Harish Damodaran

India Inc’s austerity moment

HARISH DAMODARAN | Updated on November 22, 2017 Published on August 20, 2013

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The current crisis, unlike in 1991, has been largely made by private corporates rather than a fiscally imprudent state.

The word ‘austerity’ is normally associated with cutbacks by spendthrift governments when faced with unsustainable fiscal imbalances.

A corollary to this is the belief — rather ideology — that governments are solely responsible for macroeconomic or external payment crises.

Thus, current account deficits (CAD) are invariably caused by government dis-savings or over-consumption spilling over into generalised excess demand and resulting in higher imports. The solution then is ‘austerity’: Fix the source (fiscal/revenue deficit) and the CAD will come down, thereby restoring macroeconomic balance in the economy.

The above diagnosis may have well been true in 1991. Out of India’s total external debt stock of $83.80 billion as on March 1991, as much as $48.59 billion or 58 per cent was on Government account.

That was also a time when the Centre’s gross fiscal deficit alone had crossed a record 7.6 per cent of GDP, with the corresponding ratio for its outstanding internal and external liabilities almost touching 60 per cent.

One could, therefore, conceivably have argued then that the situation demanded ‘austerity’. The only issue was ‘how’ (what kind of expenditures to be cut and from where to raise additional resources) and ‘under whom’ (International Monetary Fund/World Bank or a programme designed from within).



It’s private, stupid

Today’s crisis, by contrast, has little to do with a fiscally irresponsible state.

According to the Reserve Bank of India’s (RBI) latest status report, the country’s outstanding external debt as at end-March 2013 was placed at $390.05 billion. But unlike 1991, the sovereign component within this was only $81.65 billion or under 21 per cent. The rest was all non-government debt.

Also, while in March 1991, 45 per cent of India’s debts were owed to multilateral and bilateral agencies — the IMF included — the combined share of these official creditors was just around 21 per cent at the end of 2012-13.

The largest component of debt now comprises external commercial borrowings (ECB) — mostly by big corporates — whose share has risen from roughly 12 to 31 per cent over these 22 years.

That the current external payment problems cannot be attributed to a spendthrift government is clear from not just the low sovereign component in the total foreign debt stock. For all the stimulus measures following the 2008 global meltdown, the Centre’s finances, too, are in much better shape than they were in 1991. The fiscal deficit has been contained within 5 per cent, even as its aggregate liabilities have dropped to 50 per cent or so of GDP.

Leverage (un)Ltd

If anybody can plausibly be accused of living beyond its means and contributing to the crisis currently under way, it is the private sector, more so the large corporates.

As a recent Credit Suisse research report shows, the total outstanding borrowings of just ten large corporate groups have registered a six-fold increase in the last six years to over Rs 6,30,000 crore or $100 billion.

But the aggregate debt figure apart, what is of no less concern is the interest coverage ratio, a measure of a company’s ability to service borrowings out of its operational earnings.

In 2012-13, the aggregate profits before interest, depreciation and tax of the 10 conglomerates could cover only 1.4 times their annual debt obligations. In half of these cases, the coverage was less than one ( see table), meaning that their operations weren’t generating adequate cash to even pay interest. They are, thus, caught in the classic debt trap of having to borrow to service existing borrowings.

Needless to say, these business houses are vulnerable to any rise in interest rates or depreciation in the rupee in case of foreign currency-denominated loans. Right now, we are unfortunately seeing both happening. Credit Suisse has, in fact, estimated the forex component in the debts of the 10 groups to range from 40 to 70 per cent.

Coming home to roost

So, how did our corporates — they number far more than just the ones in the table — land in this mess?

Well, it had to primarily do with the ‘animal spirits’ and irrational exuberance of the last decade. Between 2002-03 and 2007-08, private corporate investment as a percentage of India’s GDP rose from 5.7 to 17.3. Subsequently, it fell to 13.4 in 2010-11, but was still higher than the single-digit levels till the early 2000s.

The above investment binge was significantly financed through large-scale borrowings, contracted with the confidence that the projects executed would generate sufficient returns to service the debts. Moreover, the large differential between domestic and overseas interest rates, besides the belief in a perennially strong rupee, emboldened corporates to increasingly resort to ECBs.

All this was further actively encouraged by policymakers at the Finance Ministry, RBI and Planning Commission. Among other things, corporates were permitted to access up to $500 million of ECB under the ‘automatic approval’ route every year, which got subsequently enhanced to $750 million. The underlying assumption was that the private sector could do no wrong and only governments are prone to financial excesses.

It is this belief — ideology, just to re-emphasise — that now lies in tatters.

What next?

The private equivalent word for ‘austerity’ is ‘deleveraging’, which is what many corporates are currently engaging in.

From past experience — India Inc did go through it from roughly 1998 to 2003 after the collapse of a much smaller investment boom in the mid-1990s — the process can be painful and prolonged. As it unfolds and firms either close down or gradually bring down their debts, investment and jobs in the economy dry up.

The private corporate investment rate mentioned earlier may have plunged below 10 per cent by now. No amount of confidence building or talking up the markets can make up for companies simply not having the money to invest.

But knowing the ideologues at North Block, Mint Street and Yojana Bhawan, they are likely to yet again identify fiscal deficits as the villain and austerity as the solution. And the best part of being an ideologue is you aren’t accountable for your actions and are always right!

Instead of ideologues, what India probably requires today are men and women with practical wisdom above everything else.

Atal Bihari Vajpayee showed it in 2001. At a time when the economy was in deleveraging mode, the former Prime Minister launched a Golden Quadrilateral national highway programme through old-fashioned public investment and tendering of engineering, procurement and construction contracts. This was before public-private-partnerships, build-own-operate-transfer and other such models became current.

The same goes for Delhi Chief Minister Sheila Dikshit, who put her weight behind implementation of the Delhi Metro project under the leadership of an able public sector manager like E. Sreedharan.

It’s not for nothing that the Delhi Metro and Golden Quadrilateral remain the country’s most successful and efficiently executed infrastructure projects till date. Equally important, they played a role in infusing liquidity into private firms and kick-starting economic activity just when it was required.

We need something similar again.

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Published on August 20, 2013
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