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A note I received - Author Unknown - But provokes thought

I share below a note that a friend of mine forwarded to me. I can claim no information on who the author is nor on the veracity of the contents. My limited response is as follows.

I have since sometime strongly believed that India is on the cusp of a repeat of the 1991 financial crisis but one that could be worse in magnitude due to a domino effect than on its own. I have on my TL predicted that this crisis can hit India over the next 3 to 7 years depending upon how our own economic policies, political changes, global economics play out. But given current state of affairs I would be surprised if we did not face such a crisis given the profligacy of our economics, paralysis of our administration, obstinacy of our politics and the inward looking attitudes emerging in western economies.

Whatever the veracity of these claims in terms of numbers popular perception is that many of the percentages  and issues are infact correct. Remember perception is NOT fact but often does mirror fact. So while specifics can be challenges the broad contours of what is being said seems to ring true.

There would many who can strongly contest many figures, comments but the reason to share this here is that it has some interesting comments, helps raise questions that we must ask if at least to satisfy ourselves that they are untrue. Like my boss used to say - this stirs the pot - and makes you think afresh.

Happy reading.....

Vasisht

Why the Indian Economy is sick despite the Efficient private sector? 

The answer is not far...to seek. It's the most corrupt Central and State Governments which always work towards the next election  to stay back in power!

Is it time to suspend Democracy which a developing, most populous Nation like India can ill afford?  Or lets have a least corrupt Government like Gujarat!  

It is a profitable, tax and dividend paying company and I was wondering where was the question of turnaround. Nevertheless, I instantly zeroed in on the balance sheet. I observed that the company had invested approximately Rs 700 crore on its subsidiaries and lent another Rs 300 crore — in the aggregate Rs 1,000 crore. Flipping across the accounts, I asked a simple question – what is the return from this investment of Rs 1,000 crore?(Amounts changed for obvious reasons.)

The CFO was silent. The executive director hummed and hawed. The body language of the rest was a dead giveaway of their uneasiness to discuss this matter further.

The junior-most amongst them blurted out, perhaps unwittingly, that it was virtually nil. His answer got a cold stare from his superiors. “Nil!” I exclaimed. “You must be paying approximately Rs 150 crore as interest annually on this sum.” I commented, probably rubbing salt into their wounds. I went on to probe further, “Why, what happened to this money?

This time my question was followed by thundering silence. Even the junior one was quiet this time around. May be he had already got the message.

I attempted to be at my persuasive best. Probably my training as a chartered accountant helped me. Unable to bear my repeated questioning, the CFO finally broke down“Sir, as you are aware we are in infrastructure. That requires tremendous pay-offs to politicians and bureaucrats. We have used approximately 150 subsidiaries, some of which are foreign ones, to route these payments.”

I was stunned. My jaw dropped. “Sir, we expected you to know all these practicalities of our business. The turnaround strategy needs to factor these ground realities.” Obviously, this time around I was at the receiving end.

Importantly, I understood that India’s outbound investment policy was not a liberalisation process, but a facilitation one – one that ensured smooth pay-offs! Importantly in this mess, businessmen, politicians, professionals, bureaucracy, judiciary and even the media are involved. No one can blame the other.

The economics of kickbacks and payoffs

Instantly my thoughts raced to the Nira Radia tapes. Fifteen per cent was the kickbacks payable to the Minister concerned for approving every road contract. Add another fifteen to the bureaucracy and local politicians. Add another five to seven to bankers, lawyers, consultants and agents to procure funds.

What we have is a staggering 35-40 per cent additional cost to every infrastructure project.

That implies a road project costing Rs 100 crore would in effect be a Rs 140-150 crores project. Naturally, the toll for the stretch would not be Rs 100 but Rs 150. This has profound implications for the Indian economy. This extra Rs 50 in toll levy for every 100 km has a cumulative effect on the manufacturing cost.

The net result – imports from most of our neighbors of several items [despite cost of transportation and customs duty] are competitive than manufacturing the same in India. Forget competing abroad, Indian manufacturing has become uncompetitive in India!

There is another dimension to this issue. Somewhere down the line these “costs” were funded, mostly by our banks. Corporates altered their top-line as well as bottom-line to keep their banks in good humor. The Banks in turn suspended their sense of disbelief. As chartered accountants we too played ball in creating a mini-Satyam in most of India’s corporates.

