Chasing the Chimera? An Economic Perspective Time to Introspect

Urgent and sweeping reforms had pulled a faltering Indian economy out of a dangerous nose-dive more than two decades ago. Are there indications that it is once again headed into a disastrous tailspin? A report by Team Inclusion

01 April, 2012 Economy, Research Reports
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Nearly 21 years ago, a troubled finance minister told a hugely subdued parliament that the economy was in deep crisis. It was July of 1991, and the nation’s parliament listened to Manmohan Singh in stunned silence as he presented his budget to a nation teetering at the edge of a catastrophic debt repayment default.

Singh’s speech was so solemn, that it was actually bleak. The balance of payments situation was precarious, international confidence in the economy was weak, to say the least, and the road ahead was uncertain. Capital inflows from commercial borrowing and NRI remittances had dropped sharply and the country was left with just Rs 25 billion in foreign exchange reserves, enough to finance imports for a mere fortnight.

The government had borrowed so much, that one-fifth of its total expenditure was going in interest payments on those loans. Short on funds, the government had run up a fiscal deficit of Rs114.3 billion, a dangerous 8 per cent of the GDP, and double-digit inflation was beating down on demoralised Indians, forcing Singh to say: “We have not experienced anything similar in the history of independent India.”

The subsidy burden was extremely high and the tax system was full of loopholes, the public sector was grossly mismanaged and had little or no investible surpluses of consequence, according to Singh’s budget speech. The weaknesses were systemic-the industry was poisoned with excessive and indiscriminate protection, and as a result, exports were paltry (Rs 325 billion).

Singh laid out a detailed, 3-year strategy for steering the economy back on track, primarily by adjusting, controlling and managing its income-expenditure mechanism. “But there can be no adjustment without pain. The people must be prepared to make necessary sacrifices to preserve our economic independence and restore the health of our economy,” added Singh in his trademark sombre tone of voice.

The years ahead were tough, but Singh and his crack team of economists put together a revival plan that opened up the economy to foreign investment, eased restrictions on doing business within and without India, and took a host of never-before steps that would help restore the world’s confidence in India and its economy. The fiscal and macroeconomic measures not only revived the stricken economy, but eventually went on to make it one of the best performing in the world, in the two decades since.

Cut to March 2012

Singh is now the Prime Minister of a government whose finance minister Pranab Mukherjee seems to be saying almost the same thing as Singh had said 21 years ago. There is much water under the bridge, and yet, it seems a lot hasn’t changed.

Mukherjee recently made an impassioned appeal to UPA allies and even the opposition, to cooperate “in the national interest” to restore India’s economic health. Addressing the Federation of Indian Chambers of Commerce and Industry (FICCI), Mukherjee said bluntly that a looming crisis was “staring us in the face” and that restoring economic balance was “a question of broad national interest.”

He said he was committed to protecting the credibility of plans in his budget, stemming the growing fiscal deficit and pruning burgeoning subsidies. But Mukherjee said cutting spending “will involve tough decisions that we will have to take collectively”, referring to coalition and opposition members who have been obstructing economic reforms at a time of slowing economic growth.

The government is grappling with a slowing GDP growth rate of 8 per cent or less and the fiscal deficit is still the highest among emerging markets—5 per cent in 2011-12 and nearly 6 per cent before that.

Among the hard decisions Singh had suggested in 1991 was reducing crippling subsidies. This government seems to be at the same crossroads—whether to raise prices of the highly subsidised fuel and fertilisers. The government’s dilemma is just as political as it is economic—raising the prices will definitely reduce the sizeable subsidy burden, but the resulting inflation always impacts the bottom-of-the-pyramid more than any other stratum. That can hurt politically, especially when general elections are less than two years away.

That sounds like a crisis, all right. But more than half a century ago, John Kennedy had made a speech in Indianapolis, in which he had spoken of Weiji, the Chinese word for crisis. He’d said there are two parts to the word—danger and opportunity. Contrasting, but complementary, like the colours red and green.

