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One Letter That Explains Most of India's Economic Problems

Apr 27, 2017

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Dear Reader,

This column originally appeared in the Vivek Kaul Letter edition dated April 21, 2017. I think it is important to see how India's economic problems are interconnected with one another. I try and explain that in this column.

Here is how you can subscribe to my Letter.

Happy Reading!
Vivek

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In the Letters that I have written till date, I have tried to build a logical argument on the basis of data. Given this context, this Letter is different from the usual. The idea for this Letter came from a random conversation with a dear friend who works as a writer in the Mumbai film industry.

Typically, when I write to you, dear reader, I get into a lot of detail with numbers, graphs and tables, in order to explain a single issue. While it is important to have a good understanding of individual issues that plague the Indian economy, at the same time it is important to have a Big Picture understanding as well.

As they say, getting into too much detail about any issue leads to a situation where you can miss the wood for the trees. To set this right, in this piece I will try and explain what I see are the biggest problems which are likely to hold the Indian economy back in the years to come and how they are linked with each other, the 7-8 per cent official economic growth rate notwithstanding.

I have written this Letter in the form of a conversation I had with my friend. Of course, this is not the real conversation I had. Real conversations cannot be as well-structured as any writeup can be. Nevertheless, in an ideal world this is the conversation I should have had, if the idea was to explain to my friend India's economic situation, the way I see it.

So here we go.

It has been many years since I walked the lanes of Versova, a quaint suburb of Mumbai, where the rich strugglers of the Indian film industry also stay along with the stars. (The poorer ones stay in Oshiwara). A 15-minute walk from a coffee shop and I am at my friend's place.

As soon as he opens the door, one of the two cats he has, jumps on me. Funnily, I don't recall the name of the cat. "He is just trying to be friendly, Sir!" my friend says. Once upon a time I had a morbid fear of cats. But living in a building which is full of cats, this fear has gone away.

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I went in and made myself comfortable on the sofa and had a cup of black coffee, which my friend had made. Like any normal Indian I like a dash of sugar in my coffee (though I am perfectly fine with sugarless tea). This is something my friend finds a little odd. "Who puts sugar in black coffee?" he asks rather animatedly. And I ended up with sugarless black coffee, which as they say is an acquired taste. Now that is something that you say when you don't like something and are trying to fit in.

After an hour of talking about films and politics, we somehow end up talking about the Indian economy, of all things. This, even though I make it a point not to talk shop when I am with friends.

And honestly, I don't recall how I ended up talking about one million Indians entering the workforce every month, India's so called demographic dividend. "So, you know one million Indians are entering the workforce every month," I said. "This means 1.2 crore during the year, which is half of Australia's population."

"What is the big deal asked my friend?" asked my friend. "As people age, at some point of time they need to start making a living and enter the workforce."

"True. But as they enter the workforce, they need to find jobs, which they currently aren't."

"Ah. Jobs. Yes. I once had a job, you know, with a newspaper," my friend said, getting a tad melodramatic.

"Yes. You did," I said. "So, there are 1.2 crore individuals Indians entering the workforce every year and there are very few jobs being created for them. And that is a huge problem."

"But I remember reading somewhere last year that India's rate of unemployment was just 5 per cent."

"Yes," I replied.

"How do you reconcile this with the fact that those entering the workforce are not finding jobs?" my friend asked.

"Oh, that is because of the way unemployment is calculated. There are two methods. In one method, anyone who has been employed for 183 days is considered employed. As per this method the rate of unemployment is 5 per cent. In another method, anyone who has been employed for the last 30 days is considered employed. As per this method, the rate of unemployment is even lower at 3.7 per cent. Hence, you could be unemployed for a major part of the year and still be considered employed."

"Ah, this is that classic statistics are like bikinis point..."

"Yes. Interestingly, only 60 per cent of Indians who are looking for a job through the year are able to find one. The figure is close to 52 per cent in rural India. This tells you the real state of India's unemployment scenario rather than the rate of unemployment, which clearly doesn't."

"Yeah, it does. So, what is the real state of India's unemployment. Are there any estimates for that?"

"A recent report titled OECD Economic Surveys India puts the rate of unemployment among India's youth between the ages of 15 and 29 at more than 30 per cent. These youths are neither employed nor in education or training," I replied.

"But tell me something what's wrong with people working in agriculture after all bharat ek krishi pradhan desh hai (India is a country where the main activity of people is farming)," said my friend, coming up with a cliché.

"In agriculture, across the generations the plot sizes of land have become smaller and smaller. You know, the average size of the plot was around 2.82 hectares in 1970-1971 and by 2010-2011 this had fallen to 1.16 hectares. The 2010-2011 data point is the latest data point that is available, and since then the plot sizes for agriculture would have fallen even more," I explained. (one hectare = 2.5 acres).

"How do you remember so many data points," my friend asked.

"You forget this is a quasi-fictional conversation my friend," I replied. "And we are both characters in the hands of the writer, who also happens to be me."

"Ah. So, agriculture is no longer as viable as it used to be," said my friend, getting back to the point.

"Yes. Hence, people need other kinds of jobs."

"Yes, that is clear."

"Interestingly that explains why several land-owning castes across the country which includes Jats in Haryana, Patels in Gujarat, Marathas in Maharashtra and Kapus in Andhra Pradesh want reservations in government jobs. With size of agriculture plots falling across generations, agriculture is no longer as viable as it used to be. Hence, they want government jobs."

