Different Strokes - STRUCTURAL INITIATIVES
As explained in our recent quarterly update,
we expect gross domestic product to rise by 6.4% in 2017-18 and a slightly
higher rate in the coming year. Output understandably took a bump in the wake
of demonetisation and the subsequent roll-out of goods and services tax (GST).
However, we believe these are largely behind us and recovery, going forward,
should be robust and sustained. The fact is, consumption has been strong and
constitutes the principal driver for growth with investment lagging behind. Be
that as it may, in the years ahead the impact of certain government initiatives
will play out favourably, as this paper will in subsequent paragraphs seek to
explain.
The perception is that fresh investments
have lagged behind and that spending on plant and machinery remains subdued.
However, the reality, we believe, is different. With demand continuing to grow
companies are clearly producing more goods from existing capacities. This is by
virtue of productivity rises which in themselves constitute an important
component of growth. The reasons are a greater investment in automation and IT
spending through which more widgets are churned out from existing
infrastructure. However, such spends are frequently not amortised as investment
but written off as a current account spend on the profit and loss statements.
Therefore, whilst capex is not rising rapidly enough it is still much higher
than the aggregate figures would suggest.
Transfer Benefits
Since coming to power in 2014, the Modi
administration has rolled out a few structural reform initiatives some of which
promise to be game changers in the longer term and are approaching a certain
level of maturity. The first amongst them is direct benefit transfers (DBT), a
programme formally launched in 2013 but subsequently boosted with a serious
thrust in 2015. In simple terms, DBT involves the deposit of a subsidy or
monetary benefit directly into the intended beneficiary’s bank account rather
than through intermediaries, in-kind substitutes or cash, each of which are
susceptible to pilferage, leakage and diversion. The volume of fund flows through
DBT-based schemes has increased from Rs 74 billion in 2014 to around Rs 1
trillion now while the number of beneficiaries has spiked from 108 million to
610 million. According to Government estimates cumulative savings through DBT
up to FY17 stood at Rs 570 billion stemming primarily from three schemes –
liquefied petroleum gas distribution, the public food distribution system and
the national rural employment guarantee scheme. Further, direct benefit
transfers removes price distortions in the economy due to controls and
regulation which creates inefficiencies with a multiplier impact far worse than
the initial folly. More significant perhaps, is a near elimination of
pilferage. Some estimates suggest that approximately 50-60% of earlier spending
was misdirected, never reaching the ultimate beneficiary. Such money often
found its way into poorly monitored sectors such as real estate, creating
unreasonable price inflation.
In FY17, savings from DBT at Rs 209 billion
amounted to 28% of gross flows in the year i.e. almost a third of total spends
were ultimately saved. Total government expenditure on welfare programmes and
subsidies adds up to approximately Rs 6-7 trillion annually; by extension therefore
the total savings that could ultimately be achieved would be 1.7% of GDP, or Rs
2 trillion. However, the ultimate implications may be well and truly beyond
this figure. This is based on the premise that bigger savings can be achieved
when Aadhar seeding for a welfare scheme reaches 100% because leakages are
invariably concentrated in the un-seeded component. Currently, the average
Aadhar coverage stands at around 77%, up from 65% two years ago. When this
approaches 100% the savings surge might be disproportionate, perhaps even 40%
or so the logic goes. Further, some schemes with very large leakages such as
fertiliser subsidy are yet to be covered by DBT. In the fullness of time,
Aadhar based authentication could enable more targeted subsidies and payments, consequently
greater benefits with lower costs. Longer term savings could even touch 3% of
GDP.
Money in the markets
The second initiative has been the
‘financialisation’ of savings and the household balance sheet. Households are
the largest savers in India contributing to a 60% share of national savings.
Private enterprise adds another 36% and state-owned corporations, 7%. The
Government of India, on the other hand, dis-saves approximately 3% through its
fiscal deficit. However, the bulk of household savings have traditionally been
in dud assets such as gold, which offers no return at all, and real estate.
Therefore, the net free capital intermediated through the economy added up to a
meagre Rs 8-9 trillion. However, following the demonetisation and Jan Dhan
exercises, this has jumped to Rs 13-14 trillion. This was made possible because
households have rebalanced their investment in financial instruments up from
31% to 41% of their savings. The opening of 250 million new bank accounts and
the creation of a digital financial architecture were both instrumental in this.
Households now invest considerably larger sums in mutual funds and by extension
in bond markets. As a result, mutual fund mobilisations have nearly tripled to
Rs 3.5 trillion and bond issuances to Rs 4 trillion over the last 2 years.
Apart from the fact that this change brings
in larger amounts of free cash into the economy it benefits individual
households in two distinct ways. Firstly, the monetary gains from investment
yields can rise by 1.5-6% annually by substituting gold with financial
instruments in the savings portfolio. Secondly, the cost of borrowing for
households could fall by 2-4% annually by replacing informal borrowings with
formal banking debt. Taken together, overall real household income could rise
by anywhere between 4% and 12% per annum through a more ‘financialised’ balance
sheet. This translates into a tangible gain in national income as households
constitute 60% of GDP.
Electric dreams
Finally, the benefits of the Government’s
power sector reforms – specifically Ujjwal Discom Assurance Yojana (UDAY) – are
not widely understood. With the first phase of UDAY involving a restructuring
of discom debt well underway, interest savings amounting to Rs 170 billion were
achieved in the previous year; more importantly, Rs 400 billion of bank
defaults were averted. In FY18, savings are likely to be even larger as the
full year benefit of deleveraged balance sheets is realised. Further, the
scheme has brought about a significant drop in under-recoveries on the sale of
power from Rs 0.60 per unit to Rs 0.35 per unit through cost reductions and
tariff hikes. In the long term, substantial benefits – of the order of Rs 1.8
trillion – are possible if the programme continues to progress at the current
rate.
Theoretically, if everything worked
according to plans, the rise in savings, income and investment from these
measures could translate into GDP growth increasing by as much as 5% per annum.
Even if 50% of the targets were accomplished the impact on longer term output
could safely be estimated at around 2% annually. This would be no mean
achievement even from the most stringent benchmarks.
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