What are the prescriptions to fix India’s once-resilient economy which has slowed down under global pressure and instances of domestic irregularities? The policy makers are faced with structural and fifi scal challenges as they try to balance growth rate with inclusive development

By Dinesh Narayanan
in New Delhi

Investors in India are unlikely to have spotted the blossoms in the spring of 2012. They were shivering in the chilling wake of the then Indian finance minister Pranab Mukherjee’s budget proposals that were more an expression of state power than a pragmatic route map for a slowing economy. The minister laid out plans to amend laws that would burden businesses with back taxes and effectively neutralise a Supreme Court of India verdict blunting over-aggressive tax collection in what is now famous as the Vodafone case.

The budget was a public relations disaster. “India will lose significant ground as a destination for international investment if it fails to align itself with policy and practice around the world and restore confidence in the relevance of the judiciary,” a group of seven trade bodies, including Confederation of British Industry, Japan Foreign Trade Council Inc. and United States Council for International Business, that together represent about 250,000 companies, wrote to the Indian Prime Minister exactly a month after the budget.


An already besieged government, headed by Manmohan Singh, widely acclaimed as the architect of the 1991 economic reforms as finance minister but equally blamed for presiding over gross economic mismanagement and institutional decay on his return as PM, could only make promises. “Faster, equitable, sustainable, and more inclusive growth is the objective of all the economic policies that our government under our leadership has put before the country. That is the challenge – how we ensure that the economy moves on to a faster, sustainable and more inclusive growth path,” he said in a post-budget interview. The challenge was never met. Economic growth plummeted as the government hopped, skipped and jumped from one financial scandal to another.

“Corruption has become embedded in the Indian economic system. It is so essential to the ‘functioning’ of its post-1991 quasi-market, improperly liberalised economy – where the grant of licences and inexplicable asymmetries in regulation play key roles in introducing anti-market distortions and subsequent market failures – that one now sees the visible damage being done to the functioning of the economy as ham-handed attempts are made to root it out,” Percy Mistry, finance professional and author of the report ‘Mumbai As An International Finance Centre’ wrote in the Financial Express in July 2012. In the same year, India ranked 94th out of 176 countries on Transparency International’s Corruption Perceptions Index. It is placed 134th on the World Bank’s ‘Ease of Doing Business’ rankings in 2013. The World Bank said it became tougher to start a business in India as, among other things, getting an electricity connection became tougher and protection for investors weakened.

Earlier this year, the Confederation of Indian Industry had presented a list of 62 stalled infrastructure projects, each worth at least $166 million or 10 billion Indian Rupees, indian-economyto the Project Management Group in the India’s Union Cabinet Secretariat for fast tracking. Of these, 35 were power projects and 11 were for construction of roads and highways. Most got stuck because of lack of environment approvals, state level clearances or inability to acquire land.

That did not necessarily mean that capital did not flow into the country but merely that most of it was short-term, speculative investment. The Securities and Exchange Board of India (SEBI) data shows foreign institutional investors (FII) pumped in $27 billion or 1630 billion Indian Rupees in 2012; $21 billion or 1270 billion Indian Rupees of that flowed into equities and the rest into debt. That is why the stock market indices never really reflected how the economy was weakening, stalling projects, depleting jobs, hurting domestic savings and bank balance sheets.


forex-traderOver the past couple of years, the Indian economy has slowed down considerably. Consumers were shackled by rising prices causing demand to decelerate. Public finances were in a mess and general business sentiment hit the bottom. Eventually it has reflected in FII investment as well. In the first nine months of 2013, FIIs have invested only $6.1 billion or 367 billion Indian Rupees, according to SEBI. Industrial expansion suffered as policymaking practically ground to a halt. The woes were compounded by the gale force of a global downturn that has played havoc with all the major economies such as the US and Europe which have traditionally driven world demand and consequently exports from countries like India and China.

finance-minister“These are not easy times, and the economy faces challenges,” Raghuram Rajan, the new governor of Reserve Bank of India, India’s central bank, said upon taking charge on September 4. “At the same time, India is a fundamentally sound economy with a bright future. Our task today is to build a bridge to the future, over the stormy waves produced by global financial markets,” he said.

