VIEWS WEDNESDAY, 18 SEPTEMBER 2019

NEW DELHI 15

MY VIEW | CAFE ECONOMICS G LO B A L VO I C E S

Even sectoral solutions call for I

A misguided restructuring of export markets
t is certainly necessary for the country to step up efforts to diversify its export mar-
kets in the face of a prolonged slump in outbound shipments. But the govern-

a broader economic outlook ment’s plan for restructuring export markets, which was unveiled last week, is
unreasonable and could erode the global competitiveness of South Korea’s export-
oriented companies. Under the plan, the proportion of four major markets—the
US, China, Japan and the EU—in the country’s total exports is set to decrease from
53.4% in 2018 to 40% in 2022.
It is a misconception that Korea excessively relies on the four largest economies
The Modi government should not limit itself to sectoral policy responses each time there is trouble in one part of the economy for its exports... It should also be noted that it is relatively easy for companies with
an established reputation in advanced countries to make inroads into developing
markets, while it is not so easy for those successful in developing nations to attract
BLOOMBERG customers in developed markets... In its current form, the government’s plan for
restructuring export markets would be not just unachievable but also detrimental
to the country’s trade competitiveness. It does not make sense to overhaul the
export structure focused on advanced markets, which has been established through
five decades of efforts by local companies to overtake world-class foreign rivals.
The Korea Herald

Trump has dug himself into a hole with Iran

NIRANJAN RAJADHYAKSHA
is a member of the academic board of the
Meghnad Desai Academy of Economics C onflicting reports were circulating Monday about who launched the devastat-
ing attack on Saudi oil production facilities Saturday, and from where. Though
Yemen’s Houthi rebels claimed credit, Saudi Arabia and the United States said the
assault did not come from Yemen; both blamed Iran, but without providing
evidence.
What is certain is that the strike represented a major escalation in the conflict
in the Persian Gulf—and that US President Donald Trump, who triggered the crisis
with his “maximum pressure” campaign against Iran, seems to have lost any ability

