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

    THE DETOX: 12 Steps To Fix India’s Economy - A New Monthly Series

    1. Vanquish the Ghosts of the Licence Raj

    They are strangling genuine entrepreneurship. And nurturing crony capitalism

    By Jaithirth Rao

    Jaithirth Rao

    Jaithirth Rao

    Photo: Tushar Mane

    THE INTERNATIONAL situation is pretty grim. India will not be able to escape the effects of the fallout from the dismal global economic scenario. Our degrees of freedom are limited and circumscribed. In the aftermath of the 2008 crisis, we pumped in a lot of liquidity into our system. That was probably the right thing to do then. But excess money and credit creation almost invariably comes back to bite us. Hence the persistence of inflation.

    Our government experts are given to obfuscation and unwarranted optimism. They have been predicting that inflation will come down and, of course, events have proved that they are pretty bad soothsayers who perhaps flunked Astrology 101.

    In any event, the option of easing off on money and credit no longer exists for us. If we try that, inflation is bound to get out of hand with disastrous social, economic and political consequences.

    Another way to deal with economic slowdowns has been the Keynesian solution of going in with an aggressive fiscal stimulus. Unfortunately, this option is also denied to us. In good times when we had buoyant revenues, our short-sighted government frittered away the opportunity for fiscal responsibility. We have a deficit and national debt situation that is out of control. We may end up being forced to tighten our belts in an undesirable pro-cyclical way, worsening the economic news rather than improving it.

    The monetary actions (by no means mistakes) and the fiscal imprudence (definitely a mistake) have impacted our external situation considerably. The current account deficit has widened; the capital account is not sanguine as investors are deserting our financial markets; the rupee is weakening, increasing the prospects of higher inflation and of bad systemic problems as so many of our corporates have foolishly borrowed in foreign currency and are now stuck with unsustainable liabilities. A “run” on India cannot be ruled out. We may yet be called upon to pay the economic and human costs that the East Asian economies paid in the 1990s.

    Our political masters will probably wring their hands and complain that we can do nothing. Some Luddites will make out a case that we should never have liberalised our economy in the ’90s: If we had remained a closed economy, we would not have faced these problems. While that may be true, it conveniently glosses over the fact that we would also not have had 20 years of robust growth and much-needed poverty reduction.

    Tax departments need to be instructed to not maximise their revenue but implement a fair tax regime

    Fortunately, there are actions we can take where our degrees of freedom are not limited and where our options have not been foreclosed. We still have a situation where the government, for a variety of ill-conceived reasons, has actively (and sometimes passively) choked economic growth in a long-term structural sense. The astute Narasimha Rao had realised this. He saw the crisis of the early ’90s not just in terms of monetary, fiscal and external imbalances. He saw it as an opportunity to structurally “liberate” the Indian economy.

    Illustration: Sudeep Chaudhuri

    More important than Manmohan Singh’s wellpublicised Budget speech was the decision made by the government of the day to bid goodbye to the Industrial Licensing Policy of 1956, which had for about half a century throttled Indian business activity. A factory was allowed to make only 1,000 widgets. If by chance (or by increasing efficiency levels!) the plant produced 1,001 widgets, the intrusive inspector of the draconian State would penalise the business. A more laughable scenario that systematically inhibited economic prosperity could not be envisaged. And yet that was the law of the land.

    Ultimately, it was the partial elimination of the notorious Licence-Permit Raj, more than any IMFinduced correctives, that “unleashed” the Indian economy. Unfortunately, Rao was unable to complete the dismantling of the Licence Raj. Fortunately for our present leaders, this gives them an opportunity to create an impact despite limited options in the fiscal and monetary spheres. What India can undertake is a second and overdue liberalisation to eliminate residues of the Licence Raj that still strangle genuine entrepreneurship while supporting crony capitalism (which incidentally has always been the principal characteristic of the elaborate system of “permits and approvals” that we created in 1956).

    The UPA regime cannot hide behind ‘coalition pressures’ or ‘Opposition negativism’ to kickstart reforms

    THE SECOND round of liberalisation has been confused with specifics in the areas of foreign investment and financial sector reform. The current government does not have the clout to push them through. Instead, it should consider bold executive moves (which require no legislative backing) to aggressively move away from the discretionary environment that perpetuates the worst arbitrary features of the Licence Raj. We still carry the whiff of being a country ruled by whimsical humans (susceptible to cronyism, corruption and arm-twisting) rather than a country ruled by impartial laws.

