Aditya Vikram Singhal on how the pandemic has an impact on our economy, India’s current situation and a three-point programme that the private/ public sector should consider to create growth and long-term prosperity.
Having worked in finance for over 15 years and traded various products across the globe, I would like to share some thoughts given the current crisis and how India can make a renewed economic recovery. As fellow Indians, we all have to embrace certain structural advantages and disadvantages that our country offers, and try to maximise the most to enhance quality of life for generations ahead.
This article is spilt into two parts, the first covering some macroeconomic concepts to illustrate a simple working model for a nation and how disruptive events like a pandemic can have an impact on their economy. The second part will shed light on India’s current situation within that working model and highlight a three-point programme that private/ public sector should consider to create growth and long-term prosperity.
The Imaginary World
Let us start by making some assumptions:
- Imagine the world started today. It was Year 1 and only two countries existed: China and India
- Imagine both China and India were like a home with two floors: Ground Floor (GF) & First Floor (FF)
Let’s also assume China is a self-sufficient country and has the following in its two floors:
- China GF – raw materials, crude oil reserves, agricultural produce and basic essential items
- China FF – educational institutes/innovation hubs and where majority of the population resides
India also has an identical setup and is self-sufficient apart from owning crude oil reserves, of which it needs one barrel a year and is a critical raw material needed to drive goods and services from India’s GF to FF to feed its population.
What does India do?
India imports 1 barrel of crude oil from China to fulfill its one-year demand and in return gives China, INR 100 (its currency). (India runs a current account deficit and China a current account surplus)
What can China do with this 100 INR for the entire year? It has four options:
- Hold 100 INR as a Reserve with itself to use in the future
- Spend 100 INR or a portion of it to buy something from India it needs (Balance the current account surplus)
- Invest 100 INR or a portion of it in India’s industry or market (Foreign Direct Investments or Foreign Institutional Investments)
- Lend 100 INR or a portion of it to India’s public or private sector and charge interest (Corporate borrowing or Government borrowing)
India asks China for one barrel of oil again. However, this time China demands 200 INR from India for the same one barrel of oil. India has no choice but to oblige as it’s a critical import for the country. One barrel of oil which was 100 INR the previous year now has become 200 INR and suddenly India has in effect created a depreciation of its currency.
India, uses the same one barrel of oil to move equal amount of goods and services from its GF to FF, but in Year 2 has to charge its people more INR as its cost of imported oil is higher making everything more expensive leading to inflation.
India decides to print money to give to its citizens, this solves the problem for the short term but risks China demanding an unreasonable price for the same one barrel of oil in the following year. Since China holds INR as reserves, India realises it can’t indefinitely print money as its currency is in the process of becoming worthless to a self-sufficient China and will end up creating hyperinflation which is not sustainable. (As in the case of many African countries)
What does India need to do?
India needs to find a way that will encourage China to buy something from it, or invest those INR held as reserves by China back into it. As India grows, its requirement for crude oil will also go up and it will have to find a way by which China is incentivised to pick ideally the first three options listed above as the fourth option is the least desirable. India biggest worry is that in the years to come, the price China demands on crude oil would go up exponentially.
A few years go by and then a pandemic like Covid-19 hits China and India
China in this period accumulates close to 100,000 INR as reserves and INR has lost value against CNY (China’s currency). In order to mitigate the economic slowdown, both China and India decide to print money relative to their GDP to support its citizens till a cure/ vaccine is to be found. Let’s see how it effects both nations.
Relative standing of both countries doesn’t change, however since China is a self-sufficient country, printing more money boosts its economic activity via internal consumption. However, India is dependent on China for crude oil and an increase in India’s economic activity, in turn leads to greater demand for crude oil which China offers at a higher price. This process eventually leads to hyperinflation in India and a collapse of the INR and the country.
The key message via this example is that although globalisation has been a boom to the world in the last few decades, to deal with unprecedented events like Covid-19 a country has to be self-sufficient on its key goods and services. Nations can print money and run a fiscal deficit, provided they have a current account surplus against the rest of the world and are a net investor nation to the world. Japan is a classic example of this in the real world.
The Real World
Moving onto the real world and applying the above example to state some observations for India:
- India needs to reduce dependence on critical imports from the rest of world while finding ways to enhance exports (especially of critical items). Ideally imports from other countries should be value added and exported back (Japan/ German model)
- India needs to increase goods and services consumption locally by investing in homegrown industries and promote an environment of research and innovation
- India needs to diversify its reserves from USD to Gold and try to make INR as one of the reserve currencies of the world. (USD dominance was established mid last century when trading of oil was linked to it. The world currently uses USD as a means of exchange for trade and capital flows thereby allowing America to fund its current account and fiscal deficit indefinitely)
How does India get there?
