia’s recent spike in inflation has been and continues to be cost-push, driven by galloping domestic food, soaring global energy prices, and accelerated by chronically deficient supply chain and distribution systems and an overburdened infrastructure.

The central bank, the RBI, has been forced to respond for the past few years by raising interest rates, in contrast to most of the world – clearly a demand-pull measure, and the only policy alternative that it has in its disposal.

Instruments of monetary policy, which consist only of a handful of measures, cannot be expected to be effective in managing this sort of inflation. It is hence unrealistic to expect the bank, as it has done in the past, to exclusively shoulder the burden of inflation management.

In order to support the RBI on the supply side, we suggest the commissioning and execution of an institutional mechanism to aggressively manage resource prices without resorting to price controls.

Even though India itself has commodity exchanges and developed futures and forwards markets, as an entity it is routinely exposed to oil, gas, agriculture, and currency spot price volatilities.

A remedy for this is to create a dedicated financial institution for national resource purchasing, operating in a strategic and cost effective fashion in the derivatives markets.

The principal result would see commodity and currency prices hedged by producers, suppliers, buyers and the liquidity providers, and positions managed effectively, in order to keep a tight rein on India’s national-level energy and transactional currency exposure.

To facilitate this, an India Special Purpose Vehicle (I-SPV) could be set up. Such a body should be well-capitalized and AAA-rated (for funding cost minimization), with an exclusive mandate to conduct consolidated and coordinated global derivatives trading, clearing and risk management.

ThinkAloud4Given that the talent and resources for world-class derivatives trading and risk management talent and resources are readily available in India, this could be accomplished quickly.

Secondly, the main inflationary pressure comes from domestic retail prices of food items.  This is significant as the producer prices of these items have not jumped as much, but rather the issue is with increases systematically occurring further up the supply chain, in spite of all the recent efforts and advancements in agricultural storage and marketization in India.

In the absence of fully exchange-traded valuing of agricultural goods, in the short run physical markets will have to be relied upon, which in turn are supply-chain sensitive.

Speeding up the supply chain helps remedy dislocations in supply and demand, which leads to equilibrium pricing.   Accordingly, we recommend discontinuities in the farm-to-fork supply chain in agricultural products be subjected to ongoing audits in the same vein as are used in the financial services industry.

This auditing process, already well-established in India’s financial services sector, would not only highlight planning deficiencies on an ongoing basis, but would also enable the enforcement of project execution, an area that India could well utilise.

Measure II:  Obtaining Best Financing for the Trillion Dollar Infrastructure Upgrade

delhi-streetMuch of the country’s infrastructure is in dire need of upgradingInfrastructure expansion is where the greatest opportunity and the greatest potential exposure lie.

The government has said it expects to spend upwards of $1 trillion on infrastructure upgrading in the next five years, but that figure is simply the aggregate notional value of the projects. The “carry” or interest costs added on to this could be extremely significant.

Additionally, if we were to factor in currency exposure, the resultant risk could be massive. So what can be done to minimise this exposure?

Infrastructure projects are top-priority national assets.  For proper asset creation, simple transfer payments and independent multicurrency loans will prove to be expensive and intractable, especially given the mega projects that are envisaged.

Instead, we suggest that each set of similar infrastructure projects, be financed by a proper pool of dedicated loans, bonds and structures (or liabilities) on the best terms.

This is possible only if the private and public funds flow into another well-capitalized and AAA-rated set of infrastructure I-SPVs. Each entity would then run a number of infrastructure projects, which would be highly-related, both on the asset and liability side.

A cost-effective way to execute this would be to engage a portfolio of private equity firms, global reinsurers, sovereign wealth funds, pension plans and other long-term institutional investors to underwrite these dedicated I-SPVs.

At each stage, financing efficiencies via spread benefits across related I-SPVs would be realized, and material interest cost savings would accrue at the aggregate level.

Measure III:  Controlling India’s Sovereign Credit Rating

It is important to note that, with the exception of dedicated and separately-rated I-SPVs, all financing costs to India will revert to a spread over its sovereign credit rating.

That rating is a passive grade assigned to a country based on a range of indicators selected by the ratings agencies themselves – such as the current account deficit level – which in turn are driven by other components.  In short, a country’s credit rating is a macroeconomic assessment by the ratings agencies of a country’s ability to repay its debts on time.

In the wake of the Global Financial Crisis, ratings agencies cannot be opaque about their risk assessment methodologies.

India, as a consequence, has an opportunity to work with the ratings agencies to minutely understand their scoring approach, and execute the appropriate actions to optimize its own ratings score.

We note that discussions have been conducted at both the Ministry of Finance and the RBI previously, and both the recognition of and a knowledge base on this matter already exists at the official level in India.

Leveraging on this, a task force should be re-commissioned to actively work on improving India’s credit rating.

Best practices

Given the pace of expansion that is expected, the most significant parameter that will drive future performance of the Indian economy is the cost of capital. In this context, priority measures and the roadmaps to achieve them have been suggested above.

metro280New infrastructure facilities like the Delhi metro are needed across the countryThese measures would help reduce economic growth risks, yet manage consumer prices better. They could also manage capital costs in the planned massive infrastructure expansion, and lower the country risk premium for India and hence lower the borrowing costs for both the government and India Inc.

In all cases, the talent and commitment needed for the execution of these measures abounds in India.

But there are other essential steps to be taken. India must also strive to move up the “Best Places in the World to do Business” rankings.

It currently languishes at 134 – versus China’s 16 – in the IFC/World Bank’s “Ease of Doing Business” tables.

While the rule of law has to be always upheld and enforced uniformly, it is ironic how on the prosecutorial side, Indian business leaders get hauled before the courts for the smallest infractions. This at the same time as, according to a recent analysis by India’s Association for Democratic Reforms, the country’s new parliament includes 186 of its 543 lawmakers (about 34 percent) facing criminal cases.

In addition to the initiatives that are already being put in place by the new government, the above suggested best practices and prudent application of the rule of law could significantly propel the growth and infrastructure components in India’s exciting and unfolding development story.

The rest of the world, meanwhile, is watching with bated breath.

Ranjan Chakravarty is a Research Fellow at the Centre for Asset Management Research and Investments (CAMRI) at NUS Business School and the former Chief Risk Officer at Singapore Mercantile Exchange (SMX), now known as ICE Futures Singapore. Joseph Cherian is Professor at the school and Director of CAMRI.

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