Opinion » Lead

Updated: April 1, 2013 01:23 IST

Outsourcing investment & other follies

Pulapre Balakrishnan
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Dependence on a private sector-led boom in infrastructure and foreign finance to offset the balance of payments deficit is not sound policy

P. Chidambaram has upped the ante by referring to the “laws of economics” implying that they cannot be bucked and suggesting that his own actions reflect an awareness of them. Space now unfolds for a serious discourse on the current stance of economic policy of which he is the sole architect. Of his announced strategy for the economy, two elements deserve our attention — the one for raising the investment rate and that for financing India’s soaring deficit in the balance of payments.

Financial incentives

Let us for a start agree with the Finance Minister that the solution to the flagging economic growth is to raise the investment rate. It has, after all, fallen from its peak in the year 2007-08, the last time a 9 per cent growth rate had been recorded. The Minister is also right in identifying infrastructure as the segment where the increased investment most ought to occur. Infrastructural investment increases the supply of producer services essential to economic activity, raises aggregate demand and creates employment across the economy. It would appear then that it is not in his objective but in the means that he has adopted that such follies as may be found must lie. Principal among them is that he has provided for only the slightest increase in public capital formation in his budget, having explicitly assumed that the necessary increase in investment will come from the private sector. To precipitate private investment, he has announced a slew of measures that are financial incentives. Among these, the most important is the encouragement of debt funds by allowing tax-free bonds up to Rs. 50, 000 crore. It must be agreed that this is a substantial figure for exemption. However, while financing is an issue, the measure itself is unlikely to be a big draw at the present moment.

A trick appears to have been missed in the strategy in that when private investors are skittish, tax breaks per se are unlikely to make the difference as much as the government wading in to invest. Then there is what economists refer to as ‘the accelerator’ to be reckoned with. In an environment of slowing growth, private investment slows as firms see no incentive to add to capacity. When the growth of aggregate demand thus slackens it slows output growth in turn, and a vicious cycle sets in. Something of this kind is playing out in India currently. The right medicine for a languid economy was identified over 75 years ago by J.M. Keynes. Autonomous, in our case public, investment must be stepped up when private investment sags. Instead in India since 2008-09, when it had peaked, public investment as a share of GDP has steadily declined. Predictably, growth has slowed in tandem. However, it is not known widely enough that not even private corporate investment has declined as much as the public. In fact, for the private sector as a whole, investment has marginally risen even as growth has slowed. These data may be read in the first chapter of the government’s own Economic Survey. While it may sound harsh to state that the government precipitated the current slowdown in growth, we would be quite right in querying its investment strategy in the midst of such a slowing.

The Finance Minister gambles on a private sector-led boom in infrastructure. Looking at the world around us, something economists no longer do enough of, we would find this questionable as a strategy. Here two examples should be instructive. In the winter of 1999, the Los Angeles County Museum held an exhibition titled ‘Made in California’. As Californians are conscious of the importance of the economy to their lives, the exhibition had featured the major economic developments in the State. Of these, after the Gold Rush was mentioned the great transformation of agriculture and, finally, the impact on its economy of the construction of the Federal Highway system. While the last was on, close to a million dollars are said to have been spent in a day in the State, and this was done entirely by the federal government of the United States. So, in the land of private enterprise the highway was funded by the government and not by Wells Fargo. British private capital had of course played a role in the building of the Indian Railways in the 19th century. But it is a reflection of the inextricable involvement of government, especially in the form of financial guarantees, that a separate Railway Budget was presented every year by the colonial Government of India. The point of all this is to show that public funding is likely to remain crucial to building Indian infrastructure for some time to come.

Decline in public saving

But public saving has virtually collapsed in India since 2007-08 when the growth rate peaked. The figures are revealing. What had been 5 per cent of GDP in that year was down to 1.3 per cent in 2011-12. Once again, private saving has not declined by anything on a similar scale. In a situation when both the public debt and the fiscal deficit are high, as they are in India, the government has no avenue but its own saving if it wants to invest. The strongest economies of the world, notably those in Scandinavia and in the Far East, have maintained a high rate of public saving.

The U.S. may have neither high private saving nor public. But then its infrastructural deficit is somewhat less than India’s, and in any case it has monopoly over the world’s reserve currency with which its government can purchase what it likes.

Some part of the decline in public savings in India must be traced to the relatively recent upsurge in social sector spending. While some social spending, such as on health and education, has a positive long-term impact on growth and thus public revenues, when social spending begins to eat into what is available for investment it can lower the growth rate of an economy. As mentioned already, certain forms of capital crucial for growth are more likely to come from the public sector, and hence must be financed by public saving. We cannot rely on the private sector here, as the Finance Minister suggests we can. At the same time, while still on matter of investment, we must not lose sight of the efficiency of the spending. This is apparent when we recognise that some of the years of high growth during 2003-08 were years which had witnessed a lower investment rate than what it is today. Clearly, the productivity of the investment has declined. This is not unrelated to what has been flagged as the government’s pre-occupation with social programmes. The enfeebling impact of this can also work independent of funding. A government that sees its task mainly as the handing-out of welfare cheques can lose sight of its ultimate responsibility in a democracy, which is to maintain the public infrastructure and create the public goods vital to growth and well-being, respectively. The latter only the government can do and there are only 24 hours in a day to do it. So they who chant “policy paralysis” have got it wrong. The truth is that we have a “governance paralysis,” only that the domain of governance must be understood to extend beyond law and order to the governance of public infrastructure. So, before we fix our sights on ‘mag-lev’ trains we may want to reflect on what it is costing us in terms of income generation in not having an efficient waste disposal system in our cities. Think of the number of economic proposals that are left unrealised due not to the absence of finance but an industrial waste disposal facility.