Reduce largest item of critical import (Crude Oil)
India imports under normal conditions 4.5 million barrels of crude oil a day. Even with a push on renewables energy over the next 10-15 years, crude oil imports will rise to 7-8 million barrels a day and only start to taper off 2035 onwards.
In 2019, at an average price of 50 USD per barrel of oil (which is a conservative number as crude oil prices due to OPEC cuts could easily rise), India imported 83 billion USD of crude oil. At 100 USD per barrel of crude oil, the import bill will go to 166 billion USD. This number will only rise as country grows over next 10 years.
To put things into context: The entire public sector bank’s Non-Performing Loan book is around INR 7.2 lakhs crore or 95 billion USD which is approximately: one-year oil import bill of India at 55 USD per barrel of crude oil.
India must immediately
- Contractually ask local and international oil firms to explore all its unexplored basins onshore and offshore
- Provide them a 15-year tax holiday and in return demand all international and local firms to reinvest majority of earnings back into the country
- Establish a joint hedging strategy as a country on crude oil when prices fall below 40 USD a barrel
- Incentivise private and public sector to invest more in renewable energy and natural gas alternatives so that crude oil demand never reaches eight million barrels a day in next 10-15 years
The last firm that credibly found crude oil in India was Cairn India plc, and even if we allow international players to explore, build and operate crude oil production facilities onshore – India will still get to keep its foreign exchange in house and can find ways to encourage those proceeds to be invested back into the country.
For other large import item like Gold and Defense equipment a similar approach must be adopted.
Establish India Innovation Centres (IICs)
When a nation finds an innovation, it creates a marginal demand for that product/ idea both for its own citizens but also for people of other countries and helps the country create growth and earn valuable reserves. India has some of the most brilliant minds coming out of the IITs and other institutes, but they go abroad to only help other countries/ companies like Apple, Intel or Microsoft innovate. Those new technologies are then sold back to India and we end up losing valuable reserves and in worst cases create large current account deficits.
As it stands, almost the entire start-up and new age firms established in India which have contributed immensely to growth and prosperity over the last 20 years, are mostly servicing lower end value chain needs (In Hindi, as they say: Roti, Kapada aur Makaan and things associated with it – if one was to pick Maslow’s hierarchy of needs, the very bottom of the pyramid is where most Indian industry focusses) and are not moving up the innovation ladder.
India must immediately
- Set up India Innovation Centres and fund them with grants/ investments from government and business to build the SME sector
- IICs have to emulate a certain aspiration value for young brilliant minds, who feel they can use the platform to enhance quality of life vs choosing to settle abroad
- Collaborate with IITs and other institutes to identify talent and encourage private sector to invest in R&D both inhouse and via these centers to fund new age technologies. To name a few: Frontier technologies that include Quantum Computing; AI & Data; Life Sciences including medicines, vaccines research & manufacturing; Clean Growth and Future of Mobility
An example that stems to mind is Quantum Computing. Large investments are being done by UK/USA/Germany/Japan and China vs almost nothing in India. Once this technology is commercialised in the next few years, India shall again spend next 30 years paying royalty to some western firm/ country to use it, similar to what we pay today to American, European and Japanese firms. High barriers to entry on the back of innovation helps a country earn more stable revenues vs services being provided currently by India, where the advantage comes due to cheap labor that can be moved to lower cost locations.
India should try to maximise on all inherent advantages, but aim to change the mix and go up the value curve. Having said that, ISRO is a classic example of innovation where India is becoming a leader in missile technology and satellite launch market and its success is a template to drive innovation in all aspects of industry especially defence.
Reform the Judiciary
One of the main reasons India is not able to retain talent or attract local or foreign investment is due to the extremely tedious and lifelong legal process on conflict resolution.
India must immediately
- Set up 10,000 new courts in Grade A, B and C towns – it might sound a big deal but speaking to many lawyers, this can be done within 3-4 years
- Try the concept of E-Courts (online), as most delays in Indian cases are on account of defendants/ lawyers not showing up due to various reasons, but with technology many problems are solvable
- Incentivise judges financially, via the state to take decisions to close out pending cases and put a hard deadline on different type of cases which get delayed due to corruption
- My father in 2019 won a cheque bounce case post 25+ years of fighting which he initiated in the 1990s. The amount of misery and time wasted was immense but worst of all it dis-incentivised him from taking any further risks
The expected growth of India’s middle class in the next 10 years will bring exciting new opportunities that will make the unthinkable possible. There are many initiatives India has already undertaken despite the complexity and scale of the country. However, renewed focus by the government and private sector on the above listed three points will in itself create a huge positive momentum of growth & prosperity for our beloved country.
Any feedback/ thoughts are welcome. Please post your comments below or write to Aditya Vikram Singhal at firstname.lastname@example.org