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You mention crony capitalism in corruption in the last 5 years leading to low investor confidence in India. Crony capitalism was seen in the mid 1980s when the Bofors gun scandal broke out. It was followed by over 20 major scams involving the Westland helicopters deal struck between two prime ministers, import of medical equipment by top Indian hospitals under a hastily formulated customs duty exemption scheme, the Lakhubhai Pathak case and Saint Kitts forgery case which dragged the then sitting Prime Minister Narasimha Rao into the courtrooms, the fodder scam involving Lalu Yadav, the housing allotment scam (monitored later by the Indian Supreme Court), the gas station allotment scam (monitored also by the Supreme Court involving the then petroleum minister). The list is long, and endless. Yet, the Indian economy grew in the 1990s and the first decade of the 21st century in spite of those scams. Why is corruption affecting investment today? What is different?
The difference is size. Growth figures are higher when the size of the economy is small but growth figures are smaller when the size is large. In 1990s and first decade of 21st century, India was able to growth at 10% (despite corruption) because size of the Indian economy was smaller but now with a larger economy it is difficult to achieve a 10% growth (with rampant corruption around). Moreover, when the corruption cases (you mention) happened, India was not having a centre stage in the world economy. But now with the whole world observing India, the new corruption cases loom larger (psychologists say that negatives always loom larger than positives) and it is having an adverse effect on investor sentiment.
The decline in the Indian rupee by nearly 16 per cent against the US dollar since May is a symptom of a much deeper malaise in the Indian economy. Three crucial reasons which originate due to the deep malaise in the Indian economy and drive the decline of the Indian rupee are as follows: Since the financial crisis in 2008 Indian markets had greater focus on attracting short term money from foreign institutional investors (FIIs). This short term money was available in Indian markets because FIIs had less investment opportunities in the developed markets of Western Europe and North America. Moreover, short term money became more easily available because of quantitative easing in the developed markets. But, with the turnaround of recession hit developed markets foreign institutional investors (FIIs) have greater investment opportunities in Western Europe and North America. This has led to the withdrawal of investment by FIIs from Indian markets resulting in the decline of the Indian rupee. This situation is aggravated with the tapering of quantitative easing which results in lesser liquidity with FIIs and is forcing FIIs to withdraw money from Indian markets. This too is driving the decline of the rupee.
Secondly, India has been rigged by crony capitalism and corruption in the last 5 years. In the last 5 years a series of corruption cases (each involving of billions of dollars) benefitting the cronies of the political class have been reported in the media. This has battered the image of India as a reliable investment destination and has hit investor (both domestic and foreign) confidence adversely. The low investor confidence has resulted in India losing out on investment from both domestic and foreign players. Lower investment by domestic and foreign players in the Indian market has led to lesser capital formation, lesser employment, lesser tax collection and lesser consumption. All of these have a combined effect on driving the decline of the rupee.
Finally, the lack of reforms (which has been termed by the media as “policy paralysis”) has made the Indian manufacturing sector less competitive than its counterparts in other developing countries. This lower competitiveness has hit Indian manufacturing exports and has seen a surge in the import of manufactured items, in turn increasing the current account deficit for the country. An increased current account deficit depletes India’s foreign exchange reserves and pushes the decline of the rupee.
Is there a definite turnaround in the recession-hit markets in Europe and North America. Or are we reading too much into the situation too quickly?
The fundamentals seem to suggest that the economy will improve. It may not go back to its heydays but there is indeed improvement.
During the past five years, one American President, one British Prime Minister, one French President and numerous other world leaders have visited India with top CEOs in tow. Numerous deals have been signed between India and these countries. Would you still maintain investor confidence is low?
Low and high are relative terms. A 5% growth looks low in comparison to 8% but looks high in comparison to 1%. The visits happened because everybody was expecting a growth of 8%. Now with the growth at 5% indeed the expectation has not been met.
Do we have figures of the extent of investment withdrawn by FIIs from the Indian market that has resulted in the decline of the Indian rupee?
I have not collected those figures. But those figures should be easily available from media reports.
If FIIs that are withdrawing money from the Indian market, are they really investing that money in the European and American markets, in view of the statement that “… results in lesser liquidity with FIIs…”
“Lesser liquidity” means it is less in all markets. The tapering of quantitative easing has resulted in less liquidity in all markets. Just that India’s dependence on such money looks more.
What steps must the Indian Government take to make the Indian manufacturing sector more competitive?
Several long term steps need to be taken. The steps will include from improvements in training and education to greater investment in R and D ability to purchase best in class technologies.
While the FDI flow into India may have been slow, and exports not picking significantly in the past two years, the quantum of deposits by NRIs into Indian banks has surged considerably in the last five years according to World Bank figures. How do these situations combine to affect the value of the rupee vis-à-vis the dollar?
The size of the Indian economy is so large now that I will not expect the rise in remittances to outweigh the decline in the
exports.
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