The second issue that the Finance Minister has spoken about of late is his intention of attracting foreign direct investment (FDI) to finance the deficit in the balance of payments. He is indeed right to draw our attention to the disturbingly large deficit we now face, but it is questionable whether financing it via FDI inflows is the right approach. While they may not be debt-creating, to assume that they constitute no draught on an economy’s foreign exchange reserves is plain wrong. Only, this emerges in the future, when profits are ripe for repatriation. And, depending upon the volume of profits to be transferred overseas, the final requirement of foreign exchange could even be larger than the original inflow. So, by relying on FDI for our foreign exchange needs we only postpone the imperative of earning the foreign exchange to pay for our spending. We need to learn to cut through the thicket and treat the problem at source. For India, there is no alternative to becoming more competitive. Two decades from 1991, we can see that macroeconomic policy has a limited role here. Governance is all, and it cannot be outsourced.

(The author may be reached at

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I sincerely hope that our Finance Minister reads this article. F.M
tried to come out of the crisis using private sector investment but
the matter of the fact is private sector investment won't serve the
purpose completely. In the current alarming situation when the
government is facing all sorts of deficits, govt needs to invest more
in infrastructure when it doesn't have required money to invest. Only
way of coming out of this to increase public savings. Public savings
can be increased in two ways: 1) increase the interest rate on bonds
which will not eventually serve the purpose 2) Give tax reliefs and
incentives so that people can invest more in the government. Ohh
yeah!! another way to come out the situation is go after the black
money stashed by Indians in foreign countries but who does have the
guts to do this by going against the likes of almost all the
politicans?? Sadly, Answer to the question is none :(

from:  ranjithp
Posted on: Apr 2, 2013 at 00:14 IST

FDI is a powerful tool of exploitaion by western nations as it is also a financial product to make black money of Indians white money without paying taxes. The first one happens because of artificially distorted exchange rate. A dollar is Rs.54 officially, but as per purchasing power parity a dollar is Rs. 19. When a foreign company brings $ 1000, officially he gets assets worth Rs. 54000/- , but actually the company brought to India only Rs.19000/- as per purchasing power parity exchange rate. So the company made Rs.35000/- profit on the day the money was invested in India; Indians lost Rs.35000/- on getting dollar worth Rs.19000/-. Over and above this the foreign company got entry to market and perpetual profit opportunity.The PPP exchange rate is provided by United Nations, CIA website and many other international organizations. The second point for black money, it is obvious and acknowledged by the previous FM in the white paper on black money. Investment from aborad is a loose-

from:  Srivastava
Posted on: Apr 1, 2013 at 22:41 IST

The ultimate test for me is how far it helps our nation and its people. I would like to make two points to advance my view. One is a valuable book of western research captioned “Greening Aid”. It is the result of the study of around 4 lakh projects in over 30 countries in various continents between the period 1970-2000. It came to this conclusion: put in simple terms these are: good, bad, neutral and positively bad. This approach appealed to me the most. Now consider a case in our country. Several years after the Bhopal gas tragedy, our government gave a project to a foreign company. The proposed activity of that foreign company was to research in poisonous chemicals and gases. Govt, was hurrying it through even giving police protection so that it could be completed quickly. The farmers agitated and the project was dropped. The company was none other than Dow Chemicals which took over Union Carbide’s assets minus its liabilities. Now, you can judge for yourself what should be our norms

from:  s subramanyan
Posted on: Apr 1, 2013 at 20:21 IST

Good articulation, perhaps, author has deliberately chosen the Keynes
name to stress the importance of demand, supply, pricing and
employment equilibrium to offset the economic growth. However, at
present India is aberrant from what Keynes had the mode pf government
in mind. PC and Manmohan Singh, both have proven their mantel as
Keynesian. The fact is India is ruled by a coalition government,
which has paralyzed the governance model. Public spending should
always be the most preferred choice of government spending, I agree,
but we should not ignore the harsh realities of red tap-ism,
corruption and regional conflicts widely prevalent across India.
Democracy in India says government is by the people, for and of the
people, but citizens of India have boldly forgotten the of the people
clause. We do not respect any public property or spending until it
does not carry a private brand name. In India, we elevate individuals
and forget the cause.