In India, we know contrasts rather well. This is a nation of glaring contrasts. There is dream-like wealth right in its midst of mind-numbing poverty. Its population is massive, infrastructure sparse, opportunities limited and aspirations high. Three-fourths of its people still live in villages, literacy is slow to catch up and education, health and banking are largely limited to cities.

There was a time when the world’s economists worried about India’s rising population and how the nation would feed, house and clothe its teeming millions.

That was then. The population is still quite high, at more than 1.2 billion, but India is now among the world’s ten largest economies, has nearly a billion mobile phone connections, the largest milk output and seventh largest automobile market in the world, among other things.

How did a nation, that was “at the edge of a precipice,” in its own finance minister’s words in 1991, manage so much in just two decades?

The ministry of rural development, that administers MGNREGA, was allocated nearly Rs 880 billion this year This is 15 % of the entire government expenditure for the year, and three times the ministry’s allocation of 2006-07

“By introducing a host of targetted reforms and staying on top of them,” says Rishikesha T Krishnan, IIM- Bangalore.

The thrust of the reforms process was to increase industrial efficiency and its international competitiveness, according to Singh’s budget speech of 1991. The government moved away from restrictive protectionism and opened the economy up to foreign investment, modernised the financial sector and abolished the crippling licence Raj by deregulating the domestic business sector. The liberalised economy began to acquire a more free market-like appearance, became more amenable to development and yet, ensured that one half of all the money was spent on agriculture and rural development.

Since then, the economy has consistently posted a growth rate of 7.5 percent. Per-capita income has almost quadrupled compared with 1991. Economic liberalisation has greatly affected Indian attitudes toward money, business, development and politics, and opened doors for the ambitions of millions of young people.

Rural India, where three-fourths of the population still lives, is growing the slowest. The economy grew at an average of nearly 7 per cent between 1991 and 2011, but agriculture grew at less than 3 per cent. By contrast, just the four southern states constitute nearly one-fourth of the GDP and nearly 30 per cent of the employment. Volume hasn’t necessarily meant share, however. In 1991, agriculture contributed nearly 30 per cent to the economy. Twenty years later, its contribution is just half—15 per cent. The rural population, however, has burgeoned from 640 million to 810 million.

Income and development disparities between urban and rural, and industrial and agrarian India were pulling the economy in different directions. To set the balance right and to turn the energies from opposing to complimentary, the government introduced a series of development and uplift schemes.

MGNREGA: Generating Rural Employment

Among the many schemes and programmes that the government launched, the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) has been its most ambitious and perhaps the most talked about. Launched in 2006, it is the government’s flagship rural development scheme, and the largest programme run by the ministry of rural development. The ministry of rural development, that administers MGNREGA, was allocated nearly Rs 880 billion this year. This is 15 per cent of the entire government expenditure for the year, and three times the ministry’s allocation of 2006-07. Rs 400 billion of this allocation is meant for MGNREGA, which generated nearly 2.6 billion man days of work nationwide during the year.

States with larger populations of people below the poverty line (BPL), generated less employment, compared with states that had lower BPL populations. With 60% of the country’s total BPL population, Uttar Pradesh, Bihar, West Bengal and Madhya Pradesh generated just 34% of the total employment the scheme provided. On the other hand, Andhra Pradesh and Tamil Nadu, which together account for 8% of the country’s rural BPL households, provided 23% of the total MGNREGA employment.

MGNREGA is a demand-driven scheme. Every year, states provide details of anticipated demand for unskilled manual work and draft a plan for providing employment to workers. 90% of its funds come from the government. At least half of all the MGNREGA work is executed by Gram Panchayats.

Although several types of works are undertaken under MGNREGA, in 2010-11, water conservation and water harvesting accounted for the largest share of MGNREGA works at 20 percent, followed by rural connectivity and irrigation, at 18 percent each.

