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Thinking India can induce enough private investment just because of the size of its market is a big mistake.

The Economic Survey, which is by tradition presented the day before the Union Budget, is frequently more forward-looking and economically sensible than the actual Budget. Naturally: The former is written by economists and the latter by bureaucrats, even if both want to please the same politicians. There’s also the small matter of the Budget having to live in the real world, while Surveys can live — as many economists do — in the world of the ideal.

Even so, the differences between this Budget and the Survey in their broad approach are startling. And worrying, because they throw into sharp relief the false assumptions that have taken hold within the corridors of power in New Delhi. Both the Survey and the Budget sought to revive investment as a major immediate priority. But the big divergence is in terms of strategy: The Survey correctly argued that exports growth is indispensable to any approach that puts investment first.

Investment can best be fed by a secular increase in the share of savings in the economy. But that leads to a conflict: Private sector investment will not take off without the promise of demand, and increasing savings conflicts with the aim of increasing consumption demand domestically. Here’s what the Survey says: “With the share of consumption in GDP constrained by the high level of savings, domestic consumption can, at best, act as a force-multiplier when high income growth feeds consumption. So, where would the final demand for the large capacities created by high investment come from? The answer is exports. This is why an aggressive export strategy must be a part of any investment-driven growth model.”

This analysis cannot be faulted. In fact, it broadly fits with the experience of almost every major economy that has successfully graduated to upper-middle-income status or beyond. India’s recent economic history demonstrates the difficulties of reviving investment when domestic consumption demand is the only justification for new investment. Even a consumption boom — driven in part by low fuel prices — has not solved the over-capacity problem faced by much of the private sector, which in turn has retarded investment growth. Exports were static in real terms since 2014, and growth recently has been halting, tentative, and easily reversed. As a consequence, sustainable growth has remained elusive. It will remain so as long as we seek a consumption-driven growth strategy.

The Budget has taken a different approach from the Survey. It has certainly attempted to fix the supply side when it comes to investment — for example, it includes measures intended to reduce the appropriation of household savings by the government for its own revenue expenditure. But there is no change in strategy on the demand side. India is to remain focused on creating and protecting domestic demand as an inducement for investors. This is an error of historic magnitude.

What would draw investment to India? The possibility that it is a good place to produce not just for a not-yet-mature domestic market, but also for the world. Global supply chains are in flux, thanks to tensions between the United States and the People’s Republic of China, and India currently has less than two per cent of world trade: This is the moment to cash in. Even if the world trade is growing slowly, a labour-surplus country with such a small proportion of world trade compared to its population and resources should be easily able to grow its exports by cutting into the share of other economies — notably China’s.

Yet, if such investment is to take off, it needs a stable policy environment and a sense that it can effectively be part of global supply chains. From the current government’s point of view, the main constraint was India’s problematic infrastructure. This is only partially correct. As the Survey also argues, policy stability is equally important. And so is competitiveness. How does the Budget address these two constraints?

It does not address them at all. It continues to hand out step-motherly treatment to large companies, which are excluded from the 25 per cent base rate of corporate income tax. These are the companies that are most competitive, productive, and which create the world-class jobs we need. If we need large-scale job creation, we need large-scale investment from the largest companies. A disproportionately high rate of tax targeted at precisely these companies renders locating in India for exports uncompetitive. What would help is labour law reform — as the Survey points out, it has helped states such as Rajasthan. But although the Budget mentions once again the rationalisation of labour law into four codes, a commitment to flexible labour markets at the national level continues to be elusive.

When it comes to policy certainty, the Budget makes things worse. In global supply chains, tariff stability is crucial — you don’t want to invest somewhere which has the reputation of fiddling around with tariffs that might at any moment make it difficult for you to manage your margins or to meet your deadlines. A simple, competitive rate of taxation and tariffing is what is needed. But this Budget continues the trend, visible in previous Budgets under the Modi government, of arbitrary changes to import duties. Worse, it specifies that the purpose of these changes is the protection of the domestic market. As a signal to greenfield investors, this could not be worse. It is clear that India is interested only in its own consumers, and not in producing for the world. This fits into an entire set of recent policies, which target foreign investors across the board — whether in e-commerce, like Amazon, or in payments, like the credit card majors. Given this aggressive and protectionist attitude, it is odd that the Budget speech also included an invitation to “global companies through transparent competitive bidding to set up mega-manufacturing plants in sunrise and advanced technology areas”. The wording is puzzling in the extreme. Bidding over which asset? Over subsidies? Free land? This is typical. First make the economy so uncompetitive that nobody wants to come without inducements. Then come up with inducements, so that power rests with politicians and bureaucrats.

India needs an investment revival not just in the short term but in the long term. It needs to render its over-capacity problem irrelevant. For that, it needs to look beyond its own shores. Don’t be blinded by the number of our consumers —that is an illusion, because each consumer is also someone who needs employment. A big country trying to develop has the same constraints as a small country: Its own demand is rarely enough to induce the private investment needed. Just like anywhere else, India needs to export. The economists, and the Survey, remember that. The politicians, and the Budget, don’t seem to care.

This commentary originally appeared in Business Standard.

Mihir Swarup Sharma (ORF)
12 July 2019

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