A
classic Peter Sellers movie from the
Cold War years was based on a sur-
real premise. The Mouse That Roared
tells the hilarious story of the tiny
Duchy of Grand Fenwick, which is
battling an economic crisis after its
wine exports are obliterated by an American com-
pany making a cheap imitation of Pinot Grand
Fenwick wine. Grand Fenwick declares war on the
US, a war it knows it will lose. The zany plan is that
the US would then offer lavish financial aid to the
defeated country to rebuild its economy, as it did to
Germany and Japan in the 1950s, and then all
would be well in Grand Fenwick.
Economic strategies in the real world are thank-
fully less whimsical. In his January 2019 lecture in
memory of Sukhamoy Chakravarty, Vijay Kelkar
noted that one of the main lessons he learnt from
the latter was that strategies for economic growth
should begin with empirically identifying what is
the most dominant structural constraint faced by
an economy, and then designing policies that
would alleviate that constraint.
The initial wave of Indian development thinking
was focused on broadly three sets of constraints—a
domestic savings constraint, a foreign exchange
constraint, and a food constraint. India did not
have adequate domestic savings to fund the ambi-
tious investment programmes outlined in its early
plans. It did not earn enough foreign exchange to
import the capital goods needed for rapid industri-
alization. Inadequate food supply meant that eco-
nomic expansion would be inflationary.
The plans were attempts to ease these structural
constraints through investment by the public sec-
tor in capital goods industries. The mistaken
assumption was that food was a bargain sector that
would see productivity growth with minimal
investment, as long as there were institutional
changes such as agricultural extension services or
cooperative farming.
All three historical constraints have significantly
eased in recent decades. The domestic savings rate
is far higher than before, despite the recent
decline. India still runs a current account deficit
but ample capital inflows have ensured that for-
eign exchange is not a major constraint. India has
not had a balance of payments crisis since 1991. The
food constraint could be easing if one goes by
recent research that suggests that India is now into
a new era of structural food surpluses. There is still
an energy constraint, especially given our depend-
ence on imported oil, but recent developments in
the global energy market could offer relief over the
medium term.
Former chief economic adviser Shankar
Acharya wrote last week in Business Standard that
India could have entered a new period of disap-
pointing economic growth. Other economists ask
whether India is in the midst of a deeper structural
slowdown. There are also wider concerns about
risks to social stability, in case India fails to grow
at a rate that provides opportunities to a young
population.
There is now a strong case to think about the
economy as a whole rather than sectoral decisions
in response to the latest problems dominating the
news headlines. In his forthcoming book, Subra-
maniam Swamy writes that the Narendra Modi
government “has an unstudied familiarity with
microeconomics but not macroeconomics and its
intricacies of inter-sectoral economic dynamics”.
We need a contemporary variant of the famous
M document authored by Montek Singh Ahluwalia
in 1990 as economic reformers in the government
had begun convincing the political leadership that
the old strategy was no longer delivering results.
Mere tinkering at the edges would no longer work.
It eventually took a P.V. Narasimha Rao to junk the
old policies.
Ahluwalia himself has clarified that his strategy
document was a blend of work done by several col-
leagues in government—but its great achievement
was in the way it presented an internally consistent
set of ideas on fiscal, industrial, trade, monetary
and financial policies. The lack of an internally
I sraelis go to the polls on Tuesday for a second general election in six months. If
consistent policy framework could mean that
reforms in one part of the economy create distor-
tions in other parts.
India was staring down the economic abyss in
1990. The worst balance of payments crisis in its
history was only a few months away. India is now a
different country after several decades of rapid
growth. It is not the India of 1990 and definitely not
the Duchy of Grand Fenwick in the Peter Sellers
movie.
The economic strategy for the next couple of
decades needs to grapple with key analytical
issues. Will the collapse of food prices help
industrial sector profits by capping wage growth
or reduce profits because of a collapse in rural
demand? Is weak private sector investment a result
of the high cost of capital or rigid factor markets?
Are fiscal, monetary and trade policies internally
consistent? Then there are emerging constraints
such as climate change and risks to globalization.
There are no simple answers to such questions.
The point is that the Modi government needs a
broader economic policy framework that can
power the Indian economy towards $5 trillion and
beyond—and not limit itself to sectoral policy
responses each time there is trouble in one part of
the economy.
to control it... The attack should not go unanswered, but the best response may not
be a military one. Mr. Trump risks compounding his strategic problems if he acts
hastily or recklessly. The US must first work to definitively establish who was
responsible for the operation and how it was carried out, and make that information
public. Especially since it was Saudi and not US assets that were struck, no retalia-
tory US military action should be undertaken without consultation with Congress.
Mr. Trump recently seemed to recognize the hole he had dug for himself in the
Middle East... Now he finds himself struggling to defend the kingdom’s most pre-
cious economic assets—which are likely vulnerable to new attacks if the conflict
continues.
The Washington Post
Netanyahu’s tired election playbook
opinion polls are any guide, the vote may fail to break the deadlock that has left
the country’s politics in limbo for much of the year. The last election, in April, pro-
duced an inconclusive result. A potential coalition between security hawks and
religious groups had a slim majority in the Knesset, but former defence minister
Avigdor Lieberman, leader of the nationalist Yisrael Beiteinu party, refused to join
unless the government agreed to enact a law to make it harder for ultra-orthodox
Jews to avoid military service. That put Binyamin Netanyahu in a bind: although
religious voters have long viewed the four-term Prime Minister with suspicion, they
remain a core part of his electoral base.
Netanyahu, who this summer overtook David Ben Gurion as Israel’s longest-
serving leader, had every incentive to cling to power. His legal troubles have been
mounting... Several cases involving allegations of corruption, fraud and breach of
trust are expected to come to a head in the autumn... If he wins the election, he is
expected to push through a bill granting immunity for a sitting prime minister. Net-
anyahu, in the closing stages of the campaign, has sought to shore up his support
with what has become his grimly traditional closing message: trampling on Pales-
tinian rights and pandering to the worst inclinations of the settler movement.
The Irish Times
A constructive discourse on Japan-Korea ties
T he Japanese news media are awash with comments about this country’s rela-
tionship with South Korea. Even though the proliferation of arguments on the
topic was triggered by new strains in bilateral ties, we welcome the active debate
on Japan’s diplomacy with its neighbour. But there are many worrisome elements
in one increasingly pronounced trend in public discourse about South Korea. Cer-
tain media outlets seem to be trying to stir up hatred toward South Korea, a senti-
ment often referred to as “kenkan” in Japan. Japan’s relationship with the Korean
Peninsula has a long and deep history... Inevitably, conflict between the two coun-
tries undermines the international standing of both sides while cooperation
increases the chances of the two countries prospering together.
With bilateral ties trapped in a downward spiral, it is the media’s role to discuss
how diplomacy between the two countries should be conducted. But articles simply
designed to denounce the other side do not lead to constructive debate... Negative
comments about South Korea are also proliferating in television programs... The
media [has] every right to criticize any political or social move, either at home or
abroad, that deserves to be criticized. But all debate in a public space should be
underpinned by a solid commitment to rejecting any form of discrimination and
offering perspectives helpful for the development of healthy diplomatic ties.
The Asahi Shimbun

