The Hindu Business Line : Liquidity overhang

EVEN AS India is starving for investments, especially in infrastructure, education and heath-care, there is enormous liquidity overhang in the economy. Perhaps, there is a behavioural explanation for not only India's inability to invest, but its capacityto save and acquire substantial liquid resources. A look at India's liquidity overhang and what can be done about it.

Liquidity overhang is the excess funds in the system that is not being used for consumption or investment purposes. It is idling money. At the present rates of exchange, the liquidity overhang in India is almost $70 billion.

The implications

Some simple arithmetic first. If just half the liquidity overhang were to be invested, then Rs 150,000 crore would be available for investment. If the resources invested were to generate output equal to just their nominal value, which is a low estimate anyway, the output, valued at Rs 150,000 crore, would be generated.

Assuming a multiplier value of two, which again is a low estimate, the combined value of output would be worth Rs 300,000 crore. Not a small sum for a country the size of India — indeed, a goodly percentage of its current GDP.

That is not all. Profits and savings are important. Assuming the standard economic rate of return of 8 per cent, the profits from the output generated would amount to Rs 24,000 crore. If these were to be treated as corporate savings, they can be re-invested. If invested in social assets instead, the return would be measured in non-financial terms, but the social asset enhancement would be equally valuable.

The economic consequences, and the losses, of a liquidity overhang in India are, thus, substantial. The country is not making huge investments and is losing equally significant sums as output and profits every year. Therefore, policy-makers must address the question of the liquidity overhang in the economy.

Inflation control is often cited as a reason for creating liquidity. It is argued that releasing large sums of money into the economy would immediately drive prices up. That is, unfortunately, a pessimistic monetarist thought. It is exactly the type of thinking that made the Margaret Thatcher government starve the British economy of critical investments in the transport, health and education sectors for years, as the sanctity of M1 and the M3 was sought to be maintained and the focus was on inflation control.

The financial reality of reducing the liquidity overhang is quite different. Releasing such large sums of money into the economy as investments can raise productivity. Investment in the latest knowledge-embodied technologies is only going to raise efficiency and lower real costs. Capacity investments can only drive down costs. Therefore, inflation is not really a worry at all.

Where does the liquidity overhang come from?

There are several sources for liquidity:

The Liquidity Adjustment Facility has resources worth Rs 40,000 crore;

The Market Stabilisation Scheme has Rs 60,000 crore.

Surplus funds with the Life Insurance Corporation of India total Rs 100,000 crore;

Excess funds with commercial banks add up to Rs 50,000 crore;

Surplus funds with development finance institutions aggregate Rs 25,000 crore; and

Funds available with the Infrastructure Development Finance Company Rs 25,000 crore.

All this totalto Rs 300,000 crore. To be sure, there could be some double-counting and some over-stating. Or, there could be items not listed at all, such as the substantial sums brought in by foreign institutional investors. Unfortunately, such funds have the effect of creating asset value bubbles, first of financial assets and then of real estate that may become unsustainably high. When these bubbles burst, the results can be compellingly unwelcome.

The upshot of all these numbers is that the large amounts of money sloshing around the economy, and, yet, the economy is crying for investments. But, ironically, India does not seem to have development schemes that are worthy of funding.

What are the limits of feasibility?

The sums available today within India and to India from the world's financial markets are of the stuff of a nation-builder's dream. So much can be done. A look at what Rs 300,000 crore or $70 billion, can do, if invested properly.

Some areas where the scope for investment is phenomenal:

At least 5,000 new national highways miles can be built for Rs 10,000 crore.

The airports of Ahmedabad, Bagdogra, Bhubaneswar, Coimbatore, Jaipur, Lucknow and Nagpur can be made world class for Rs 10,000 crore.

At least 100 million square feet of space that can revolutionise retail sales in all the cities of India with a population of one million or more can be set up for Rs 10,000 crore.

At least two large power stations the size of Dabhol can be set up for Rs 10,000 crore.

Enough public toilets and sanitation facilities for the cities of Mumbai, Kolkata, Delhi and Chennai can be provided with Rs 10,000 crore.

A mass transit system that doubles the carrying capacity of the system in metropolitan Mumbai and reduces journey time by more than half can be created with Rs 10,000 crore.

A faculty compensation endowment fund can be created with Rs 10,000 crore that will pay at least 9,000 university faculty annual salaries that are reasonably competitive with private sector compensation rates.

An investment of Rs 10,000 crore could lead to the acquisition of a petroleum company the size of UNOCAL that the Chinese were after, and add significantly to India's strategic energy reserves.

An investment of Rs 10,000 crore could help diffuse broadband communications infrastructure to at least four million households in the non-metropolitan towns.

An investment of Rs 10,000 crore could make possible the establishment of 50,000 hospital beds in India.

What is the problem?

Indeed quite a bit can be done with the available money. So, where lies the problem? Is it that Indians do not know how to invest? Or, is it that the risk aversion is so profound that they are just unable to commit resources to a long-term project?

There are some other explanations for this lack of investment. One, the continuing licence-raj mindset among the bureaucrats. After all, those who joined the bureaucracy in the late 1960s and the early 1970s are senior bureaucrats now. They grew up in the licence-raj milieu and, by 1991, had completed more than half their careers. Are they finding it difficult to change?

Another reason is in the absence of the more important reforms at the local administrative levels where projects are actually implemented; entrepreneurs have become de-motivated in proceeding with their plans. In actually implementing an investment project, several operational steps are to be gone through and the role of the States governments becomes paramount. A variety of factors appears to be at work to retard investment growth in India. This is probably the best time for men of action to rise and change the face of the country.

(The author is Professor of Technology Strategy, University of Texas at Dallas. He can be reached at majumdar@utdallas.edu)

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