from:  Himanshu Sanguri
Posted on: Apr 1, 2013 at 20:06 IST

It is the Responsibility of the Government-State and Centre- to
provide Infrastructure for when collect various Taxes from Public.
They cannot outsource this to Private Sector.The growth of the Pvt.Sector showed the alarming rise in prices and this growth at
any cost has resulted in unpecedented corruption in all areas and the common man faces the brunt of it.The Govt.has to stress its
responsibility to the people and by taking up the massive requirements needed for India to become REAL POWER-the employment potential also go by leaps.UPA has been guilty in this aspect of

from:  ajith kumar
Posted on: Apr 1, 2013 at 18:24 IST

Mr.Chidambaram refused to acknowledge what every economist knows. FDI is short-term loan, with unpredictable repayment schedule. Long term foreign debt is dependable. If our economy is to improve, we should stop dumping by China.

from:  seetharaman
Posted on: Apr 1, 2013 at 17:42 IST

to put the article in a nutshell: the author is undoubetdly a proponent
of keynesian economy and has little faith in the private sector during
the time of slump.

from:  sushant
Posted on: Apr 1, 2013 at 17:11 IST

Interesting article.The "Governance paralysis" should be an eye opener to ardent advocates of the Budget

from:  Abhilash S
Posted on: Apr 1, 2013 at 13:53 IST

When we seek investment in business it is to serve multipurposes like
1.Standard products produced in the country in large numbers for our
people.2.Export when we produce in excess which slowly returns to
India the cost of investment.3.Employment of our people in skilled
trades which gives them further opportunities.4.Recycling of earned
and hoarded money to give livelihood to others.5.Revenue from the same
source which would otherwise be difficult to achieve.6.Satisfaction
among he people that they are also contemporary and technologically
savvy and advanced.7.It also gives the other country an opportunity
to share technology,sell it to politically sensitive countries and use
the second country to achieve monetary success.Actually even the
Shinkansen would have been good to achieve and the Japanese and India
could have sold it to a whole lot of countries and the cost could
have been balanced and hence it would never have been expensive but we
could have had better economic success.

from:  Prof.Paul.V.John
Posted on: Apr 1, 2013 at 11:50 IST

Pray, how did we achieve 8-9% growth? For that matter how did China
achieve it's stupendous growth?

from:  samvadi
Posted on: Apr 1, 2013 at 11:22 IST

Most Indian private sector entrepreneurs are short in own financial capability and payback time horizon, neither suited for infrastructure investment. Unless of course, there is a monopoly right involved and a secure system in place to get price increases through. Without a question, private sector won't be able to build major new rail or road or power transmission and distribution systems. India has to step up its own saving rate, it is as simple as that. Not just the public sector, but also the private savings rate has to go up. This is turn means raising the tax to GDP ration, denial of consumption and cutting back on government's wasteful expenditure. Indian industry and politics will support none of this. India will fail to grow consistently and equitably over a time frame long enough to remove poverty and reduce disparity.

from:  P. Datta
Posted on: Apr 1, 2013 at 10:55 IST

Private sector will only invest when they can earn some profit in that
avenue. Infrastructure has a long gestation period, thus attracting
private investment is an difficult task. The FM dependence on FDI and
Private investment shows inability of the government to break the
vicious circle of low growth. FM desperately need to take some strong
steps to control CAD and Fiscal Deficit.

from:  Akshay Dhadda
Posted on: Apr 1, 2013 at 09:58 IST

excellent; precise and thoughtful piece. thanks!

from:  G Arunima
Posted on: Apr 1, 2013 at 08:38 IST

I am not an economist, but I strongly feel that this opinion is somewhat questionable. While it is true that attracting FDI to improve the balance of payments now is by itself a negative outflow at the time of pay off, this is only true if the investment is not wisely used. If the inflow of FDI results in job creation and helps to prop up the economy, it probably is a wise approach to attract FDI inflow. China has demonstrated convincingly the value of FDI inflow. India can do the same with dynamism.

from:  Nathan
Posted on: Apr 1, 2013 at 07:31 IST

If indeed there are "laws of economics" these are results of
unquestioned assumptions simple looking models and to many impressive
appeal to mathematics but rarely confirmed by data and received
without reservations by warring ideologues. Little in real life is
without risk but more often than not commonsense, intuition as opposed
to and "the follies" questioned in the Lead Opinion is wiser and less
risky than confident reliance on the so called "Laws". The risks of
dependence mainly on the FDI are well demonstrated in the experience
of the South East Asian Tigers

from:  Govind Mudholkar
Posted on: Apr 1, 2013 at 03:21 IST

Governance is an issue and so is transparency, but it's also true that you can bring
an economy to it's knees by removing the money supply. Money supply is what that
keeps the global economy where it is today. There is a lot of inflated or inflationary
instruments that every government in the world is using. That would mean that there
is going to be an uptick in the money supply of Dollars. The earlier we attract it and
keep it, it going to be good for us as the value of the dollar will fall faster than any
other currency in the long term. Attracting is one and keeping it is another.

I guess what India needs to do is bet on the long term and have foreign funded
investment proposals come in into India without much delay. Some sort of bond that
foreign investors can buy into and have it return a decent interest rate, assured by
the Government of India.

Only state governments and central departments that take transparent measures
should be allowed to participate.

from:  Jacob
Posted on: Apr 1, 2013 at 03:13 IST
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