    Here are some actions in the sphere of executive decision-making that can add several percentage points to our growth rate with virtually no costs except to a limited body of vested interests:
    • The Central government can announce that in any legal dispute they will not go in appeal if they lose the decision at the level of a duly constituted tribunal. Currently, no official is willing to take this approach as by doing so he or she is at the risk of being accused of corruption. So routinely, legal matters are endlessly appealed. If there is a change in government policy, the officials concerned are freed from these pressures. A large number of productive economic activities currently held up in litigation will get freed up to commence or in some cases re-commence. This does not restrict citizens’ rights of appeal and cannot be opposed by the ‘legal rights’ lobby
    • The Centre can announce that in all litigations between two Central government agencies, departments or organisations, there will be compulsory arbitration and the results will be accepted implicitly by the contending parties. No sour grapes; no further appeals. By not requiring the same of state governments, we can avoid any ugly confrontation with the federalists of the country who are currently in top form. This too will result in providing oxygen to many economic situations that are currently in paralysed gridlock. The public sector in India complains of being stifled. At least some of this will stand eliminated, giving a fillip to growth.
    • The tax departments of the Central government need to be instructed loudly, clearly and emphatically that their job is NOT to maximise revenues and cash retentions, but to implement a fair and predictable tax regime where citizens can build productive business enterprises in an environment that is comprehensible and non-whimsical. Consider our muchtouted IT industry. Service tax refunds have been routinely held up because the signal to the officers is that refund outflows are bad. Any official who therefore does not use an arbitrary technicality to deprive the taxpayer of legitimate dues is “suspect”. He or she therefore, once again is perfectly fine with blatantly incorrect positions being endlessly appealed. The situation with the BPO industry is worse. Despite the finance minister’s assurance of appropriate safe harbour provisions in the area of transfer pricing, captive BPOs are being harassed by the “system”. It is no wonder that this employmentintensive industry is running away. No one wants to talk about it. But in the twinkling of an eye, India has conceded its competitive advantage. Within the past five years, the Philippines has outstripped India. Transfer pricing harassment is clearly one of the major reasons precipitating this trend. Verily, we are cutting off our noses to spite our faces. There are numerous such examples where arbitrary tax assessments and delayed refunds are creating an atmosphere that drives away investment and slows down economic activity. The finance minister needs to revisit at a FUNDAMENTAL level the incentive systems of Indian tax officials and departments. I have personally worked in countries as diverse as Venezuela, Saudi Arabia, the UK and the US. I have not found any of these countries having a tax administration as hostile to business as India. This is not something that we should be proud of. A prosperous growing business base is the proverbial goose that lays the golden eggs of taxes. Let us always remember that 30 percent of 100 is almost twice as much as 80 percent of 20. We want many more businesses with taxable incomes of Rs 100 and not of Rs 20. We want captive BPOs to thrive in India (with no offence to the Philippines).
    • It is probably politically too late to revisit the Cairn transaction. But at least going forward, the government should make it clear that it will not use “approval” powers to raise unrelated demands from businesses, be they Indian or foreign investors. If the company acquiring Cairn’s equity was not considered “fit and proper”, then under the government’s rights in the area of “change of control”, let us say so. But to use this process to get advantages for ONGC in matters that are subject to separate due process and arbitration, again makes a mockery of our claims to being ruled by laws rather than humans. More dangerously, this sinister trend does great harm to India as a credible destination for investment (and I repeat, foreign as well as domestic investment), harm that cannot be wiped out by speeches at Davos or elsewhere. The problem here again is that our system suffers from the fact that correct action is invariably subject to attack as being corrupt. It would take a very brave ONGC official to state that the arm-twisting of Cairn was plain wrong. He or she would immediately be accused of being partial to Cairn. That is why it is important that at a “policy level”, the government should announce its stand and make an individual official’s discretionary opinion irrelevant.

    MY PURPOSE in enumerating the three eminently implementable suggestions listed above is to highlight the fact that systematically moving away from the discretionary approval system of the Licence Raj (a system that encouraged patronage, corruption and crony capitalism) is not part of a moral crusade against corruption, although that might be one of its incidental benefits. It is merely to point out the fact that the insufficient liberalisation of our economy can turn out to be a “fortunate” thing for our present government. Rather than bemoan the fact that there is very little elbow room in the fiscal and monetary areas, there are enough structural impediments to economic growth that can be gainfully addressed. The resulting increased economic activity (possibly several percentage points of GDP) will be welcome and we could probably avert riots in urban and metropolitan India, a distinct possibility if growth rates continue to drop and inflation refuses to budge. Additionally, these steps will improve the long-term investment climate. At the risk of repeating myself, I’ll say that reducing arbitrariness improves the investment climate for all — not just foreign investors, but also for domestic private sector investors and public sector investors. And if there is anything we have learnt from macro-economics, it is that increased investment is the only route to future prosperity and poverty elimination.

    Opposition to the first two proposals will, in all likelihood, come from the legal fraternity. Lawyers love endless appeals. The government needs to take them head-on and at the same time assure them that with a decline in legal arbitrariness and delays, there will actually be many more lawsuits in the country. Today, many avoid litigation as the results are seen as unpredictable and slow. Ironically, in an environment of greater certainty, many more litigations will be the norm. Lawyers may not buy this argument. But then the country is run for the welfare of its citizens, not just lawyers. Large sections of honest civil servants are actually likely to support these measures.

    Most importantly, the UPA government cannot hide behind ‘coalition pressures’ or ‘Opposition negativism’ to undertake them. If there are no credible, logical arguments against them, then why not move? Narasimha Rao had the courage. Does the present government?

    One of India’s foremost right-wing economic thinkers, Jaithirth Rao is founder and chairman of Value and Budget Housing Corporation, a company in the affordable housing space.
    [email protected]

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



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