MGNREGA provides at least 100 days of paid work each year to every household, mandating 33 per cent participation for women. More than 52 million households benefitted from it in 2009-10.

Rural India, where three-fourths of the population still lives, is growing the slowest. The economy grew at an average of nearly 7 % between 1991 and 2011, but agriculture grew at less than 3 %

The wages that villagers earn under MGNREGA, have risen steadily, especially when you adjust for rising prices. As a result, analysts are afraid that the rising wages will fuel the inflationary fire and make farming more expensive in India. “That’s not the case, really,” argues Dinesh Singh, a successful farmer in Muzaffarpur near Patna, in Bihar. “We have seen in the past few years that these government-sponsored schemes have made better wages possible for farm workers right here, in the village. Because of that, fewer people are moving to the cities for better job and income prospects,” he added. Even before MGNREGA came along, farm labour was becoming scarce, as the able bodied men and women were moving to the cities, and were dissuading their children from working in the fields. Those that stayed back, were exploited—their wages weren’t good enough and they had to work longer hours for lesser money. With the coming of MGNREGA and similar welfare schemes, true, wages have risen, and true, our cost of production has risen, too. But then, what was happening earlier was exploitation of poor farm labourers—an unnatural advantage that the better off farm owners had over the poorer, needy labourers. They are now getting their due. So, if you need farmhands now, you will have to match their wages with what they are getting elsewhere. These are market forces in action, and will eventually correct the scales in everyone’s favour. The sooner the farm owners learn this, and the sooner they adjust to this change, the better it is for them and for everyone, in general.

Early last year, the government had benchmarked the wages under the scheme as Rs 100 per day. Replying to a question in parliament recently, Rural Development Minister Jairam Ramesh said states differ in their minimum wage bars, and therefore, keeping a uniform minimum wage for MGNREGA wasn’t an easy thing. He said the government might bring in legislation to delink MGNREGA wages from the minimum wages of states.

In a recent interview to Live Mint, Ashok Gulati, Chairman of the Commission for Agricultural Costs and Prices, said “The society should get ready to pay higher prices for agricultural goods as this (higher MGNREGA wages) will certainly increase the demand for higher minimum support prices.”

Of India’s 28 states, only seven have minimum wages that are on par with MGNREGA wages. The rest lag far behind MGNREGA, including the agricultural centres of UP, Punjab, Haryana and Bihar. As a result, MGNREGA is a far more attractive proposition for rural labour. The agriculture ministry has raised the red flag over this matter, saying the scheme is pulling away hordes of farmhands, causing widespread labour scarcity. This has led to suggestions that MGNREGA should be suspended during peak farming season to ease the pressure on farmers.

But Abhijit Sen, a member of the Planning Commission, says rising farm wages through MGNREGA are what is called routine indexation. Planners use indexation to fine-tune the economy by linking wages to the cost of living—higher cost, higher wages, and vice versa. It cushions the impact of inflation on the poorest sections of the society.

Sen explains that indexation is a universal economic tool that guards everyone against rising prices. It is meant to help, but indexation itself also pushes prices up, because wages go up and people’s purchasing power improves. “Any form of indexation adds to inflation,” Sen added.

NRHM: Promising Health

Launched in 2005, the National Rural Health Mission (NRHM) is the government’s largest public health programme, having received more than Rs 180 billion in 2011-12. This is more than half of the government’s total spending of Rs 300 billion on health in the same year.

But India spends a very small percentage of its GDP on health—in 2009, it was 1.4%, lower than China (2.3%) and Brazil (4.1%).

In spite of the NRHM, however, the health sector suffers from a serious human resource deficit. More than half the primary health centres (PHCs) in Madhya Pradesh and one-fourth in Uttar Pradesh are short of doctors. In Uttar Pradesh PHCs report a 23% shortfall. Uttarakhand reported a significant reduction in shortfall between March 2009 and March 2010 from 47% to 2%.

