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    From Tehelka Magazine, Vol 9, Issue 02, Dated 14 Jan 2012

    Can Manmohan Singh Pull Off a Repeat Trick?

    A higher political direction is necessary to salvage the economy, says Nitin Desai

    Nitin Desai

    Nitin Desai

    Photo: Tarun Sehrawat

    THE INDIAN economy is in serious trouble. Inflation, a slowdown in growth, the fall in the rupee exchange rate, the loss of investor confidence that is roiling the capital market, the cutbacks in investment decisions, the overhang of short-term external debts are all storm signals of trouble ahead. The government has tended to blame the global economic turmoil for this. But it must own up to some part of the blame. Splurging fiscal resources on populist schemes and leaving the burden of inflation management entirely to monetary policy meant that the RBI persisted with high interest rates long after informed opinion started advising some relaxation. The five-year boom in corporate investment was stopped in its tracks by the inter-ministerial squabbles that delayed clearances and the paralysis in decision- making because of the fear of attracting the attention of anti-corruption vigilantes. The sudden loss of global confidence in the India growth story that hit us in mid-2011 was not anticipated either by the government or by the corporate sector.

    Some senior policy makers now seem to recognise that some change of policy stance is needed. But not much has been done to bring this about. Nor are there any hopeful signs in the world outside. The government is, of course, preoccupied with the anti-corruption agenda that has grabbed public attention. But if this means that economic policy is left to the limited steps that bureaucrats can take, then we will get into serious trouble. A higher political direction is necessary. The prime minister, as the maker of the grand strategy that has transformed the Indian economy since 1991, must now use whatever political capital he has left to steer the ship of state through the storms ahead. A five-point agenda on the following lines can be the basis for this rescue act.

    1 Contain inflation by addressing supply side constraints: The government has been trying to control inflation mainly through measures like interest rate hikes that work on the demand side. They do work, but on the wrong end of the economy. Interest rate increases have led to cutbacks in investment and consumer spending on durables. But they have little impact on food and fuel price inflation. The mid-December numbers on food inflation have been loudly tom-tomed by the government. But a closer look at the numbers shows that the slowing down is almost entirely because of the fall in vegetable prices. Inflation in pulses, milk products, eggs and meat continues unabated. Which is why housewives are not impressed by the government’s claims.

    Very little can be done in the short-term to contain inflation in these non-cereal items, except imports where possible. There is no mechanism of public procurement and distribution for these products, as is the case for cereals, which can provide countervailing power in the market. The limitations of the laws that constrain agricultural markets add to the thinness of the markets and the sudden spikes that hit the headlines and provoke panicky reactions by the government. The only medium-term answer is to change these marketing conditions on the model of the milk cooperative pattern of integrated procurement, processing and urban marketing or, failing that, opening the system to organised private sector retailing. The marketing transformation needed for inflation management is even more necessary as agriculture moves from the production of staple food crops into higher value crops like fruits and vegetables, eggs, meat and so on, that an increasingly affluent consuming class demands.

    The five-year boom in corporate investment was stopped in its tracks by the inter-ministerial spats

    2 Reduce interest rates and restore confidence in capital markets: The Indian growth story since 2003 has depended on the rapid increase in corporate profits and investment. This is now at risk. Corporations are holding back on projects. Capital mobilisation through new issues in the capital market has more or less collapsed. Analysts are forecasting a continuing bloodbath in the stock market. The capital goods sector has shown a much sharper slowdown than other industrial sectors. Many large houses are turning overseas where it is easier to do business.

    This has to be reversed. The most quick-acting aphrodisiac for the capital market would be a significant interest rate cut, which is now overdue and should have come six months ago. It is in any case necessary for macro-economic reasons because of the need to boost investment and durable spending. Beyond that, a more substantial measure to boost sentiment would be to liberalise the rules that limit direct pension fund participation in stock markets.

    The Indian banking system is vulnerable. The non-performing assets on its books will go up and erode their capacity to borrow abroad. Corporates who fail to get refinancing for their external loans may have to turn to Indian banks for help. Direct and indirect bank lending against gold and real estate as collateral may be at risk if the bubble in these markets bursts. Hence prudence requires that interest rate and monetary policy must also be designed to maintain the viability of commercial banks.

    3 Use political capital for domestic liberalisation: Every government, more particularly coalition governments, work with a finite amount of political capital that they can use to push through policies that may not enjoy a broad consensus. The UPA-2 government has been using this scarce resource on external liberalisation, like in the recent mismanaged move on FDI in retail trade. In the present global environment, the immediate pay-off to such opening of options for foreign investors may have a limited impact. Instead, the government should ram through long overdue measures that improve greatly the ease of doing business in India.

    India is way down in the World Bank’s ranking of the ease of doing business. Even within South Asia, it ranks sixth out of eight, with only Bhutan and Afghanistan behind. The government should have a focussed programme that addresses the four or five areas where the country ranks exceptionally low, which are the procedures and time for starting a business, getting construction permits, paying taxes, enforcing contracts and resolving insolvencies. The first three of these are amenable to executive action and the last two require a major effort at judicial reform.