THEIR VIEW

Entrepreneurs can no longer treat debt like equity

that nominal prices always rose and the
GOPAL JAIN & MANISH SABHARWAL replacement cost argument with appreciat-
ing rather than depreciating assets became
a viable argument. Finally, the nationaliza-
tion of banks and legal system choke
ensured that debt defaults had weak conse-
plan—as they often do—equity investors
don’t come to collect their collateral or take
ownership, but debt investors do. The cur-
rent troubles for many Indian banks arise
from their acting like equity investors, but
any returns on the principal cannot com-
their ventures will end up owning between
5% and 25% of their companies by their last
round of private financing or initial public
offer (think Flipkart, Ola, Quickr, Ratnakar
Bank, and many others) in line with global
norms (Jack Ma owns 9% of Alibaba, Reed
Tax and UPI, among others, to extend cash-
flow-based credit. The Indian private equity
industry will grow faster in the next decade
than it has in the past—it already has $130
billion in assets. Initial public offer markets
are already becoming more sophisticated at

H
istorians warn that nothing fails like
success. Philosophers warn that the
most dangerous lies are the lies we
tell ourselves. Doctors warn that the dose
makes the poison; anything powerful
enough to help has the power to hurt. Syn-
thesizing these three warnings is important
for corporate India because the climate—
quences because of slothful or unwilling len-
ders (amenable to “phone banking” and
political influence). Consequently, many
Indian entrepreneurs treated debt like
equity—payable when able.
Debt and equity sit on the same side of any
company’s balance sheet, but are very differ-
ent species. Debt targets security, but equity
pensate debt holders for principal losses. Hastings owns 4% of Netflix, and Jeff Bezos weighing intangible assets, rewarding sus-
When projects fail, equity owns 16% of Amazon). Once tainable cap tables, and offering a govern-
investors can still be on the the current court challen- ance premium.
same side of the table as an The current pain ges of the Insolvency and The current economic slowdown has
entrepreneur. But debt Bankruptcy Code are set- many reasons, but the most important one is
providers have no choice in corporate tled, the immediate, auto- that the old is dying faster than the new is
but to be on the other. matic and strong conse- being born. But this surely represents over-
The future of Indian
finance is an quences of default will due medicine: short-term pain for long-term

are, respectively, co-founders

low competition, slothful lenders, and high
inflation—that encouraged and rewarded
of Gaja Capital and Teamlease
Services
entrepreneurs for taking huge amounts of
debt for their companies and personal finan-
ces no longer exists. This shift is not a pass-
ing shower, but a climate shift with funda-
mental implications for how Indian entre-
preneurs must fund, structure and run their
businesses. Borrowing equity must end.
Before looking ahead, let’s look back. The
love affair of big entrepreneurs with debt
that began in the 1970s was rational. The
licence raj ensured that businesses did not
have clients but hostages, and prices almost
never went down. The lack of fiscal disci-
pline and formal inflation targeting ensured
loves risk. Debt collects interest at periodic
and pre-agreed intervals, while equity waits
for returns. Debt investors expect full princi-
pal repayment; equity investors expect to
lose their principal on some investments (a
few of which typically account for most prof-
its in their portfolio). Equity investors think
differently about scale (linear growth means
lower risk) and transformation (lateral
growth means greater risk); and once a busi-
ness model is validated, scale should be
funded with debt and transformation with
internal accruals and equity. Unfortunately,
companies have funded both scale and
transformation with debt without realizing
that when things don’t go according to
entrepreneurship looks
quite different from the
atonement for
past. Entrepreneurs will
borrow less, with lending
the past errors
against shares and pyramid of mixing up
structures for equity hold-
ings coming down. Entre- debt and equity
preneurs will run less
diversified businesses and
sharply distinguish between their three
roles—as executive authorities on perform-
ance, as board members for quarterly over-
sight, and as shareholders pushing for
accountability. These roles were tradition-
ally concurrent, interlinked and guaranteed.
First-generation entrepreneurs that scale up
ensure that a market for
corporate control will
emerge. We expect 200
companies to change
hands. Banks and debt
markets that traditionally
lent to the rich will become
less aristocratic and more
meritocratic. This means
that the underleverage of retail customers
with real incomes will blunt the overlever-
age of large corporate India. The working
capital crunch of Micro, Small and Medium
Enterprises will not be solved by banks, but
a new generation of lenders that will use the
digital exhaust of the Goods and Services
gain, with India emerging stronger. Entre-
preneurs cannot predict the future, but they
can make themselves worthy of it. The cur-
rent round of pain in corporate finance is an
atonement for past mistakes around the rel-
ative roles of debt and equity, but this churn
is birthing a new world of financial struc-
tures, leverage ratios, accountability and
governance. This will be good for India, the
country’s banks, investors and entrepre-
neurs because money will stop looking at
entrepreneurs through the lens of their par-
ents or bank balances, but evaluate the cour-
age in their heart, the strength of their back,
and the sweat of their brow. Welcome to a
more just and meritocratic India.