Transcription
Nothing but the truth.
Hello, I'm Raj Chengappa of India Today and your host for Nothing But the Truth. This is my weekly x-ray of key issues that matter to you without holding back on the truth.
Prime Minister Narendra Modi rarely asks Indians to fundamentally alter the way they live unless he believes the challenge is serious. During COVID, India learned the language of restraint, work from home, reduce travel, change consumption habits, and a recalibration of our daily lives. Now the Prime Minister is invoking some of those very habits again. But this time not because of a virus but because of economics.
Global oil shocks, mainly from West Asia, uh, to energy markets are colliding with India's own structural vulnerabilities. And the pain is being felt across the board uh, in the country, all across. You can see it. Fuel prices are surging. Foreign investors are pulling money out. Gold imports have exploded and the government has asked, uh, that to be curbed. The rupee is weakening and there are signs that all these negative trends impact India's GDP or gross domestic product growth uh, as much as, uh, some experts say by 1%.
Among the measures Prime Minister Modi, uh, has urged citizens to adopt, uh, for prudent spending was to avoid, uh, buying gold for a year, cut foreign travel and destination weddings, uh, work from home wherever possible, reduce fertilizer edible oil use, promote public transport, uh, and of course carpooling. And as, uh, he added, try and buy Swadeshi products.
So in this episode we will examine how serious is this economic crisis? Is India simply preparing for turbulence or facing something larger? Is austerity the answer and who ultimately bears the pain? To discuss all this, I'm delighted to be joined by one of the of India's foremost economists, Sajid Chinoy, who is managing director and chief economist in India at JP Morgan and as importantly a long-time member of the Prime Minister's Economic Advisory Council. Sajid, welcome to Nothing But the Truth.
Lovely to be here, Raj. Thank you very much for having me. Let me begin with the big question. Prime Minister Modi's public messaging was unusual. He effectively asked Indians to change consumption habits. How do you interpret that signal? Was this precautionary or does the government see a genuine economic storm ahead?
Thank you, Raj. I think it's important to understand the the backdrop here, right? What we're witnessing in the world is the largest energy shock in history, right? And this shock is different from previous shocks in a very important way. You know, coal prices have gone up multiple times in the last few decades. They went up most recently in 2022 when you had the Russia-Ukraine conflict, but that was a price issue, right? So, prices go up. Economists call it a terms-of-trade shock for energy importers like India and there's a well-established playbook about what one should do. The main question was how much of that price increase should be borne by the public sector, how much by the private sector, what are the inflation implications, how should the central bank react.
This shock is very different in that there's actually a concern about shortages. We're now, you know, 3 and 1/2 months into all the well into the third month into the crisis and the state of almost is still closed with no prospect of it opening. Uh 14 million barrels, that's almost 15% of global crude and petroleum products are off stream. Now, normally that would have resulted in significant shortages and very high prices, but we look around and we see that in fact around the world you're not seeing these shortages. What's going on? Well, because the global economy is running down inventories at an unsustainable pace. So, the bulk of these 14 million barrels that are off stream are being offset temporarily by an inventory drawdown. Now, this cannot go on forever. In fact, the estimate that many people have is that inventories will reach their operational minimum sometime in the month of June. So, if the strait doesn't open by the end of June, then shortages become real, then the adverse supply shock really hits the global economy.
Now, the So, the worry here is that we have to prepare potentially down the line for shortages. It's not just a price issue, it's a lack of physical availability. This is actually quite important to recognize because what COVID taught us is when there's a sudden stop of industrial activity, you know, you you have non-linear impacts. When a small business shuts down, it very often doesn't open back up again. When a gig worker goes back to their village, they often don't come back. So, we have to protect against non-linearities. I'll make one final point. I think there are amidst all the gloom and doom, there's a very important encouraging statistic. India has been able to scout aggressively for energy around the world. We saw a hit in March. We saw a hit in April. The good news is our LNG imports, our crude imports have picked up meaningfully in May. So, the good news is we're not seeing widespread shortages yet, but I think we have to be prepared that this could be the lull before the storm if the strait remains closed for the coming months. I think the Prime Minister was kind of looking ahead to say that if we have to brace for shortages, we must begin to anticipate that now.
Okay. I mean, is the West Asia conflict the principal cause of this economic threat? Or in some senses has it simply simply exposed underlying weaknesses in India's economy?
