India’s Big Government

by Vivek Kaul

  The basic idea behind the coupon system is fairly straightforward. Rather than run a terribly leaky PDS to distribute subsidised rice and wheat, the government should simply hand over coupons (or simply cash in their Aadhaar-enabled bank accounts) to people who are the intended beneficiaries of the subsidy. These coupons can then be used by people to buy subsidised grains directly from the open market instead of the fair price shops they are currently forced to visit.

  Also, if one shopkeeper tries to adulterate the product, the buyers can always move on and buy from any other shop. Hence, the system would create some competition among the shopkeepers. A similar system which hits at the heart of Big Government can be envisaged for the education system as well.

  Instead of setting up schools in every neighbourhood, as the Right to Education Act mandates, the government can simply hand over education vouchers to the parents of students. The parents can then use these coupons and decide which school in the neighbourhood to send their children to. This system would give parents some sort of bargaining power in deciding which school to send their children to. Also, schools which do well would get more vouchers, which, in turn, would mean more money from the government.

  It would also make teachers more accountable, given that schools which do not attract enough students would either have to be shut down or be merged with other schools. The point is that, unless the system manages to create some sense of competition between schools in order to attract students, the issue of teacher accountability and absenteeism will not get solved on its own.

  Of course, all this would mean that Big Government in education would have to get sidelined. And no government would want anything like that to happen.

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  The world over, the youthful population is fast shrinking and the dependency ratios (where more and more old people are dependent on fewer youth) are going up. But this is not true for India. It is one of the youngest nations in the world. More than 54 per cent of India’s population is under 25 years of age.938 Some of these individuals have already entered the workforce, and some of them will do so in the years to come.

  As per an estimate made by the Ministry of Human Resource Development, 10.46 crore fresh entrants are expected to enter the workforce between now and 2022.939 This means that around 17.5 million (1.75 crore) individuals will enter the workforce, on an average, every year between 2016 and 2022.

  Pay careful attention to the number 17.5 million. This is more than any of the other estimates of the number of individuals entering the workforce every year that we have seen until now. The other estimates are scattered around about one million individuals entering the workforce every month. But this estimate works out to around 1.5 million (15 lakh) individuals entering the workforce every month, which is significantly higher than the earlier estimates.

  Whether it’s one million individuals or 1.5 million individuals who eventually end up entering the workforce every month, only time will tell. But either way, this is India’s demographic dividend. And if this has to be cashed in on, jobs need to be created for India’s masses. But that is not happening. To explain why, we need to understand the fundamental problem with the Indian economy right now.

  The GDP, or the size of any country’s economy, can be measured in various ways. One is through estimating the size of various industries. The other way of measuring the GDP is by measuring the different kinds of expenditure. This essentially is the sum of the private consumption expenditure, the government expenditure, investments and the net exports (i.e., exports minus imports). It is a measure of economic activity in a country during a given period.

  If one were to look at the expenditure way of estimating the GDP, it is easy to see that the gross fixed capital formation in 2016 has fallen in comparison to 2015. Between June 2015 and June 2016, it had fallen by 1.1 per cent (in nominal terms). (See Figure 14.1.)

  Gross fixed capital formation is basically a proxy for the investment happening in the economy. (At a more technical level, it measures the net increase in the physical assets of an economy during the measuring period, but we don’t need to get into that.)

  As can be seen from Figure 14.1, the gross fixed capital formation has seen a rather slow increase over the past five years. In fact, the rate of increase between June 2011 and June 2016 is a rather modest 6.3 per cent (in nominal terms) per year. Any growth in nominal terms does not adjust for inflation.

  If we were to adjust for inflation, the growth in the gross fixed capital formation over the past five years turns out to be a little less than 3 per cent per year. For an economy like India, this is clearly not good enough. Given that investment is growing at a fairly slow pace, it isn’t surprising that not enough jobs are being created.

  Figure 14.1: The gross fixed capital formation between June 2011 and June 2016 (in Rs. crore).

  Source: Centre for Monitoring Indian Economy.

  Now take a look at Figure 14.2. This shows how the gross fixed capital formation (which, I remind you, is a proxy for investment) as a proportion of the nominal GDP has fallen dramatically between June 2011 and June 2016.

  Figure 14.2: The gross fixed capital formation as a proportion of the GDP between June 2011 and June 2016.

  Source: Centre for Monitoring Indian Economy.

  As of June 2011, the gross fixed capital formation as a proportion of the GDP had stood at 35.8 per cent. Since then, it has fallen to 28.3 per cent. This basically means that investment as a part of economic activity (as measured by the GDP) has fallen dramatically over the last five years.

  During the same period, government expenditure has picked up, and this, to some extent, has kept the growth going. But the government does not form a big part of the economy (it’s at around 12-13 per cent of the GDP) to be able to drive overall economic growth all the time. To put it simply, an increase in government expenditure to drive economic growth can be the icing on the cake, but certainly not the cake itself.

