VOLUME 1, ISSUE 2 SEPTEMBER 2016

The Real Problem with the Indian

Economy is…
Vivek Kaul
There is too much news on TV –
Anders Roslund and Börge Hellström,
Pen 33
And in newspapers.
And on the internet.
And on mobile apps.
And in the process you miss you
out on the news that matters.
On August 31, the ministry
of statistics and programme
implementation declared the gross
domestic product (GDP) numbers for
the period between April and June
2016.
The GDP is a measure of economic
activity.
For the period between April and
June 2016, the real GDP growth was
at 7.1 per cent in comparison to the
same period in 2015. The real GDP
growth is obtained by adjusting
nominal GDP growth for inflation.
The nominal GDP between April and
tell you, for the lack of space (in
case of newspapers) or for a lack of
understanding and the unsuitability
of the medium (in case of TV), is why
had this growth slowed down to the
slowest in five quarters.
A perpetual reason is agriculture.
Agriculture does not grow as fast as
other sectors of the economy. It grew
by 1.8 per cent in real terms during
the period. It had grown by 2.6 per
cent in the period between April and
June 2015.
And this is where most the analysis
stopped, unless you happened to read
the edit pages of a few newspapers
very carefully (Now how many of
us get around to doing that in the
rigmarole of daily life, is a question
we will leave for another day).
The GDP is measured in various
ways. The government of India
measures it in two ways. One is
through estimating
the size of various 'ƌŽƐƐ&ŝdžĞĚĂƉŝƚĂů&ŽƌŵĂƚŝŽŶ;ŝŶZƐĐƌŽƌĞͿ
industries. ϭ͕ϭϬϬ͕ϬϬϬ
expenditure, investments and net
exports (i.e. exports minus imports).
If one were to look at the
expenditure way of estimating the
GDP, it is easy to see that the gross
fixed capital formation has fallen in
comparison to 2015. Between June
2015 and June 2016, the gross fixed
capital formation fell by 1.1 per cent
(in nominal terms).
Now before you start breaking
your head, on what is this gross
fixed capital formation, let me define
it for you. It is basically a proxy
for investment happening in the
economy. (At a more technical level it
measures the net increase in physical
assets in an economy during the
measuring period. But we need not
get into that).
As can be seen from the chart
below, the gross fixed capital
formation has seen a rather slow


June 2016 stood at 10.4 per cent.

And another is ϭ͕ϬϬϬ͕ϬϬϬ
The rate of inflation used to adjust
by measuring ϵϬϬ͕ϬϬϬ
the nominal growth to arrive at the
expenditure. This ϴϬϬ͕ϬϬϬ
real growth is referred to as the GDP
essentially is a ϳϬϬ͕ϬϬϬ
deflator.
sum of private ϲϬϬ͕ϬϬϬ
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the story that the GDP growth had expenditure,

been the slowest in five quarters. government
What they did not get around to Source: Centre for Monitoring Economy

1
 The Vivek Kaul Letter

increase over the last five years. In terms). In real terms,

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fact, the rate of increase between ;ŝŶZƐĐƌŽƌĞͿ the government
June 2011 and June 2016, is a rather ϱϬϬ͕ϬϬϬ expenditure has
modest 6.3 per cent (in nominal ϰϱϬ͕ϬϬϬ moved from 9.7 per
terms) per year. ϰϬϬ͕ϬϬϬ cent to around 12
If we were to adjust for inflation,
ϯϱϬ͕ϬϬϬ
per cent.
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the growth in gross fixed capital ϮϱϬ͕ϬϬϬ In fact, between
formation over the last five years has ϮϬϬ͕ϬϬϬ June 2015 and
been a little less than 3 per cent per ϭϱϬ͕ϬϬϬ June 2016, the

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year. For an economy like India this is government

clearly not good enough. expenditure
Source: Centre for Monitoring Indian Economy has grown by a
In fact, look at the following chart.
It shows how the proportion of gross whopping 24 per
In nominal terms (as seen in the cent (in nominal
fixed capital formation (a proxy above chart) the growth has been a
for investment) as a proportion of terms). In real terms, the increase
whopping 18.3 per cent per year. In has been 18.8 per cent. Such an
nominal GDP, has fallen dramatically real terms (adjusted for inflation)
over the last five years. increase is not sustainable given that
the growth has been there is only so much money that a
11.3 per cent per government can spend.
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year.
ϯϳ͘ϬϬй The government also has to keep its
ϯϱ͘ϬϬй
The trouble is fiscal deficit in mind while spending.
that even with this Fiscal deficit is the difference
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huge increase in between what a government spends
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expenditure over the and what it earns. In 2016-2017, the
Ϯϵ͘ϬϬй
last five years, the government is trying to achieve a
Ϯϳ͘ϬϬй
government does fiscal deficit of Rs 5,33,904 crore or
Ϯϱ͘ϬϬй not form a large 3.5 per cent of the GDP.
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portion of the Indian