So, there are two three dimensions to this and I and I want to talk about where we're more insulated and where we're more vulnerable. Let's start with the glass half full. Compared to COVID, the good news is we came into the West Asia shock on a good cyclical footing. Right? And I want to emphasize cyclical because 2025 the government had a lot of stimulus aimed at the economy. We saw direct tax cuts in last year's budget Feb 25. GST cuts in September. There was 150 basis points of effective monetary easing. There was regulatory easing that acted as a force multiplier. We had the a strong monsoon and inflation was just 2% last fiscal year, which boosted purchasing power. So, what you saw was these six cyclical tailwinds come together and the economy was just picking up November, December, January, February. In fact, if you look at the auto sector, you know, it's been booming after the GST cuts. If you look at first quarter earnings growth Jan, Feb, March, they're still very strong. So, the good news was unlike COVID, where the economy was slowing in 2019, we came in with stronger starting points. Growth was much stronger. So, the starting point there was more favorable. We could absorb a hit. Similarly, on inflation, you know, we just had 2% inflation last year, good monsoon, strong buffer stocks. You know, the starting points are muted. So, I think on those dimensions, we're better placed.
I think where the focus needs to be and where the pressure is and you alluded to this was on the rupee. Right? That the rupee has seen relentless pressure, but I think it's very important to identify what's going on. For starters, the rupee has been under pressure for a couple of years. Right? This is the first time in many decades that we've seen two back-to-back balance of payments deficits, and we may be bracing for a third consecutive year. But, there's a very important difference between previous episodes and this episode. Typically, when the rupee is under pressure, there's a very familiar evolution. The current account deficit tends to widen. We become more reliant on fickle capital flows. Something happens in the world, those capital flows stall, and the current account can't be financed, and the rupee comes under pressure. And there's a well-established playbook of how to respond to this. Because the current account is widened like in 2013, you respond you respond by what's called expenditure compression. You tighten fiscal you tighten monetary, you bring domestic demand and the current account down. Right.
>> This time, the pressure is emanating from a very different source. The current account deficit in India for the last 3 years has been less than 1% of GDP. It's not the current account. Instead, it's actually capital flows. That India used to attract 2 and 1/2% of GDP in capital flows, and that has slowed very sharply the last few years and virtually dried up in 25, and a lot of this is actually FDI flows. So, for me, I think the main challenge that India has going forward is to attract FDI and to attract capital flows. So, the problem the pressure point has been because capital flows have slowed, we've been unable to finance even a small current account deficit, and now with the war and higher crude prices, the current account deficit's going to widen significantly this year, and capital flows will not be enough to finance it. So, that's where the pressure is, but I think the lesson from this is what we have to do is go back to the drawing board and see how do we attract more FDI flows. I'll say one more point. Some recent research we've done shows that FDI in India the FDI is driven by push factors and pull factors. Push factors tend to be global. When global interest rates are zero, FDI goes to emerging markets. Pull factors tend to be country specific, right? India saw strong pull factors between 2005 and 2010. At that time we had a large private investment cycle and that attracted a lot of FDI. But since 2010, over the last 15 years, FDI into India has been driven largely by push factors. When US interest rates go down, India gets FDI. And the reason FDI has dried up the last 3 years is because in the from 2023, US interest rates have gone up a lot. The Fed has raised rates and US fiscal policy is precarious. So 10-year bond yields have a large term premium. So in a way, tightening global financial conditions have dried up FDI. So the lesson from all of this is once we get through this period of the storm, we have to ask ourselves what does it take to attract solid, stable FDI? And in my mind it goes back to the biggest objective, attracting private investment. So far the government's done the heavy lifting by doing big public investment push. When you get a private investment cycle, then FDI tends to gravitate automatically. So I think that's the biggest pressure point, learning, lesson that we have to draw from this.
Now, if there are two or three things and you start uh you know, done a lot of work on the structure of the economy and other issues as well, two or three things that you would say uh we need to do, the country needs to do to create what you call this pull factor, and what would those be?