  This basically means that investment (or gross fixed capital formation) needs to pick up if the Indian economy needs to keep growing in the days to come. Once investments pick up, only then will jobs be created and the demographic dividend begin to get cashed in on. This would then lead to further economic growth.

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  There are several short-term factors holding Indian investment back. The capacity utilisation rates of the manufacturing sector continue to remain low. For the period from January to March 2016, the 1,058 companies surveyed by the Reserve Bank of India reported a capacity utilisation rate of 74.1 per cent.

  This was almost unchanged from the corresponding capacity utilisation rates of these companies between January and March 2015. This basically means that the companies aren’t fully utilising their existing capacities, and hence, there is no need for expansion. This means no new investments, which, in turn, means no new jobs, and so, ultimately, no cashing in on the demographic dividend.

  Another reason why investment is not picking is because a substantial part of the Indian private sector is highly leveraged (i.e., they have borrowed much more than they are in a position to repay). Furthermore, there have been huge corporate loan defaults, and this has led to distress in the public banking sector. This is a Big Government factor, with the politicians over the years having forced these banks to lend to many crony capitalists, who are no longer in a position to repay their loans. The banks haven’t been able to do much about recovering these loans (as we saw in Chapter 11).

  As of March 31, 2016, the gross non-performing loans (or bad loans) of the public sector banks had stood at 9.32 per cent of the total loans. This has led to a situation wherein these banks are not interested in lending to construction companies, in particular, and corporates, in general.

  One sector which has been particularly impacted is the construction and real estate sector (including the construction materials sector). Between June 2011 and June 2016, the total amount of money riding on outstanding projects in the construction sector had fallen
by 4 per cent.940

  In June 2011, construction projects formed around 12.9 per cent of the total outstanding projects. This has come down to 9.8 per cent in June 2016.941 This is indeed worrying for multiple reasons. The physical infrastructure in India continues to be appalling. For a programme like Make in India to take off, the physical infrastructure needs to improve. For this, the construction sector needs to pick up.

  Furthermore, as we saw in Chapter 6, construction is a huge job creator in India’s natural area of comparative advantage, which is unskilled and low-skilled labour. The sector employs around 4 crore people in direct and indirect jobs. Over and above this, it has major forward (infrastructure, real estate, manufacturing) and backward (steel, cement, etc.) linkages. This leads to a multiplier effect of almost two times, i.e., one rupee spent on the sector adds two rupees to the GDP. Furthermore, the sector creates 2.7 jobs for every Rs. 1 lakh invested.942

  Hence, the job creation potential of the construction and related sectors is huge. This in an era when Indian economic growth is driven by less labour-intensive sectors, like business and financial services as well as information technology and information technology-enabled services. As we saw earlier, these sectors require only one or two people to produce Rs. 10 lakh of real value added to the GDP. This basically means that faster growth in these sectors does not necessarily translate into jobs.943 And this contributes to what economists refer to as jobless growth.

  The question is: Why has construction activity fallen? Some of the reasons, like the bad loans of banks, have already been explained above. In fact, banks have an exposure of Rs. 3 lakh crore to construction firms. Around 45 per cent of these loans are under stress.944 This basically means that the borrower has either stopped repaying the loan or the bank has had to restructure the loan.

  Another major reason for the slowdown in construction is the difficulty in land acquisition. No construction can happen without land being available. This, as we saw in Chapter 8, is another Big Government issue, which can only be solved if the land titles system throughout the country sees a substantial improvement from the way things currently are.

  It is estimated that there are 3 crore cases pending across various courts in India. Of these cases, around 80 per cent are civil cases, and a greater part of civil cases are, in one way or another, essentially landrelated disputes.945

  Hence, clear land titles need to become the order of the day if the construction and real estate businesses need to pick up in a big way. Other than Rajasthan, the state of Karnataka has done good work on this front as well.

  The Revenue Department of the state has computerised land ownership records of 67 lakh farmers in the state. As the document titled Success Stories on the National Land Records Modernisation Programme, released by the Department of Land Resources, Ministry of Rural Development, points out:

  Previously, farmers were solely dependent on the Village Accountant (the village-level functionary of the Revenue Department in Karnataka) to get a copy of the Record of Rights, Tenancy and Crops (RTC). RTC is a document needed for many tasks, such as obtaining bank loans, selling properties, creating partition deeds, etc. There were delays and harassment. Bribes had to be paid. Today, for a fee of Rs. 10, a printed copy of the RTC can be obtained online at computerised land record kiosks (Bhoomi centres) in 203 taluk offices.

  Other states need to move towards such systems in the years to come.