Between April 2016 and June

economy. Take a
Source: Centre for Monitoring Indian Economy 2016, the first three months of this
look at the following
financial year, the government had
chart.
As of June 2011, the gross fixed already reached 61.1 per cent of the
capital formation as a proportion In June 2011, the government fiscal deficit target for this year. One
of GDP stood at 35.8 per cent. Since reason for this is
then it has fallen to 28.3 per cent. In 'ŽǀĞƌŶŵĞŶƚĞdžƉĞŶĚŝƚƵƌĞͬ'W that a good portion
real terms, it has fallen from 35.4 per ϭϯ͘ϱϬй of the revenue for
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cent to 29.6 per cent. the government
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So how has the overall GDP comes in the second
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growth (or economic growth) been ϭϭ͘ϱϬй
half of the year,
decent enough over the last five ϭϭ͘ϬϬй even though the
years, despite the slow growth in ϭϬ͘ϱϬй expenditure tends
investments.
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Nevertheless, even
Take a look at the following chart. ϵ͘ϬϬй
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It shows the government expenditure 
mind, this jump
over the last five years. Source: Centre for Monitoring Indian Economy
in government
As is clear, the government expenditure is not
expenditure over the last five years expenditure formed around 9.5 per sustainable.
has gone up at a very fast pace. cent of the GDP. In June 2016, this
stood at 12.9 per cent (in nominal Also, at around 13 per cent of the

2
 The Vivek Kaul Letter

economy, government expenditure is

not big enough to be driving overall
economic growth, all the time. To put
is simply, an increase in government
expenditure to drive economic
growth, can be the icing on the cake,
and 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. Several
factors are holding this back.
The capacity utilisation rates of
the manufacturing sector continue
to remain low. For the period January
to March 2016, the 1058 companies Source: istockphoto Note: The picture is only for representational purposes
surveyed by the Reserve Bank of
particularly impacted is the levels of growth in employment at 3.7
India, reported a capacity utilisation
construction and real estate sector per cent per year and 7.1 per cent per
rate of 74.1 per cent.
(including the construction materials year, respectively.3
This was almost unchanged from sector). Between June 2011 and June The construction sector employs
the capacity utilisation rate of these 2016, the total amount of money around 4 crore people in direct and
companies between January to March riding on outstanding projects in indirect jobs. Over and above this it
2015. This basically means that the construction has fallen by 4 per cent.1 has major forward (infrastructure,
companies aren’t fully utilising their
In June 2011, construction real estate, manufacturing) and
existing capacities, hence, there is no
projects formed around 12.9 per cent backward (steel, cement, etc.)
need for expansion. This means no
of the total outstanding projects. This linkages. This leads to a multiplier
new investments.
has come down to 9.76 per cent in effect of almost two times i.e. one
Another reason why investment June 2016.2 Indeed, this is worrying rupee spent on the sector, adds two
is not picking is because a substantial for multiple reasons. The physical rupees to the GDP. Further, the sector
part of the Indian private sector infrastructure in India continues to creates 2.7 jobs for every Rs 1 lakh
is highly leveraged (i.e. they have be appalling. For a programme like invested.4
borrowed much more than they Make in India to take off, the physical Hence, the job creation potential
are in a position to repay). Further, infrastructure needs to improve. For of the construction and related
there have been huge corporate this, the construction sector needs to sectors is huge. This in an era where
loan defaults and this has led to the pick up. the Indian economic growth is driven
public sector banking sector being in
Further, construction is a huge by less labour intensive sectors like
distress.
job creator in India’s natural area business and financial services as
As of March 31, 2016, the gross of comparative advantage, which is well as information technology and
non-performing loans (or bad loans) unskilled and low-skilled labour. In information technology enabled
of public sector banks stood at 9.32 1984, the construction sector had an services. These sectors require only
per cent of total loans. This has led to employment share of 3.1 per cent. The one or two people to produce Rs 10
a situation where these banks are not real estate sector had a share of 0.02 lakh of real value added GDP. This
interested in lending to corporates per cent. By 2010, the construction basically means that faster growth
in particular and construction sector had a share of 8 per cent in these sectors does not necessarily
companies in general. whereas the real estate sector had a translate into jobs.5 And this
One sector which has been share of 1.1 per cent of employment. contributes to what economists refer
The two sectors showed the fastest to as jobless growth.