Yeah. So Raj, I'll just first take this in two different ways. One is to talk about pull factors for India, but I think we should also appreciate the global environment has changed very dramatically. You know, we had 80 years of a certain global economic order where the US was the guarantor. It was free trade, free capital flows, tariffs coming down. And now instead we've gone we've left that order. We're lurching shock after shock, going to some new equilibrium which we don't know you know, what my that's going to be. And so the first thing we have to do is become a little bit more shock absorbent. Because what we've seen in the last, you know, decade is repeated shocks. We've seen, you know, a tariff war under President Trump in his first term, a tariff war in the second term. We saw pandemic, we've seen two wars play out in tandem. We're seeing an AI shock which could have more you know, meaningful implications. So, I think that one set of policies is to do proactive risk management to better buffer ourselves from this shock. What will that involve? That will involve, you know, we don't want to be too dependent on any one country for for imports. You know, as we know, 90% of our LPG came from the Strait of Hormuz. Significant amount of our gas comes from Qatar. We have a lot of dependence on lithium ion from China. Almost all of our polysilicon comes from China. So, I think the first thing to do is to identify what are the economy's choke points. Where is it that we could face a chokehold? And start accumulating physical buffers of some of these really crucial choke points. China has done that for the last 10 years preparing for a stormy day. Number two, we have to do diversify our imports more. You know, the last couple of months we are sourcing more you know, LNG from the US. We are sourcing more LPG from Australia. Yes, there's a bit of a cost involved in this, but we need to diversify imports so we are not too dependent on any one country. The third is we should be hedging prices. Mexico is one of the large energy exporter and Mexico every year spends you know, 0.1% of GDP in hedging in financial markets all of its energy exports. It's called the Hacienda hedge. India should be hedging prices of crude imports that in financial markets so we are not guessing every year what will crude prices be, what is the impact on inflation or the current account of the fiscal. And I think we should also entertain seriously the thought of bringing in more Chinese FDI so that imports from China cannot be weaponized and some of these domestic capabilities are raised. So I think there's one set of actions about how do you better buffer for shocks. Right.
>> The issue about private capex I think is perhaps the most important pull factor. Mhm. What do we do to boost more private capex? And you one has to look at what is it that's holding capex back? Because you know, the old constraints have gone away. 10 years ago it was the twin balance sheet problem. There was high leverage on corporate balance sheets. There were high NPAs on bank balance sheets. That's all gone away. Bank balance sheets are very clean. Credit growth is running at 16%. Corporate leverage is at decade in lows. Profits are strong. Cash levels are high. Why are corporates not investing? My impression for the last five years has been that for the first time in the long time corporates need to see more demand. Mhm. demand visibility issue for corporates. Specially because of what's happening in China, right? China's got a lot of excess capacity and China is not consuming as much. So, China is exporting all its excess capacity around the world, Latin America, Middle East, Asia, but also to India. So, if you're an Indian businessman and you're seeing these Chinese imports flood in and you're it's hard to compete with it. And capacity utilization hasn't really picked up, right? Then why would you invest specially in a world of so much geopolitical uncertainty? So, I think the first thing to is to recognize why is it that capex is not picking up and then realize that you know, you need demand visibility. Now, I don't I I know maybe too technical, but GDP is basically consumption plus investment plus government spending plus exports. So far, government spending has done the bulk of the heavy lifting in the last 5 years, but that cannot continue forever because of fiscal constraints. So, we want private investment to pick up, but private investment needs to see final demand either from consumption or from exports. And I would argue I can't emphasize enough the importance of export-led growth. You know, we have to grow at 7 or 8% for the next 20 years. Only 13 economies in the in the last 100 years have grown at that percent for 20 years and they all had one thing in common, very strong export growth. So, we need to become structurally more competitive so we can boost exports. Service exports are doing very well. This needs to be complemented by goods exports. So, how do you become structurally more competitive? Boost goods exports, get integrated into global value chains. If you do that, then corporates can see demand visibility, then you get a private investment cycle, then you attract FDI. We're seeing this happen in a couple of sectors. You're seeing this in mobile assembly with what Apple has done. But this needs to be replicated across the board. So I think, you know, there's no escaping that more fundamental issue that we have to tackle.
Now, some of the things you said Sanjay this somewhat long-term. And here we are confronted with a crisis that's almost immediate for households, right? Uh so if you take a look and assess it, uh where does the pain hit first? Is it going to be fuel, inflation, jobs, or consumption? Because you are saying let's get demand, but you on the other side you're saying let's be austere in a lot of the spending, which means that we will not be spending on things, and therefore the demand doesn't pick up domestically, leave alone internationally. So where do you where will you find this if it just look at the short-term, where will this pain hit first on?
