Monday, June 11, 2012

What next for India?

Jim O'Neill of Goldman Sachs, who coined the BRICS acronym, recently described India as the most disappointing performer among them all. He wrote,
On many credible measures of productivity, India scores the lowest among the BRICs. On the Goldman Sachs Growth Environment Score (GES), an index of 18 variables relevant for productivity and sustainable growth, India scores 3.9 on a scale of zero to 10. This is much lower than the 4.9 score for Russia and the 5.4 score for both Brazil and China. In addition, India’s fiscal position is much weaker than the others. In fact, the steady increase in India’s fiscal and current account deficits over the past couple of years may place India in line for the kind of ill-treatment that traditional emerging markets can sometimes experience, and that is currently being dished out to the Club Med countries. India’s leaders also suffer from another commonality with much of Europe in that they cannot seem to get anything done.
As I have blogged earlier, the Indian economy is clearly facing strong headwinds. So much so that pundits argue that India, more than even Europe, should be the biggest global economic concern.

The figures are truly dismal. Its GDP growth rate for 2011-12 at 6.5% is a nine year low. Manufacturing contracted by 0.3% in the last quarter of 2011-12. All the three deficits remain high - current account deficit estimated to be 4%, fiscal deficit of 5.8%, and trade deficit of 9.9% for 2011-12. Coupled with this, inflation remains stubbornly high at 7.23% for the latest month.

All this is bad news is taking a toll on the equity, bond, and forex markets. Reflecting the high interest rates, bond yields have steadily risen from just over 6.5% to nearly 8.5% over the past three years. Equity markets have been characterized by volatility and have been on a downward trend since mid-February. And the rupee has been battered, falling precipitously by 27% over the past ten months. Though parallels with 1991 are overdrawn, it highlights the gravity of the crisis.

With public finances badly strained, the economy relies heavily on private sector to sustain growth. But, as a recent study of 2302 listed companies indicated, corporate India's revenue growth in the last quarter of 2011-12 was its slowest for eight quarters. Interest costs in this quarter jumped 47.4%, a record high at 3.47% of revenues, and it was also the eighth consecutive quarter of high, double-digit rise in interest costs. Clearly, the high borrowing costs are weakening corporate balance sheets.

All along, the focus of attention has been on the Reserve Bank of India (RBI), which has raised rates in baby steps thirteen times between March 2010 and October 2011 so as to bring down inflation. But with the economy flagging, it has been forced to reverse the rate cut cycle and has cut rates by an aggressive 50 basis points in April in order to stimulate growth. Now, with the credit policy review due in mid-June, there are expectations of another rate cut. But there is a limit to what RBI can do. The baton has to be passed over to the government which has to step in aggressively.

The standard prescriptions for reviving growth have focussed on the second generation of reforms involving taxation, labour laws, financial markets, and so on. But while these are all necessary, the sustainability of India's growth, even in the medium-term, depends on factors that go beyond these. Here is a list of seven critical challenges that India will have to overcome if it is to sustain high growth rates for a long enough period of time. 

1. The biggest constraint to India's growth are its supply bottlenecks. They include not only the commonly cited infrastructure deficiencies, but also equally important constraints in agriculture production, skilled manpower availability, and long-term capital markets.

A massive investment push in infrastructure is the most urgent and arguably most important need of the hour. For all talk of private sector stepping in, such investments will have to be essentially driven by government resources, especially in areas like urban infrastructure and public transport. Agriculture productivity, which has been stagnating, needs a second Green Revolution. A big push in vocational skill development is critical to providing the foot soldiers for manufacturing and construction sectors. Since governments are fiscally strained, debt will play a major role in raising resources for investments. A mature, liquid, and deep debt market has to be developed to meet this need.

2. All the aforementioned requires restoring the government's fiscal balance. While tax reforms are necessary, the more immediate concern is to address the runaway subsidy outgo. In recent past, all the three major subsidies - food, fertilizers, and energy - have spiralled out of control. Reining them in will be the biggest immediate challenge for the government.  

3. Another constraint is governance deficit. This is pervasive in areas as diverse as regulatory clearances to program implementation and in reining in errant and overzealous officials. Despite the pronounced end of the license raj, red tape is rampant and the country remains one of the most difficult places to do business. A concerted push at simplification of regulatory processes for starting businesses would itself provide the biggest boost to economic growth.

Ministries have to be made accountable to deliver on clearly defined outcomes and goals. The power sector generation targets keep getting continuously revised downwards. The SEZ policy appears to be fizzling out. Failures should be deeply introspected and incentives aligned to encourage performance.

4. Then there is the challenge of too much democracy in decision making. The best example of this is the interminable debate and litigations surrounding the environmental clearances for mining blocks in forest areas. Such decisions invariably come with trade-offs. The challenge is to cushion the losers and victims without halting the development process. 

5. India has to exhibit the maturity of its democracy, especially by insulating parliamentary decision making on important issues from the vagaries of political populism. The Land Acquisition Bill and the universal Goods and Sales Tax Bill are classic examples of important policy measures which are gridlocked in partisan political battles. Political parties have to rise above political considerations and exhibit responsibility to pass important legislations.

6. The Indian polity needs to quickly put behind the spate of corruption scandals and move ahead, but by imbibing the lessons from it and also punishing those responsible. Currently, the government is spending all its energies fighting one scandal after another and its externalities have had far-reaching effects on India's administrative culture. Like with many other things in modern India, the debate on corruption too has fallen prey to the disease of populist rhetoric. With the political masters abdicating, the media trials and grandstanding has left the bureaucracy wary of taking decisions. This has had a corrosive effect on bureaucratic effectiveness. An end to this drift, admittedly difficult to engineer, is an urgent need.

7. Finally, the Indian economy needs a strong dose of confidence. The animal spirits, which have been driven away by years of policy paralysis and political instability, have to be revived immediately. This would require some high-profile, confidence reviving reform measures. Investors, domestic and foreign, have to be signalled the government's commitment to reverse the policy drift. A revival of the retail sector liberalization plan and some very tangible measures to roll back the burgeoning food, fertilizer, and oil subsidy bills would be good places to start.

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