The impact of gold plating

But this gold platting of balance sheets cannot be done beyond a point. Everything has a breaking point isn’t it, especially as the economy tanked?
These developments were brilliantly captured by a Report by the Centre for Monitoring Indian Economy (CMIE)

“As the topline growth continued to slow down, the manufacturing sector as well as the non-financial services sector saw profits fall in the March 2013 quarter compared to the year-ago levels. Operating profits of the manufacturing sector excluding the petroleum sector fell by close to four per cent while the net profit fell by a sharp 23.2 per cent.”

The report goes on add  

“The non-financial services sector managed to improve its sales growth from 3.2 per cent in the March 2012 quarter to 6.5 per cent in the March 2013 quarter on account of sectors like transport services and software. However, at the net level the sector saw a sharp 28.3 per cent decline in profits.”

Well, both the manufacturing and services sector are going bust.
Simultaneously the CMIE points out that the

“Commissioning of projects dropped sharply to Rs 337 billion during the quarter ended June 2013 from Rs 827 billion in the June 2012 quarter. This was lowest since quarter ended December 2006.”

Macro-economic data too corroborate these numbersFrom a growth rate of 7.5 per cent in the first quarter of 2011-12 growth rate has witnessed a steady fall in the next seven quarters to less than 4.8 per cent in the fourth quarter of 2012-13.

If data released by the Finance Ministry for the first two months of this fiscal is any indication, manufacturing has recorded a negative – yes negative growth of two percent, mining a negative of 5.7 per cent, capital goods a negative of 2.7 per cent, consumer goods a negative of 4 per cent and consumer durables a negative of 10 per cent.

In short, when it comes to manufacturing, forget growth, we are in negative zone.

The net result – twenty per cent of lending by Indian Banks is stressed.  Obviously, when banks end up funding pay-offs and kickbacks, this is the end result. And that is a whopping Rs 11 lakh crores – approximately $200 billion – a sum that even the banks in USA cannot afford.

Added to this is the stress on account of our external accounts.The foreign debt has risen to $390 billion. This was a mere $225 billion in 2008. What is galling is that the foreign exchange reserve has remained at a constant $300 billion during this period.Needless to emphasise, the ratio of foreign exchange reserves to foreign debt has deteriorated from 138 per cent then to less than 75 per cent now.

What is adding to the consternation is that in the short term – by March 2014 – we need to pay approximately $172bn of our foreign debtsThis works out to approximately 44 per cent of the external debtand a staggering 60 per cent of the total foreign exchange reserves of the country.

The short-term external borrowings are surely the villain of the piece. Remember in 1991 the short-term external debt was a mere 10 percent of the total external debt. Now it is one-fourth.
Another important parameter – India’s net international investment position [the net claims of non-residents against external claims of residents] stood at a negative $225 billion as at 30th June 2012. This deteriorated to a negative of $307 billion by March 31, 2013. That implies an addition of $82 billion in a matter of mere nine months.

Simply put, Indian manufacturing by and large is uncompetitive at current exchange rates. And if Rupee is devalued, prices of imports, especially crude oil, would increase leading to an inflationary spiral. Either way, that means increased unemployment. The services sector too as pointed out above is spluttering. And remember agriculture has been historically recording sub-three percent growth in the best of times.

As we witness large-scale unemployment, purchasing power in the hands of the people is rapidly decreasing. That implies demand compression which in turns puts the economy once again on the downward spiral.

Add to this the absolute lack of governance, indecision and Governmental apathy – you would know what it means to do business in India. Whatever be the reason – political or otherwise — bureaucracy in Delhi has simply refused to function. Likewise every assessment with our revenue departments ends up as extortion.

Unfortunately the Government’s response has been pathetic. Surely, increasing FDI limits is not reforms. On this the UPA Government is completely off-target. What makes the set of reforms scandalous is that the Government is indirectly bribing foreigners to invest in India. The Jet-Etihad deal is a case in point.

Put pithily, we are witnessing a repeat of the 1991 crisis.

This time around, it is threatening to make the previous one look like a walk in the park. Well what makes the crisis different this time around? 

Contrary to the popular belief this is not an economic crisis, this is a crisis of national character.

Besides revenue and current account deficits,  let us also worry about morality deficits.

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