India is urbanising rapidly. Nearly 40 per cent of its population will be urban by 2011, against less than 30 percent in 2001. Covering 63 large cities, the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) is an ambitious government scheme for developing infrastructure, employment opportunities, housing and basic services for the urban poor. The government has committed Rs 500 billion over 7 years for JNNURM. Analysts agree that there has to be better tuning within the Ministry of Finance and with those who implement these schemes. The success of the projects depends on how the state governments work with the Centre and local bodies. There are problems in fund release as gaps exist at various stages between funds committed and actual releases. The reasons can be poor implementation. Sometimes the funds released are far lesser than the commitment by both the Centre and state governments. The gestation period of infrastructure projects is long and even so, before completion of ongoing projects, new projects are constantly being approved. The Mission encourages public-private partnerships (PPPs) in its projects, but in practice few projects have involved PPPs.

The government’s Total Sanitation Campaign (TSC) has seen some improvements. They are slow but can’t be denied. The number of rural households without toilets has dropped from nearly 80% in 2001 to less than 30% in the data collected in the beginning of 2012. Rural development and drinking water and sanitation minister Jairam Ramesh, admits that the TSC is a “failure that is…neither total nor sanitation nor a campaign,” and is now seeking to revamp the scheme with a higher budget of nearly ` 67 billion. The revamp will help boost this scheme. The key could lie in decentralisation. Panchayats should empowered with training, financial and technical support to enable them to draw up a develop a complete sanitation plan, for their regions. The revamp intends devolve toilet construction subsidy directly to panchayats, doing away with bureaucratic intermediaries. Data on rural sanitation in India is rather shameful especially when compared to a far weaker economy as that of Bangladesh. In 2008, Unicef made an approximation that a mere 21% of rural India was using improved sanitation compared with 52% of rural Bangladesh. India contributes 58% of the world’s population defecating in the open. The budget revamp is long overdue.

In 1991, agriculture contributed nearly 30 per cent to the economy. Twenty years later, its contribution is just half—15 %. The rural population, however, has burgeoned from 640 million to 810 million

Ensuring Education for All

SSA is the Central government’s programme aimed at universal elementary education across the country. It is implemented jointly with state governments, who contribute 45% of the corpus. With education being put in the forefront of reform processes in India funds are pouring in from the government and from the World bank. The budget for Sarva Shiksha Abhiyan (SSA) has trebled from a little more than Rs 71 billion in 2005-06 to Rs 210 billion in 2011-12. Yet, the education levels are depressingly stagnant.

The World Bank has approved a $ 1.05 billion soft loan to fund India’s ongoing education projects, particularly those aimed at universal elementary education. The challenge lies in the optimum utilisation of this giant corpus. Experts feel strongly about the need to fix the problems in the existing programmes. This is a bigger need than raising the money to pump into an already weak system. State governments are unable to meet their commitments to the Sarva Shiksha Abhiyan. There aren’t enough teachers and certainly not enough infrastructure. Even three fourth the quantum granted to the states towards education is not used. It is found that since the modalities of this scheme are decided by people sitting in Delhi, they often have no idea about the ground reality at the state levels. Increased expenditure is important considering the size of our country and its burgeoning population. But increased expenditure will only lead to satisfactory results if a concerted effort is made to reorganize education governance.

The Mid-day Meal Scheme works closely with the Sarva Shikhsha Abhiyan to educate India. The idea is lofty, to provide nutritious and hygienic meals to children who agree to come to school, empowering the literacy movement and reducing the dropout rate. There are more than 133 million students in India’s primary schools. It has been seen that half of the children drop out of school between class 1 and 10. Poverty and hunger drives them to work. The meal scheme is largely funded by the 2% education cess. In 2011, the Centre allocated nearly Rs 95 billion for the scheme with the cess contributing 63% of the total allocation, according to an analysis of MMS by the Accountability Initiative of the think tank Centre for Policy Research. Institutional apathy and lack of focussed effort has led to inefficiency in implementing this extremely important programme effectively. The issues range from lack of hygiene to teachers having to cook the meals instead of teaching.