3

The question is why has
construction activity fallen? Some of
the reasons like bad loans of banks I
have already 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.6
This basically means that the
borrower has stopped repaying the
loan or the bank has had to restructure
the loans. Restructuring a loan
essentially refers to a situation where
the borrower is given a moratorium.
During this period, the borrower need
not repay the principal on the loan.
He just needs to pay interest. The
idea is to help him get in a position,
where he can repay the principal as
well. It also involves extending the
period of repayment of the loan.
Another major reason for a
slowdown in construction remains
the difficulty surrounding land
acquisition. No construction can
happen without land being available.
Over and above this, a report
commissioned by the business
lobby CII points out other reasons
for the slowdown in the sector as
well. A major reason for the debt of
construction companies feels CII
are the pending claims from various
government bodies. These claims
amount to 150 per cent of the debt of
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.7
As a recent press release put
out by the Cabinet Committee on
Economic Affairs (CCEA) points out:
“Most companies are barely able to
cover interest costs from earnings.
Increasing debt levels remain a critical
issue affecting financial stability and
The Vivek Kaul Letter
borrowings. Several factors have
contributed to this stress e.g. in stalled
assets in infrastructure sector and high
levels of receivables [emphasis is
mine] especially from the government
entities.” Claims raised by contractors
are “pending either in the arbitration
proceedings or in courts”.8
This leads to money for
construction firms getting blocked
and in the process there is a
slowdown in economic activity and
the process of job creation. This
needs to be unclogged. On August
31, 2016, the Cabinet Committee on
Economic Affairs led by the prime
minister Narendra Modi, came up
with a solution that is likely to give
the construction industry some fillip.
In fact, most arbitral awards go
against the government bodies.
Take the case of National Highways
Authority of India. Out of a total of
347 arbitral awards, only 38 have
gone in favour of the authority.9
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. The
government of India is the biggest
litigator in the country. This is
primarily because the decision to
litigate can be made at any level, but
the decision not to litigate gets made
at the highest level.
In fact, courts generally tend to
“uphold the arbitrators' decisions”
but “referring claims to courts leads to
delayed pay-out by about 2.5 years”.
Taking this factor into mind, the
government has decided that in a
situation 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, even
4
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 crores is tied up in arbitration.
Over 85% of the claims raised against
Government bodies are still pending
of which 11% is pending with the
Government agencies, 64% with
arbitrators and 8.5% with courts.”
It is this money that needs to be
unclogged, if the construction sector
is to get going again.
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 the
total amount will not be blocked.
An estimate made by The Financial
Express suggests that this decision of
the government will release Rs 20,000
crore to the cash starved construction
companies and help them get going
all over again.
This will lead to creation of
jobs for low-skilled and unskilled
workers, which is India’s natural
comparative advantage. It will also
help the country cash in on some of
its demographic dividend.
Various estimates suggest that
around one million new workers are
entering the workforce every year.
Demographic dividend is a situation
where the working population growth
is faster than the overall population
growth. If jobs are available for the
individuals entering the workforce, it
leads to faster economic growth. This
pulls more and more people out of
poverty.
The ministry of human resources
 The Vivek Kaul Letter

development recently released a
document titled Some Inputs for Draft
National Education Policy 2016. This
document states that: “It is estimated
that there will be 104.62 million fresh
entrants into the workforce by 2022.”
This essentially means that there are
around 105 million young Indians
who are likely to enter the workforce
over the next six years.
This means around 1.5 million
Indians will enter the workforce every
month, over the next few years. This
number is greater than the estimate
of one million Indians entering
the workforce ever year, put out by
several other experts.
If India has to cash in on the 25 years—one more generation—to
demographic dividend in the years to exploit this dividend. Demography in
come, it needs to create jobs. And other words is opportunity not destiny.”
given the fact that we have a low- It is time we got our act right on this
skilled and unskilled workforce, front. Trying to get the construction
creating jobs at the lower end becomes sector up and running again is one
exceptionally important. This means step towards that direction.
that sectors like construction and real
Regards,
estate need to see a real boom. That
is something which isn’t happening
currently.
It is worth remembering what
the Economic Survey of 2015-2016
points out: “Projections suggest that Vivek Kaul
India’s working-age population share September 06, 2016
will continue rising till about 2035-
2040, meaning that India has another

Endnotes:
1. Centre for Monitoring Indian Economy data
2. Ibid
3. A.Amirapu and A.Subramanian, Manufacturing or Services? An Indian Illustration of a Development Dilemma, Working Paper 409,
Centre for Global Development, June 2015
4. Backgrounder: Initiatives to revive the Construction Sector, Cabinet Committee on Economic Affairs(CCEA), Press Information
Bureau Release, August 31, 2016
5. D.Joshi and V.Mahambare, HIRE & LOWER--Slowdown compounds India's job-creation challenge, Crisil Research, January 2014
6. Cabinet approves Initiatives to revive the Construction Sector, CCEA, August 31, 2016
7. Backgrounder, CCEA August 31, 2016
8. Ibid
9. Cabinet approves Initiatives to revive the Construction Sector, CCEA, August 31, 2016

5
 The Vivek Kaul Letter

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