It is obvious by now to almost everybody that it has
become incredibly difficult to set up new projects in India. Whether they are
new greenfield manufacturing sites or critical basic infrastructure,
not much is happening in terms of new project activity. Talk, for instance, to
any banker and they will tell you they have not seen a new greenfield project
seeking approval for almost a year now. On the infrastructure front, the
majority of projects awarded by the National Highways Authority of India over
the last 18 months have yet to start work. They can’t get land, environmental
approvals or financial closure — such is the sad state of our premier
road-building programme. As an aside, power capacity worth 20,000 MW is
stranded for lack of stable and price-competitive fuel linkages. With so much
money stuck in these projects, who will start a new power venture today?
New investments are not taking place for several reasons:
lack of clarity ingovernment policyland acquisition related
issues, delays in environmental clearances, fund shortages, lack of fuel
security and so on. All these issues are well known and discussed ad nauseam in
the financial media. Everybody knows what the issues are. On the other hand,
the solutions – while obvious – seem very difficult to operationalise. In the
absence of a fundamental improvement in the business environment, no
entrepreneur will be prepared to commit capital to new capacity.
What is more important, however, is the consequence of
this investment famine and how it will affect various players in the economy.
The first consequence concerns the impact on economic
growth. Since no investments are being planned by the private sector, a strong
revival in capital expenditure is unlikely. Even though the public sector will
accelerate its spending on new capacity creation, we are not going to get back
to eight to nine per cent economic growth unless there is a surge in private
sector capex. The lack of infrastructure is also a binding constraint; it will
cripple our growth trajectory. The current absence of fresh projects for power
and for roads will hurt us very badly two years from now. We will simply not
have enough power to allow us to grow at eight per cent. Slow GDP growth has inevitable consequences for tax revenue, fiscal stability and job creation.
Second, given limited investment in capacity creation,
supply-side issues will remain a bugbear. Much of our problem with inflation
can be traced to the supply side, and this weakness will not be addressed.
Inflation is not likely to decline in a sustained manner if we don’t ramp up
the supply of all inputs across the economy. In such a scenario, any growth
acceleration will inevitably trigger a fresh burst of rising prices, since
companies use capacity constraints to exert pricing power. Will interest rates
be able to trend down as much as the bulls assume? Can we get back to four or
five per cent inflation?
The third issue deals with the current account deficit.
We are already running deficits of between four and five per cent (among the
highest in the world). With limited new capacity creation across the economy,
we are likely to be stuck with high import growth; clearly, domestic production
capacity will not suffice to meet the economy’s needs. We are already importing
large quantities of coal; we will soon import iron ore (given the closing of
domestic mines), most of our electronics, steel, fertilisers and so on. As
domestic capacity creation stalls, our current trade deficit (over $180
billion) will blow out further at the first signs of an acceleration in
domestic economic growth. What will be the consequences of this surging trade
gap for the rupee? Any slippages on the rupee will fan the flames of inflation.
The other issue is the tilting of the playing field in
favour of the incumbent across industries. Given the difficulty and the high
cost involved in setting up new projects, producers with capacity already set
up have a huge advantage when it comes to production. They will be given the
chance to reap windfall profits.
New players, on the other hand, will either lack capacity or suffer high costs
of production (given the constraints of capacity creation). By tilting the
playing field against new players, one is discouraging the emergence of new,
more aggressive and more efficient players across industries. It will enable an
otherwise incompetent management to effectively squat on assets, seek economic
rents and benefits owing to their historic acquisition of land, environmental
clearances, natural resources and so on — when these inputs were far cheaper
and easier to obtain.
India has historically been very good at creating dynamic
new companies, and this has been one of the greatest attractions of our market.
There has been much churning in the list of the 500 largest companies by market
capitalisation over the last 20 years, even as liberalisation wiped out much of
the advantages of the older, more entrenched companies that thrived in the
licence raj. This fundamentally improved the competitiveness and productivity
of corporate India. By making it so difficult or expensive for newer entrants
to either put up new capacity or expand, one is allowing incumbents to milk
their good fortune of having functional capacity on the ground. Rather than
skill and managerial competence, historical connections and access to cheap
resources will be the greater driver of corporate profitability.
An environment of constrained capacity will also lead to
high margins. I would not be surprised to once again see the current leading
Indian companies holding among the highest margins and returns on capital in
emerging markets. By erecting artificial barriers to entry, Indian policy
makers are creating islands of high profitability, huge returns on assets and a
potentially high-cost economy. I would expect corporate earnings to surge among
these entrenched, incumbent players at the first signs of economic
acceleration. Great news for shareholders, not for consumers of these products.
We are also going to make it very difficult for suppliers
of capital goods in India to compete and survive. The bulk of corporate capex
will go towards de-bottlenecking and productivity improvements (sucking more
out of the existing assets), as opposed to fresh capacity. Again, this focus on
productivity rather than on greenfield capacity is very good for profits and
return on assets, but not for job creation. A lot more jobs are created through
the creation of a new plant than by tweaking the productivity of an existing
factory.
India should improve its business environment if it is to
become an easier place to do business and incentivise capacity creation. The
current choking up of private sector investments has multiple harmful
consequences.
Source : Akash Prakash: The rise of incumbency