So I think I think it's crucial to separate the short-term from the medium-term. Uh I think what I was referring to was more of a medium-term demand issue, and here's the unfortunate part because I just to digress for 30 seconds, we spoke about how uh demand was picking up in the months leading to the West Asia shock. So just when you had some kind of demand recovery, and the week before the West Asia shock, you know, the US tariffs on India went back to 10% because IPA was overturned. So just when you thought things were falling into place, domestic demand was picking up, and you you and tariffs came down, and then you have a war, right? In the very near-term, we need to be firefighting to ensure that uh the this crisis doesn't spill over and extract a larger cost from the economy. Uh I think there are three things one has to do in the near-term. The first is the exchange rate has to become the shock absorber. Uh there's no escaping that. Uh and so, you know, we'll have to live with the fact that when your current account is wider and your capital flows have dried up. Uh I think of the exchange rate as being a shock absorber like a seatbelt in a car. That if you suddenly break, it's the seatbelt that takes the impact to protect the person. Think of the exchange rate taking the shock to protect the domestic economy. There's no escaping that and that causes a natural adjustment. When the exchange rate depreciates, what happens is exports become more competitive. Imports become more expensive. So, you tend to change your consumption habits towards domestic substitutes and the current account deficit narrows. But given the nature of the shock, the exchange rate itself may not be enough. Uh, you know, given what we're facing on the balance of payments and so sometimes when the exchange rate depreciates too rapidly, you get into a self-fulfilling spiral. We need to avoid that and I think we need to think about raising a chunk of capital. There are many options the government can explore. Can we raise a significant chunk of capital, 50-60 billion dollars, as a circuit breaker to change expectations in the exchange rate market and not ensure that we get in a self-fulfilling spiral. I think those are the first two things to do. I think the last thing should be expenditure compression. Fiscal tightening or monetary tightening. Precisely because of where I started. That this is not a situation where the current account deficit is bloated and the economy is overheating like 2013 and we counter that. So, I think the sequence should be first let the exchange rate do its job. If that's not sufficient, try and raise a large quantum of capital and there are ways of doing that. And then only if both of these measures don't work, should we look at expenditure compression. I think that's the near-term ask. Once we get through this shock, then we can go back to saying, what do you do to boost demand and crowding private investment?
So, you are saying in some senses, correct me if I'm wrong, is that let this exchange rate free flow cross even the psychological so-called barrier of 100 to the dollar. Is that something that you're saying that's okay? You don't have to worry. You don't have to get hung up by the fact that suddenly your rupee is depreciating and the government is getting whacked by the opposition for it.
Absolutely. And I I think we should not conflate a strong economy with a strong exchange rate. In fact, very often it's the opposite. As I mentioned, strong growth happens through strong exports. And what do countries do? They sometimes use an undervalued exchange rate to boost exports. So, I think we have to realize that there are no good options when you're hit with such a large shock. If you don't let the exchange rate move, then other things will have to move. You drain your reserves rapidly and you have less buff protection for the future. Or you have to raise interest rates very sharply, which will also hurt consumers. Or you have to tighten fiscal policy very sharply. The benefit of the exchange rate doing the work for you is that it is expansionary. Over time, exports pick up, imports come down, and domestic substitutes pick up. If you don't let the exchange rate do the adjustment, then you're forced into compression, uh which means tighter fiscal, tighter monetary, lower growth, higher rates, and the like. So, there are no good options. But, I will say one thing, exchange rate management is an art, not a science. You don't want the exchange rate to be depreciating too rapidly. Because when it happens too rapidly, then what happens is behavior gets affected and you have foreign investors who have a stock of FDI or ECBs or FPI hedging that. Once you hedge that, then you create more pressure on the rupee. When the rupee weakens more, there's a greater desire to hedge, and you get stuck in a self-fulfilling spiral. We want to avoid that, so we want gradual calibrated exchange rate. But as I said, that should not be the only instrument. We should also be raising capital. So you've got the pressure being spread across multiple instruments.
One point before we wind up is gold, and that has become a major concern, of course, of great interest to India right across. Now the government has repeatedly tried duty increases in the past, and of course monetization schemes. So why has solving India's gold dependence proved so difficult?