"So, what kind of jobs are a majority of this individuals entering the workforce good for?" my friend asked.

"If I were to talk like an economist, India's natural comparative advantage is in low-skilled jobs."


"Come on. I know you never went anywhere near an Economics text book. Try talking in simple English."

"Our school education system has been totally screwed up over the years, with the learning outcomes coming down dramatically," I said, speaking in simple English. "Madhav Chavan, of the Pratham Education Foundation estimates that in the period of the ten years up to 2015, 10 crore children completed primary school without the ability to do some basic reading and mathematics. This makes it very difficult for a lot of people to get into any kind of an office job or even a semi-skilled job, which requires the ability to read, write or do some basic maths," I explained.

"Oh, that doesn't leave much scope for anything but low-end labour jobs."

"Yes. When move people move from agriculture they first move towards low-end construction jobs."

"So why isn't the same happening in India?"

"Because there isn't as much construction happening as there should.""Meaning?"

"Companies aren't expanding because they have borrowed a lot of money and are finding it difficult to repay the bank loans they have taken on. That means less construction. In fact, all the large borrowing by corporates has also left India's government owned public sector banks in a mess. They are also not in a mood to lend to corporates."

"But what about the government, construction isn't just about corporates. India has an extremely poor physical infrastructure, which only the government can build and improve."

"Yes, you are right. The government has been spending money on developing physical infrastructure and that does create jobs in construction. But there is only so much that the government can spend every year without ruining its finances."

"What about real estate?" asked my friend, a question that I was waiting for. "Construction happens there as well.:"

"Yes, real estate is one sector that can actually create jobs for the low-skilled workers who are entering the workforce or moving away from agriculture."

"So, what is the problem?"

"The eight biggest cities form the largest part of the real estate market in the country. And the price rise in real estate in these 8 cities has made most homes being built very expensive and beyond what most people can afford. In fact, this has now reached a stage where the real estate builders aren't building new stuff and at the same time they are having a difficult time trying to sell off what they had built. Hence, things have more or less come to a standstill."

"Basically, the real estate sector is in a moribund state," my friend stated.

"Yes, that is the right word to be used."

"What can revive the sector?"

"A fall in prices and a massive one. But that hasn't happened for a while even though prices have not gone anywhere in the last few years."

"Why is that not happening?"

"There are multiple reasons for the same," I replied. "Most Indian real estate companies are fronts for the ill-gotten wealth of politicians. The builders who operate as fronts have promised a certain rate of return to politicians, and hence, are not able to cut prices. This is one possible explanation. Another explanation that keeps getting offered is the fact that the builders and politicians have made a lot of money over the years, and hence, are in no hurry to cut prices to sell the real estate inventory of homes that has been built up."

"That's too generic," my friend replied. "You need to be a little more specific than just that."

"We need to understand the influx of black money in real estate in a little more detail. The question is why does a builder take a portion of the payment when he sells a flat or a house, in black, i.e., in cash? I think it is very important to understand this. He takes a payment in cash because he needs to make payments in cash. He needs to pay his suppliers in cash. But more importantly he needs to pay politicians and bureaucrats in cash."

"Now that is getting interesting."

"Unless a builder has politicians and bureaucrats in his pocket, it is very difficult for him or her to be in the business of real estate, given how complicated the regulations governing the sector are in state after state, in India. The speed money paid to politicians and bureaucrats essentially helps builders stay in the game. And this speed money cannot be paid in cheque or through NEFT/RTGS/IMPS and so on. It has to be paid in cash.""Yes."

"And this cash can only come from the buyer who is buying the flat or the homes that the builder has built. Hence, genuine buyers turn their white money into black, every time they buy a house to live in. And then there are investors who are looking to put their black money to some use. For them real estate remains the best mode of investment. And this black money also ensures that prices don't fall."

"Yes. This makes sense."

"The politician other than seeking a bribe in the form of cash needs cash to fight elections. Fighting elections in India has become a very expensive proposition over the years. Even in a municipal election in a big city, a serious candidate has to spend a crore or two, with the risk of not getting elected. Where does a lot of this money come from? From real estate. This also explains why the rules and regulations governing real estate in states across India remain so convoluted. This allows state level politicians to demand their cut every time a new real estate project is proposed. It also explains why real estate has not been brought under the ambit of Goods and Services Tax."

"Hmmm."

"So, the point is that unless electoral financing in India is cleaned up, the real estate sector won't get cleaned up. Unless real estate sector gets cleaned up, construction in the sector won't pick up. And unless construction picks up, the sector won't be able to create any jobs. And unless there are jobs in this sector, many of the one million Indians entering the workforce every month will continue to remain unemployed. India's so called demographic dividend might turn into a demographic disaster."

"Now that was very interesting," my friend said.

"Interesting. But a tad simplistic as big picture conversations are."

"And how do I get into the details?"

"You can read my new book India's Big Government-The Intrusive State and How It is Hurting Us," I replied.

By then the kebabs had come and it was time to eat.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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3 Responses to "One Letter That Explains Most of India's Economic Problems"

Libin

May 3, 2017

one letter

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Mahavir Mittal

Apr 28, 2017

I read your articles in my mail box daily and like the most of them. In this particular discussion, may I inform you that the service tax is being charged by the government through the realtors on each instalment we pay for booked flat or office space. When the GST is implemented, I think the same would be applicable on this sector too.

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Gurdeep Chhabra

Apr 27, 2017

Very well explained sir, You Nailed it!

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