The real reason why India has a high-cost economy

Brookfield Place in Manhattan, New York, is a trendy office building-cum-mall situated right across the road from the World Trade Centre. During a recent visit, I would take a ferry every morning across the Hudson River from Jersey City to have my first cup of coffee there. It cost $1.75 for a cup of aromatic coffee.

Back home in Greater Noida, a suburb of New Delhi, our local Café Coffee Day has just hiked prices: a cup of regular coffee now costs about Rs 150, which is a little over $2. More expensive than Manhattan! And here I overlook a run-down commercial complex with haphazard parking and garbage and rubble piled up at every corner.

The guy who mans the counter complains that business is bad and the outlet is losing money despite the price hike. People have cut back on spending, especially the local property brokers who would splurge earlier. Now with realty in the dumps, big spending is a thing of the past. Sales have halved. Most customers are not willing to pay Rs 150 for a cup of coffee.

Something clearly is very wrong with prices in general around where I live. Taxis, clothes, restaurants, liquor and most consumer goods are extremely high in relation to income levels.

The average per capita income in Delhi, according to the latest state economic survey, is Rs 3.65 lakhs, or about Rs 30,000 a month. In comparison, in New York it is about $4,000 per month. Apart from rents (which are astronomical), most items are cheaper in New York than in New Delhi, if one compares prices to income. A Rs 150 cup of coffee is 0.5 per cent of an average Delhiite’s income, whereas a $2 coffee is only 0.05 per cent of a New Yorker’s earnings.

The question is why is a cup of coffee relatively and absolutely far more expensive in Greater Noida than in New York? The answer, as any economist would tell you, is higher factor costs. Almost everything except labour is more expensive in most urban centres in India.

The two biggest costs are rents and money. The latter is somewhat inevitable in a capital-scarce economy like India. Given the high demand for capital, interest rates, which constitute the cost of money, is bound to be much higher here than in the United States.

But rent? It shouldn’t be that high, but is because for years the politician-builder nexus has tightly controlled the supply of real estate, both commercial and residential, in order to make inflated profits and grease the slush money economy.

Even a small shopkeeper in Greater Noida has to fork out more than a lakh of rupees a month for a tiny retail space. He can’t be viable unless the prices are high. This model worked during boom times, when money was cheap, easy or virtually free for a section of people, the big spenders.

Easy money, a lot of it generated by politically manipulated mega loans, poured into the real estate sector and a slew of companies. The big boys splurged and a vast amount of money trickled down to the lower levels, made up of brokers, small businesses and retailers.

When the bubble burst, as it had to at some stage, the big boys were left with huge debts, un-sellable assets and plunging incomes. Everything slowed down thereafter. The end of the cheap money era coupled with the implementation of GST (which negatively impacted small and micro businesses) and the decline of political influence in bank loan approvals is the cause of the current recession.

This, far from being bad news, is a good thing. For it points to a systemic correction. The unfortunate part is that the government, instead of recognising it as such, is in panic mode and taking steps that could once again flood the economy with cheap money. Attempts at loan melas and forcing interest rates down will only worsen the malady.

The availability or cost of money, as bankers know, is not the real problem. The heart of the problem is consumer demand. This has tanked and for good reason too. Growth was being led by the high end of the market — Rs 300 a shot coffee, multi-crore rupee luxury apartments, restaurants that charged as much as their counterparts in Manhattan, expensive (and heavily taxed) cars, and so on. The market for all that is practically dead — it has shrunk and will not grow, at least in the medium term.

Businesses must reorient to the middle and lower ends of the markets to grow and survive in the medium, even long term. The government must tailor its policies to aid this process, and not dish out sops, hand out easy loans or go on spending more than it earns. Trying to boost demand by providing more cash to consumers is folly.

The government cannot turn around the economy, only businesses, small and large, can do so. The way to move ahead is clear and transparent, but most do not want to see the writing on the wall.

High-end shops in expensive malls are not doing well, but the ones in small crowded bazars are doing just fine. Mall owners need to look at the Thai model for the future. Bangkok malls, for instance, house not just top-end retail but small hawker-type ones as well. The mix of high, middle and low-end retail ensures that the malls in Bangkok thrive at all times. Ours can too, but only if we are prepared to change the model.

The overpriced restaurants in malls these days are empty, while the moderately priced eat-all-you-can ones are bursting at the seams. HDFC chairman Deepak Parekh says there is good demand for affordable homes, but “we have to get over the past sins of buying land at high prices and building luxurious apartments”.

Mr Parekh has his finger on the pulse. Others too sense the changing dynamics of the Indian economy. Among them is economist Rajesh Shukla, whose organisation PRICE measures consumer spending, behaviour and so on throughout the country. He too believes that while the top end of the market has collapsed, the rest of the economy is doing just fine.

Dr Shukla points out that businesses that cater to the middle class and the masses have not experienced any slowdown — buses continue to be bought and fabricated, middle class tourism is booming, and so is e-commerce, food demand continues to grow, genuine buyers are purchasing property (not the speculators), and so on. If there is some reduction in middle class spending, it is because many companies are not offering finance as easily as before for vehicles and consumer durables.

In other words, demand has not collapsed, the pattern of demand has changed, and will continue to change. If Café Coffee Day in Greater Noida wants to do business, it must sell coffee at Rs 75 not Rs 150. But before it can do that, the back of the country’s rentier class would have to be broken. Are our present rulers up to that?