I think there are lots of, you know, reasons here. There's this cultural attachment, you know, especially in the old days when you were unbanked, that became your your source of savings, that became your securitizable, collateralizable asset. But I think what you're seeing more recently is more interesting, that gold is morphing from consumption demand, you know, jewelry, to investment demand. So as India's, you know, middle class is becoming more savvy in investing and diversifying across asset classes, you know, they're also buying gold as a hedge, as a source of diversification. Now paradoxically, what happens is when it becomes a source of investment, the higher the price, the more you tend to buy. Right? So you're you're hit with a double whammy because prices go up, your import bill goes up, and and you know, the households are told, "Oh, you should buy gold. Look at how much prices have risen. This is your source of asset." So that's the tricky part about gold. Yes, it is a large part of the current account, but a lot of what happened last year was prices because what you're seeing globally is central banks after the Russia-Ukraine war, when Russia's foreign currency assets were impounded, central banks are diversifying their reserves away from US treasuries into gold, and that's meant the structural highly higher demand for gold. I think we need to be a little bit careful though about gold because what you see is sometimes when duties are excessive, you know, this tends to happen in in other means. You tend to import it illegally. So, on paper your current account deficit goes down because lower recorded gold imports. But then you will see capital outflows increase because that's the way you finance the the you know, the the illegal imports. But therefore I come back to the beginning that I think the current account is less of a binding constraint today than it was in 2013. We should be focusing on capital augmentation measures.
And finally, does India need a third generation of reforms? It is after all Modi Modi 3.0. Is this the right time? And if you had to do it, what would be the two or three things that we need to do?
Absolutely. I think I think the only in this very hostile global environment, the only thing that's going to insulate India from the storm around the world is continuous reform. And I think what India has to do is and this has been true for the last 25 years and governments have been chipping away, but it's a process. So, we have to continue chipping away to say, how do we become structurally more competitive? Look at a Vietnam for example, right? Vietnam's FDI for the last 15 years has been, you know, four to four and a half percent of GDP and it's invariant to global financial conditions because Vietnam is seen as a big winner in China plus one. Exports are booming. It's becoming more tech-savvy. And so I would say that this is a particularly important time because you're seeing multinational companies recalibrate and reorganize themselves. They're looking for destinations outside of China. India should put its hand up to say, come to India. We've seen it succeed for smartphone assembly. We need for it to happen across the board. Now, that's going to take a thousand small steps. It's going to mean and to be, you know, to the government's credit, this process had begun last year when the tariffs came on because we had labor laws being rationalized, we had GST being rationalized, and I know the government's working on deregulation in states. But, I think it's that whole package. How do you make India more competitive by reducing ease of by improving ease of doing business? So, it's going to come down to land, labor, power, uh transportation, logistics. It's also going to mean, and this is the good news, that we have to bring import barriers down. You know, the first thing I learned in graduate school in trade class was an import tariff is the same thing as an export tax. So, if you want to boost exports, you have to bring import tariffs and non-tariff barriers down, QCOs. And the good news is in the last couple of budgets, we've begun to see tariffs come down. There's a review on QCOs. So, I think, Raj, it's the whole package of how do we attract multinational companies here? That's the FDI I was talking about. How do we become structurally more competitive? And one last thing I'll say, you know, employment is the overriding challenge of this generation for all emerging markets, including India, even before AI. How do you make growth more labor intensive? We're in a world in where growth is becoming very automated. Companies are choosing more machines and fewer people. India's got a young population, a big demographic outlook the next 10 years. What do we do to make labor compete better with capital? And that's going to mean the difficult stuff, education, health, skilling, mid-career training, so that when entrepreneurs are making this choice, labor's got some way to compete with capital.
Superb. I know, you know, you're you've run out of time, but the larger point you're making, Sajid, is uh great challenges come with great opportunities as well uh in some senses and we need to cash in on that. Uh Sajid, thank you for your incisive insights and your really converting uh your ability to simplify a very complex subject like economics uh truly remarkable, a genius at that. Thank you very much for being on Nothing But the Truth.
It's It's a pleasure, Raj. Thank you very much. And uh for more details, you can read the latest issue of India Today magazine which has an in-depth cover story called appropriately Tighten Your Belt written by my colleagues at India Today. Thank you for being with me in this episode of Nothing But the Truth. I look forward to having you with me next week.
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