Broken promises and their consequences

Business, indeed life, is all about trust. One finds that promises are being broken, and this will have consequences.

It is a sequence of events that is causing these broken promises. The incremental capital output ratio (ICOR) is rising. For each unit of capital invested, the resultant output (or gain to the economy) is much lower. This is a global phenomenon. So, for example, if India wants GDP to grow at 8 per cent and the ICOR is 4, the investment must be 32 per cent of GDP. Hence, the saving rate has to be higher than 32 per cent (or the country needs to borrow more to make up).

Central bankers are lowering interest rates in order to boost consumption growth (through lower EMIs) and investment growth (by lowering the cost of capital). It is not working, yet the policy of ZIRP (zero interest rate policy) and, later NIRP (negative) is being dogmatically pursued. This disincentives saving.

A pension is a promise by a government to its workers that if they work hard during their life, they would be rewarded in their retirement. But with ZIRP in place, the funds do not earn enough.

So, pension funds are driven to take higher risk, and invest in risky assets, in order to get their target return and be able to meet obligations.

Thus, the promise of a comfortable retirement as a reward for hard work, is broken. In fact, as many as 18 per cent of retirees are still working post-retirement age, simply because they need the income.

This is very relevant in India’s case. The outgoing RBI Governor recognised the need to encourage savings so that enough investment takes place. He did not succumb, rightly so, to pressures to reduce it. The pressures came from over-indebted corporate groups who wanted to roll over their non-performing loans.

Citizens pay taxes to their government. In return they expect to be protected against aggression, both external and internal, and against theft, cheating and fraud.

The judicial delays in delivering justice is thus a broken promise to taxpayers. There is an unseemly public spat between the government and the judiciary over the modus operandi for appointment of judges, of which there is, admittedly, a shortage.

Yet, as these columns have been pointing out, a large part of the blame for delays vests with the judiciary itself. So lenient is the judiciary in granting adjournments, ad nauseum , to lawyers, that cases drag on for generations, to the advantage of the fraudster and the woe of the victims.

Seventy per cent of bank deposits are with public sector banks. There is an implicit promise that deposits with them are safe. Yet the money deposited in them is unwisely lent to large borrowers who use the lethargy of the judicial system to default on repayment.

When banks go bust, they make depositors (not shareholders) take a haircut. Cyprus did that a few years ago, now it is feared Ireland may. An insurance company, FBD, has moved €150 billion out of bank deposits, fearing a bail in.

So, a high GDP growth needed to propel India’s economy will need encouraging savings rate and also need a responsive judicial system. The task of a good government is to talk to its various arms and ensure speedy justice, speedy punishment for wrong doing and safety of depositors. When these are ensured, India will be shining.

(The writer is India Head, EuroMoney Conferences)

COMMENT NOW