Will the proposed reforms in India’s financial, energy and retail sectors really make a difference? Is this 1991 all over again?

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Aurodeep Nandi's picture

At a conference hosted by India’s Ministry of Finance in December last year, a top bureaucrat had commented, “Two India’s sit side by side. On one side are three hundred and fifty million people belonging to the aspirant middle class who are increasingly demanding better goods and services. They are facing a crisis of expectation. And on the other side are another three hundred and fifty million Indians who are fighting for existential needs.”

What the world perceives as India’s ‘policy paralysis’, could very well be its effort to consolidate the conflicting interests of these two factions. Nothing embodies this dilemma better than the recent debate in India on allowing hundred per cent FDI in multi brand retail. The middle class family that faces a ‘crisis of expectation’ is naturally delighted to know that shopping brands that it gets to see on vacations abroad, will now be available in India. On the other hand farmers, local shop keepers and small scale entrepreneurs are understandably worried of the implications on their sustainability. Similarly while the rest of India is demanding enhanced roads, railways and factories; the displaced populace is agitating for adequate compensation for their acquired land and livelihood. While Indian industries remain starved for coal; tribes are fighting tooth and nail to save their forests from indiscriminate mining. Hence reforms in India are very often dangerously schizophrenic. While the word ‘reforms’ has a wonderfully positive connotation; it also conveniently masks the huge human cost that they may stand to inflict.

The nature of reforms in India is undergoing a paradigm transformation. There are two important differences between the reforms that are currently being debated in India; and those that were introduced since 1991. The 1991 reforms focussed primarily on the markets for final goods and services, as opposed to the factors of production involved. So while various sectors were opened up, state controls trimmed and import tariffs reduced; the factors of production like land, energy, environment, ethics, etc. remained woefully unreformed. So be it the introduction of a bill on land acquisition, or reduction of diesel subsidies, or drafting of an anti-corruption legislation – the reforms are distinctly esoteric to the current phase.

Secondly, most of the 1991 reforms could be taken at the federal level; hence requiring lesser political hassle. In comparison, the current batch of reforms involves the need to engage more closely with states. One reason is purely strategic – India is sinking into a period of coalition politics where state level political parties are increasingly playing kingmakers. For instance the current Congress government is crucially dependent on the support of Samajwadi Party and Bahujan Samaj Party; two of the major political outfits in India’s most populous state, Uttar Pradesh. The Congress government recently faced an existential crisis when the ruling party of the state of West Bengal, Trinamool Congress walked out of its coalition in protest of the retail reforms. Hence the government is currently constrained from taking any decision without the implicit consent of its coalition partners; most of whom are in turn worried about the implications on their state electorate.

The other reason is constitutional. For example the central government does not have the mandate to introduce the Goods and Services Tax (GST) that would convert India into a single market; without having the approval of most of the states. Also most of the factors of production remain under state jurisdiction and hence it is not possible for the Centre to unilaterally take decisions on them. Naturally this makes the decision making process tortuous.

But what made the government revive its reform agenda in 2012? After all, the existing reforms were already paying handsome dividends. Cities like Hyderabad, Chennai and Bangalore evidence the extent to which liberalisation had unleashed India’s IT sector. From the days when only a couple of car companies existed; India has emerged as one of the largest automotive manufacturing hubs in the world. Similarly India found its niche in the pharmaceutical sector. For three consecutive years from 2004 to 2007, the economy clocked GDP growth of over 9%. The global economic crisis struck in 2008, and within a year, India jumped back with 8.5% growth. The Congress led government won its second term in power in 2009, and there was a sense of invincibility and overconfidence. Everyone assumed that galloping at 9% growth was the new normal for India.

Except that it wasn’t. The global economic climate soon worsened, and left India struggling to find the excellent export growth that had supported it in the post crisis years. Meanwhile an overconfident government continued to spend to the tune of a fiscal deficit of over five per cent of GDP; while resisting to undertake any firm reforms. The central bank went on desperately hiking policy rates in an effort to bring inflation under control. New infrastructure projects slowed to a trickle, entrapped in bureaucratic red tape; especially from the environment ministry. Rising incomes, unbridled government spending, and falling investments, made a perfect cocktail for further inflationary pressures. Sure enough all these factors started biting business sentiment. GDP growth of 9% was no longer a given.

But what ultimately got the government out of its slumber; was the impending fear that rating agencies would downgrade India’s sovereign rating to junk. This would have spiralled costs of foreign borrowing for Indian corporates who were increasingly relying on it, given the high interest rate environment domestically. To this extent, it is uncannily similar to the trigger for 1991 reforms. Although not a Balance of Payments’ crisis, it was finally the international ramifications of its act gone wrong that compelled the government to react. There may have also been a personal angle involved – a downgrade would have meant that Prime Minister Manmohan Singh would have ultimately frittered away his legacy of being India’s fearless reformer of 1991 glory. Time magazine’s ‘Underachiever’ finally announced a barrage of reforms over two days in September 2012. The sensationalism did carry some of the 1991 nostalgia.

If the 2008 global crisis taught the world one important lesson, it was that there exists a strong link between the real and the financial economy. The fall of a bank in one continent does have the potential to threaten a florist’s business thousands of miles away in another. The 2012 reforms by India were fire fighters meant to rescue scuttling market sentiments. The ‘India story’; the promise of a rising economic power, had to be protected at all costs. Between September 2012, when the government began its reform blitzkrieg and January 2013; the Bombay Stock Exchange benchmark SENSEX rose by over fifteen per cent. The real economy was saved; but only to the extent that it’s linked to financial markets and sentiments.

Plugs still need to be filled to convert them into ‘real’ economy phenomena. For instance, the decision to increase FDI in retail was done hastily without establishing adequate guidelines for foreign companies to act upon. Given that states are allowed to decide whether to embrace or shun the policy; incumbent companies have a courageous decision to make. Financial market reform is still a half-baked process – while India plans for almost half a trillion dollars’ worth of private investment in infrastructure for the next five years; it still has an underdeveloped corporate bond market. As a result, infrastructure projects are choking for the lack of financing options given that banks, which are the major source of financing, find themselves over leveraged.

However the real problem and paradox for India still remains far from resolution – being the third largest recipient of FDI in the world; and yet ranking 132 among 183 countries in ease of doing business . India’s archaic labour laws have pushed a majority of its people into the unorganised sector, in effect creating a dual labour market. While the share of manufacturing in GDP has been stagnating for years; capital intensive industries have replaced labour intensive ones. The services sector cannot be eternally relied upon to push growth and absorb labour. If manufacturing is not revived and reinvented in India, then one of the largest cohorts of young population in the world will be potentially unemployed; effectively souring India’s demographic dividend into a demographic nightmare. In terms of law and order, police and judicial reforms are long due. Some of India’s laws and procedures date back to almost a hundred years. Intricately linked to this will be the country’s ability to embark on a sustainable model of growth. Or else new roads and mines and cities will develop, but in the process creating a warpath of social and economic upheavals.

2012 showed India that the reforms since 1991 weren’t enough. The current phase of reforms is also no different – just another battle won, not the war. If Indian policymakers confuse between the two, another crisis will soon enough encore.

BIBLIOGRAPHY:

  1. Government of India, (2012) “Draft 12th Five Year Plan”, Planning Commission, http://www.12thplan.gov.in/
  2. Mahr, Krista, (2012) “A Man in Shadow”, TIME Magazine, Vol. 180, No. 3, 16th July, http://www.time.com/time/magazine/article/0,9171,2118776,00.html
  3. The World Bank Group, (2012) “Ranking of Economies – Doing Business”, http://www.doingbusiness.org/rankings
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