Economists often get their predictions wrong or fail to see an evolving crisis. Few economists foresaw the 2008 crisis. In our case, economists’ prognosis of the India Growth Story has fallen flat. The growth crisis is becoming intractable. The common perception is that the ‘economistocracy’ is divorced from real world issues. Abhijit Banerjee and Esther Duflo find economists are among the least trusted experts across the world.

Why is this so? The gap between theory and practical experience/insight into the real world of finance and business can lead to misdiagnosis. Superficial data analytics and mechanical reading of the findings of various committee reports relating to corporate financials, financial flows and monetary developments mask the warning signals. This failure leads to wrong policy choices.

Take the case of the RBI’s reports. The RBI’s annual study of financials of non-government-non-financial public limited companies (defined as private corporate sector (PCS) here) suggests that their average gross fixed assets (GFA) to total assets ratio steadily declined from 69 per cent during 1951-2000 to 58 per cent in 2000s and further to about 50 per cent by now. There is a related increase in their financial assets.

These structural changes are corroborated by RBI’s study of 765 corporates’ financials for the 2000-12 period. Here, GFA to total assets of the PCS declined from 74 per cent to 53 per cent and financial assets to total assets increased 16 per cent to 28 per cent over FY 2003-12 (Financial Stability Report, December 2013).

The FSR of June 2014 talked about financialisation of PCS. The High-Level Committee on Estimation of Savings & Investment, 2009 and the Planning Commission’s 12th Plan Working Group on Estimation of Investment reached the same statistical conclusions, but they missed its deeper implications.

Why less capex since 2000s?

There was a large-scale circular flow-of-funds between PCS and banks during 2000s, which bypassed capex. Interest arbitrage arising from accelerated sub-BPLR lending (reaching 77 per cent of total credit by FY 2007), surge in low-interest ECB borrowings and exalted bank demand for relatively higher-interest bearing bulk deposits, prompted the circular flow of funds.

Vicious circle of more credit leading to higher liquidity to higher rating to even more cheaper credit and banks’ obsession with higher deposits and credit volume boosted this mad-rush. PCS’ fixed deposits with banks surged by a CAGR of 40 per cent during 2001-10. Its share in total bank term deposits spurted from 3 per cent in FY 2000 to 17 per cent in FY 2010. Big ticket bank loans (above ₹25 crore) surged with a CAGR of 30 per cent during 2001-10. The RBI remained inert over the decade till the Base Rate policy in 2010 ended the interest arbitrage advantage.

These abnormal trends in data points coincided with a staggering rise in Chinese imports during this same period. The links between the financialisation of investment and the rise in imports are easily explained. The lack of physical investment brought down the competitiveness of Indian industry. At the same time, manufacturing entities actually decided to simply trade in Chinese goods, putting their brand on them.

Surprisingly, economistocracy (including the RBI’s analysts) remains oblivious to these developments. It is even more surprising that the decline in capital intensity was misinterpreted as sharp jump in gross capital formation (GCF) — the very basis of the much glorified India Growth Story.

The actual investment of funds by PCS was more in bulk deposits and financial investment than capital assets.

Chinese imports, de-industrialisation

The steady spurt in imports from China since mid-2000s through various dubious ways (under-invoicing/misclassification/counterfeits of reputed brands/smuggling, gift and FTA channels) have caused deep and enduring structural damage to the manufacturing base. Capex, technological/skill development, employment, competitiveness and tax revenue have been impacted. Consumption goods dominate imports.

Imports of final products/CKD/critical components have kept the manufacturing value chain and capex at a low level. No large economy can achieve a high growth with such an import-intensive consumption/production structure. These lead to leakages in GDP and savings. Consumption/investment-led growth suffers.

The ‘economistcracy’ needs market intelligence to realise industry-paralysing effects of surreptitious Chinese imports. The Covid crisis has exposed risk of our over-dependence on China. At the same time, it can be used as an opportunity to develop India as a global manufacturing hub.

Other misgivings

The RBI’s assertion of continuous systemic liquidity surplus is deceptive. It is an economic drag. It is meaningless and absurd in a time of unprecedented liquidity gridlock confronting trade, industry and non-banking financial channels.

The average annual growth in currency since the late 2000s is higher than the nominal GDP growth, despite widespread expansion of core banking, digital payments, DBT and mass banking. This abnormal growth in cash economy taken as an indicator of black-money (the main reason for demonetisation) is mainly due to the need for cash financing of massive under-invoiced/clandestine Chinese imports. Non-appreciation of this fact resulted in critical shortcomings in the demonetisation strategy.

Remedial measures

The RBI needs to reinvent its big data management strategy. It is imperative to bridge the gaps in information/data analytics and between theory and practice to improve policy framework and reading of warning signals.

Collaborative policy-making by partnering with practitioners, business-level economists and domain experts are required to prevent intellectual hara-kiri in data management.

We need to leverage the Covid crisis by encouraging manufacturing investment. Dismantling the shady Chinese import network requires breaking the nexus between Chinese exporters, clearing agents, importers and customs. Random and surprise check of imports are needed at the ports in terms of invoice prices/description of goods and their actual/reference prices in the national/international markets to check dubious imports.

Multiple benefits of this include surge in tax revenue and industrial activities with several positive externalities. International cooperation against illegal money transfers by banks in hawala havens like Hong Kong, Dubai can be useful. Well-calibrated measures against Chinese import are required without creating sudden and large disruptions in import-dependent industries.

We may start with inessential consumer goods and proceed with creation of domestic capacity. ‘Make in India’ strategy needs to be synchronised with planned phasing out of unscrupulous imports.

The writer is former DGM, SIDBI

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