    The reform agenda should not be left to the established bureaucracy. A high-profile effort by the equivalent of a Sam Pitroda or a S Ramdorai or a Nandan Nilekani to get these reforms designed and put through may retrieve some of the loss of credibility that the UPA-2 has suffered in business circles. Moreover, the real beneficiaries of a determined effort to increase the ease of doing business in India will be small and medium enterprises and that surely is more of a vote winner than the liberalisation of FDI, which will appeal to OECD boardrooms.

    Industry is not the only area of domestic liberalisation that the government should worry about. The electricity sector is desperately in need of reform. The losses of power distribution companies, particularly the SEBs, due mainly to the reluctance to reform tariffs, are approaching unmanageable levels. New power projects are languishing for this reason and for the problems with clearances and coal linkages. Fixing this problem can be a huge boost to investor sentiment.

    There is a lot that can be done for the agricultural sector, particularly in opening the agricultural marketing system to much more competition than what one sees in mandis. Education, skill development and healthcare are constrained mainly by a corrupt system of approvals and anything that can be done to clean this up would be a boost to the genuine investor. Urban development and housing could also do with a similar approach of cleaning up and simplification. But one word of caution — do not take on too many issues at one time. Every obsolete regulation has a vested interest behind it. So choose your enemies carefully.

    4 Anticipate and manage external risks prudently: The UPA-2 seems to have a schizoid view of external turmoil — sometimes using it to explain away domestic problems like inflation and sometimes believing that India would not be badly affected by external problems like the difficulties of the Eurozone. The growing loss of confidence in the India growth story and the sharp increase in the perceived risk of staying invested in India that led to the outflow of foreign institutional investors from mid-2011 could have been anticipated.

    The uncertainties in Eurozone are perhaps the most important short-term risk factor for India. A large amount of corporate borrowing abroad in the form of convertible bonds or syndicated borrowings is coming up for repayment over the next year. Much of this debt was a consequence of the wide gap in interest rates opened up by the RBI’s interest rate hikes. European banks may well be reluctant to refinance this partly because of the perceived increase in the riskiness of Indian corporates and partly because of the need for liquidity against further sovereign default risks in Europe. Another risk factor is the large amount of short-term borrowings whose share in our external debt has increased from 4.5 percent at end-March 2003 to 21.2 percent at end-March 2011. This requires prudence in the use of our foreign exchange reserves, which have to be conserved against the eventuality of large repayments of corporate borrowings and a sudden outflow of volatile short-term borrowings.

    The decline in the international value of the rupee has to be seen in a longer context. If one looks at the difference in the rate of inflation in India and in the US than a 15 percent or so decline in the rupee over 2011 would just about maintain an equivalence in purchasing power at the rate prevailing at the start. The decline was arrested by the inflow of foreign investment funds in the first half of the year and when that flow was reversed, the change in the exchange rate was swift and dramatic. There is little that one can do to fight this except to play a little on expectations and tighten the restrictions on speculative activity. Using reserves to counter a change in the rupee’s real value would be futile and unwise given the need to conserve reserves for a potential increase in outflows when borrowings become due for repayment and are not refinanced.

    5 Shift the focus of inclusive growth from handouts to productivity enhancement: Largely for political reasons the government now spends Rs 1.8 trillion on programmes for inclusive growth, two-thirds of this on beneficiary oriented and social service schemes and one-third on physical investments to raise productivity. The Food Security Bill will add even more to this cornucopia of handouts. The actual impact of these schemes in raising the long-term earning potential of poor households is open to question. The government must use the argument of fiscal prudence, which will be justifiable politically in a crisis year, to shift the weight of inclusive growth schemes away from handouts towards measures that improve the productivity of poor households with training asset improvement and last-mile infrastructure.

    This must become part of a longer term strategic goal of broadening the geography of rapid growth in India to bring rain-fed areas, hill areas and tribal-belt districts into the highgrowth economy. One important part of the broadening is to connect the North and the East of the country into the more prosperous and faster growing West and South. In fact, the long-term potential for rapid growth depends on the demographic dividend of a rising proportion of young working persons in the population and this will arise largely in the northern states. Bihar and UP have grown rapidly in recent years and this, more than the employment guarantee scheme that has sometimes been blamed, may be responsible for the sharp reduction in the seasonal labour migration that sustained Punjab and Haryana agriculture. The Central government must rise above narrow political concerns to provide resources for logistical investments, labour training, industrial promotion and credit development in these Opposition-run states.

    One does not know how much time Manmohan Singh has before he decides to step down or on what he will choose to stake his limited political capital. As a person of sterling honesty, he may want to make anti-graft moves his parting gift. But the political class may not support this with any real enthusiasm. He could, on the other hand, go all out to get the political class to accept the tough decisions needed to protect the economy in early 2012 so that it moves onto the path of rapid and inclusive promised in the Twelfth Plan. It would be a fitting finale to a career in high politics that began 20 years ago when he did something similar to rescue the near bankrupt economy and ushered in the era of liberalised market-oriented growth.

    Nitin Desai is a leading economist, a policy maker in sustainable development and was the Under-Secretary for Economic and Social Affairs at the UN.
    [email protected]

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    From Tehelka Magazine, Vol 9, Issue 02, Dated 14 Jan 2012



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