Abheek Barua: Three things to worry about

Acute labour shortage, huge foreign debt and frequent increases in interest rates do not augur well for Indian economy

Three things about the current state of the Indian economy bother me. And no, I’m not going to harp on the clichéd “policy paralysis” that everyone is talking about. In fact, I believe initiatives like the fairly sharp increase in fuel prices, the accelerated clearance of foreign direct investment projects and the pick-up in spending on road projects and other infrastructure seem to suggest that someone is in charge (finally!) and is following a conscious strategy to fight the slowdown.

On top of my list of concerns, however, are the rising wages of both skilled and unskilled workers. Let me illustrate this with a few examples. I have come across an increasing number of companies that are involved in large-scale projects extremely keen on hiring Chinese workers, visa regulations permitting. Chinese workers have been in India for a while now, working on projects for companies like Reliance Industries Limited and Adani Group. They tend to be better paid but their high productivity compensates for this. However, the large wage differential between them and their Indian counterparts did make a case for employing Indian labour. However, this has changed with the massive increase in rural wages over the past few years – rural markets tend to set the base for wages in sectors like construction – and no visible change in productivity. The bottom line is that hardly any competitiveness seems to be left for Indian workers. Incidentally, rural wages climbed 20 per cent in 2010-11, according to the Labour Bureau.

Take the organised sector. Alarm bells are already ringing in the IT sector, where attrition rates have apparently climbed between 20 and 40 per cent, depending on the specific function despite an increase of almost 20 per cent in wages. Larger IT companies are hiring feverishly in countries like Vietnam and the Philippines to keep costs down and retain workers.

In short, we are increasingly getting into an ironic situation where there is an acute shortage of labour in a hugely labour-surplus economy. I will save my analysis of this peculiar imbalance for another column but suffice it to say that we need to take a hard look at our rural policies (especially the agricultural price policy and the National Rural Employment Guarantee Scheme) and the entire business of skill formation. If we don’t, we might as well jettison the notion of demographic dividend.

The second thing that bothers me is the urge among Indian companies to “dollarise” their balance sheets — in other words, borrow to the hilt in dollars and other low-interest currencies. This applies to both project funding and trade credit .These companies can hardly be blamed for preferring dollar loans, given the difference in rates on external and domestic funding, even if companies choose to cover their foreign exchange risk. I suspect that those with a definite – and bearish – view on the dollar aren’t even bothering to cover their entire exposure. The use of trade credit has picked up sharply — in the April-June 2011 period alone these borrowings went up by $11 billion. India’s oil companies, for instance, relied on short-term dollar lines to pay their oil bills instead of turning to the local rupee-dollar market. Thus, despite the sharp rise in oil prices, there was hardly a dent in the rupee.

I don’t want to sound alarmist but here are some facts from the Reserve Bank of India’s (RBI’s) press release on our external debt position in March 2011. As a percentage of GDP, external debt at 17.3 per cent seems well under control. However, the fine print presents a more complex picture. Short-term debt as a percentage of GDP was at a two-decade high of 21.2 per cent measured in terms of original maturity. Measured by residual maturity, short-term debt (due for repayment within a year) was a whopping 42.2 per cent. Again, for the first time in two decades, the amount of reserves slipped below the amount of external debt.

Can a chronically current account deficit like India’s afford to depend increasingly on foreign debt? Or is it making us more susceptible to an external macroeconomic shock? I have no ready answers but it is certainly an issue that our macroeconomic managers need to keep on their radar screens, especially given that global debt markets are turning increasingly jittery. A round of increase in external loan rates could result in a macroeconomic stress that may be difficult to handle.

Finally, I understand that since the RBI has to pick up the slack left behind by a loose fiscal policy, it has taken on its new aggressive avatar. It also claims that it needs to compensate for the lack of policy initiatives on the supply side.Thus, the RBI’s tack is to restrain demand so that it does not run ahead of current capacity. This could do the trick in the short term and bring inflation down. But isn’t it risky to raise interest rates continuously?

Unlike developed economies, India is a chronically supply-deficient economy and the ability to grow at higher rates without setting off inflation pressures depends on how much capacity we can bring on stream. Higher interest rates compromise capacity building by raising the cost of capital, fostering incipient price pressures if economic growth picks up. Does it mean that in order to achieve price stability in the long term, we need to remain stuck for the next few years in what has been termed the “new Hindu rate of growth” of seven to eight per cent?

The author is chief economist, HDFC Bank