That is not easy. Rajan, a Chicago school economist whose accurate calling of the impending recession as early as 2005 made him a villain before turning him into a star as the global economy crumbled, has set about it in right earnest. The measures he took on the first day shored up an embattled rupee and boosted the stock market. Two weeks later, the new governor raised interest rates even though markets and industrialists, who had been unsuccessfully lobbying his predecessor Subba Rao for a more benign rate regime, expected otherwise. In less than a month, Rajan had presented his credentials clearly – he would be an independent central banker with a bias for transparency and stability.

Rajan had pushed back the date of the credit policy to September 20 seemingly to watch for the direction the US Federal Reserve would take on unrestrained government bond buying. It ensures unlimited dollar supply in the US market and a tapering of that is expected to cause worldwide ripples. It showed that Rajan had a global picture in mind as far as monetary policy was concerned.

“What we need to do is put our house in order before it (tapering) comes back. The postponement of tapering is only that, a postponement. We must use this time to create a bullet-proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike,” he said.


Rajan’s holistic perspective and planning for eventualities – at least the expected ones – is precisely what the Indian government lacks. More than 22 years after he wrote the manifesto for a free market economy, Manmohan Singh has ended up on a watch where crony capitalism is creating oligarchic structures, institutions are hollowed out and costly public entitlements are building up on political rather than economic logic. The result is a malfunctioning economy which, according to an IMF forecast, will grow only 3.8 per cent in 2013. That is close to the Hindu rate of growth or the infamous 3 to 3.5 per cent annual growth of the sixties, seventies and eighties.


While the finance ministry needs to take short-term steps to control runaway current account deficit that is putting pressure on the rupee which drives inflation and increase efficiency in public expenditure to pare the fiscal deficit, it has to simultaneously think of long-term measures which will create jobs, infrastructure and a climate where entrepreneurship and innovation can flourish.

tour-operatorIn the next 10 years, if the economy holds up and existing industries expand at a decent clip, about 250 million jobs will be created. But young people double that number will be knocking on the job market; a large number of them likely underqualified and unemployable because of poor quality of education and training. It would require a radical and quick overhaul of the education and training sector to bridge the gap.

Skilling potential job seekers will also have to go hand in hand with creation of infrastructure for industrial activity to pick up. Even though prices rise when demand picks up, inflation in India has been fuelled by supply side constraints. Production capacities in India are limited. Even when production is adequate, shoddy supply chains and inability to move goods fast across the country result in skewed prices. The recent spurt in onion prices is a good example of poor supply management.


puttingIn a developing country like India where two-thirds of the population is impoverished and over 90 per cent of labour works in the informal sector without benefits such as insurance and provident fund, it is important that the government spends money on the welfare of the people. But that does not mean that indiscriminate spending crowds out productive capital. Worsening public finances and increasing welfare have forced the government to borrow more every year, crowding out private borrowers from the market. The central government has budgeted to borrow about $97 billion or 5800 billion Indian Rupees from the market in fiscal year 2013-14, almost double of what it was five years ago.



Four key actions can put the house in order and inspire confidence. All of them have been discussed threadbare by committees and are ready for implementation. One is the uniform goods and services tax commonly known as the GST. Once put in place, it will remove a large number of tax anomalies and is expected to improve tax compliance and collection. The second is the direct tax code that will rationalise the direct tax structure in the country, again helping payment of income taxes and improving transparency.

A committee, headed by C Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, had submitted a report a couple of years ago on streamlining public expenditure. It had suggested a number of steps to improve accountability and efficiency of public expenditure. That report, whose proposals would have made funds flows between the states and the Centre easier and removed the archaic and restrictive distinction between planned and non-planned expenditure, is gathering dust.

The last one is the rationalisation and consolidation of laws governing the financial sector. Currently India has a cumbersome web of legislations that were passed over decades – many in times of crisis such as the stock scam of 1992 – creating overlapping regulatory authority and consequently loopholes. The Financial Sector Legislative Reforms Commission, headed by Justice BN Srikrishna, has given a comprehensive set of recommendations aimed at streamlining the legislative web.

According to a senior official in the finance ministry, the government is ready to go full steam ahead with implementing it. He says it will take several months or years to complete the process but the government is committed to it. As far as removing bottlenecks from the economy is concerned, that would be a start.

(The writer is a senior businessjournalist and was Forbes India’s Economic Policy Editor)


Leave a Reply