  Getting back to the state of the construction industry in the country, a report commissioned by the business lobby CII (Confederation of Indian Industries) pointed out other reasons for the slowdown in the sector as well. A major reason for the debt of construction companies, feels the CII, are the pending claims from various government bodies. These claims amount to 150 per cent of the debt of the construction companies. The average settlement time for these claims is 7.5 years. In 2014-2015, the National Highways Authority of India paid out only 8 per cent of the claimed amount.946

  Given this, “most companies are barely able to cover interest costs from earnings. Increasing debt levels remain a critical issue affecting financial stability and borrowings. Several factors have contributed to this stress, e.g., in stalled assets in the infrastructure sector and high levels of receivables [i.e., payments due but not received], especially from… government entities”. Claims raised by contractors are “pending either in the arbitration proceedings or in courts”.947

  This leads to the money due to these construction firms getting blocked. They end up borrowing more and, after some time, find it difficult to repay their loans. In the process, there is a slowdown in economic activity and the process of job creation. If the construction sector is to pick up and jobs are to be created, this needs to get unclogged. On August 31, 2016, the Cabinet Committee on Economic Affairs (CCEA), led by the Prime Minister, came up with a solution that is likely to give the construction industry some fillip (until demonetisation played spoilsport with it, as we shall see later in the chapter).

  Before we come to what the Modi government did, it is important to understand that most arbitral awards go against the government bodies, which block payments to construction firms. Take the case of the National Highways Authority of India. Out of a total of 347 arbitral awards, only 38 have gone in favour of the authority.948

  Typically, even after an arbitration award has gone against the government, the money is not released to the construction firm. This is because the case then gets appealed in a higher court.

  To deviate slightly from the issue at hand, in the 1990s, the economist Bibek Debroy headed a project under the Ministry of Finance and discovered that the backlog in India’s legal system was more than 2.5 crore cases. It took up to 20 years to settle a dispute then.

  As Gurcharan Das writes in India Grows at Night on this:949

  What shocked the nation’s conscience was that the main culprit behind judicial delay was the government, which appealed all judgements automatically and proceeded to lose them again in the higher courts…. The problem lay in the fact that the decision to litigate was made at the lowest level in the bureaucracy, but the decision not to litigate was made at the highest level. If this process were to be simply reversed, government litigation would come down.

  This essentially explains what had been happening between different government bodies and construction firms, with cases being appealed in higher courts and the payments getting stuck meanwhile. In fact, courts generally tend to “uphold the arbitrators’ decisions”, but “referring claims to courts leads to a delayed pay-out by about 2.5 years”.

  Taking this factor into consideration, the government has decided that, in a situation wherein an arbitration award goes against a government body, 75 per cent of the contested amount will be paid to the construction firm into an escrow account. This will happen even if the government body decides to challenge the award in a higher court. This will be done against a margin-free bank guarantee. An escrow account is essentially a third-party bank account into which money is transferred.

  The CCEA estimates that “Rs. 70,000 crore is tied up in arbitration. Over 85 per cent of the claims raised against Government bodies are still pending, of which 11 per cent are pending with the Government agencies, 64 per cent with arbitrators and 8.5 per cent with courts”. It is this money that needs to get unclogged if the construction sector is to get going again, at least in the short term.

  The hope is that, with the government deciding to pay 75 per cent of the claimed amount if an arbitration decision goes against it, some money is likely to be released to the construction firms, and so, the total amount will not get blocked. An estimate made by The Financial Express suggests that this decision of the government would release Rs. 20,000 crore to the cash-starved construction companies and help them get going all over again.950

  This would lead to the creation of jobs for low-skilled and unskilled workers, which is India’s natural comparative advantage. It is worth remembering what the Economic Survey of 2015-2
016 points out: “Projections suggest that India’s working-age population share will continue rising till about 2035-2040, meaning that India has another 25 years— one more generation—to exploit this dividend. Demography in other words is opportunity, not destiny.”

  Given this, trying to get the construction sector up and running again is one step towards that direction. But much more needs to be done, and this, as we shall see, includes limiting Big Government in other areas.

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  The Narendra Modi government is also betting big on roads (a part of the construction sector) and the Railways in order to create low-skilled jobs. Let’s take a look at the Railways in a little more detail. As we saw in Chapter 6, the Modi government has major plans for the Indian Railways. The Railways has long been exploited by various railway ministers from the eastern part of the country (with the likes of Abdul Ghani Khan Choudhury, Ram Vilas Paswan, Lalu Prasad Yadav and Mamata Banerjee). These ministers abused India’s largest employer for their own political gains and left it worse off.

  Over the years, the quality of services offered to the passengers fell dramatically. The current Railways Minister, Suresh Prabhu, is trying to set this right. One of the basic problems with Indian Railways is that the freight services subsidise passenger services big time. This has been the case for a long period of time, and things continue to be this way.

  Passenger fares are rarely raised. This has led to a situation wherein people have got used to the idea of ticket prices (especially for the suburban trains which ply primarily in Mumbai, Kolkata, Delhi and Chennai) not going up at all. Any whiff of an increase in the price of passenger tickets typically leads to large protests.

  Hence, the freight earnings bring in a major portion of the revenue for the Indian Railways. In 2014-2015, for every Rs. 100 earned by the Railways, freight operations brought in Rs. 66. On the other hand, passenger services brought in only Rs. 26.