But PPPs in this area seem to be successful. In a recent programme on NDTV, Infosys founder N Narayanmurthy spoke of the success of the Akshay Patra, India’s largest mid day meal Scheme which recently crossed its 75 crore cumulative meal mark. Murthy said the success stems from the involvement of the private sector. Akshay Patra began 12 years ago, feeding 1,500 children. It is currently feeding 1.3 million underprivileged children per day at government schools in 8 states across India – including Assam, Orissa, Chhattisgarh Uttar Pradesh, Rajasthan, Gujarat, Andhra Pradesh and Karnataka. An AC Nielsen impact study of the programme reported an improvement in school enrolment, reduced dropout rates and an improved student performance. It is generally the view that PPP can help greatly in the implementation of government schemes.

According to the reputed US-based Institute of International Education (IIE), that administers the premium Fulbright Programme and Gilman Scholarships, India has sent more students to the US in the last six years, than any other nation. Only in 2010, China wrested the top spot that it had lost to India. “This is driven largely by the spirit of the great Indian middle class. It educates itself, arms itself well, plans out its life path carefully, and then, little by little, edges up. That’s why, even in the US, Indians are the most successful immigrant community, who send their children to the best schools, own the best houses and cars and live a life of moderation,” says Ajay Gupta, Professor of operations research at the Delhi-based Management Development Institute. An IIT-IIM product himself, Gupta hails from a middle class family, and says he understands the mindset of the class.

Vikram Nehru, Chief Economist and Director of the Poverty Reduction and Economic Management and Private and Financial Sector Department for the East Asia and Pacific Region of the World Bank, says “Growth of the Indian middle class is associated with better governance, pro-growth reforms, even better infrastructure. It appears that as people gain middle class status, accumulate savings, and educate themselves, they are likely to use their greater political clout to press for accountable government. This includes the rule of law, property rights (they now have more to protect!), and greater public goods supportive of growth, including better infrastructure, education, fewer trade restrictions, and economic stability. Interestingly, the larger the middle class a country has, the more likely it is to reduce poverty faster.”

In an article for BBC online in 2007, Kaushik Basu, Professor of Economics at USA’s Cornell University, had said: “One economic variable that eludes popular attention but is arguably the most important indicator of an economy’s long-term health is the savings rate. A nation’s savings rate or investment rate – the two are usually closely aligned – is the fraction of the nation’s total income that is saved or invested.” Basu is now the Chief Economic Advisor to Finance Minister. “In India… what has gone unnoticed is the phenomenal rise of the savings and investment rates. These now stand at 32 per cent and 34 per cent respectively. Economic theory had long taught us that savings and growth are closely connected. But it is not easy to deliberately raise a nation’s savings rate.”

Directly linking the rate of savings to economic growth, Basu said: “It gives reason to believe that the high growth of over 8 per cent per annum of the national income is sustainable.”

“There are three sources of savings in a nation—domestic savings, corporate sector savings and savings of the public sector,” explains Bibek Debroy, Honorary Fellow, Skoch Development Foundation. “Since Independence, the household sector has remained the predominant source of the gross domestic savings. In fact, until recently, it contributed nearly three-fourths of the total domestic savings. Bank deposits constitute the largest proportion of household financial savings, and continue to be the most important instrument of financial savings among households.”

The government is grappling with a slowing GDP growth rate of 8 % or less and the fiscal deficit is still the highest among emerging markets—5 % in 2011-12 and nearly 6 % before that


More than a decade after the reforms introduced in 1991 had kicked in, Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, delivered an address at the World Bank, listing a set of six lessons that India’s planners had learned from the reforms process. According to him, the first lesson spoke of the importance of home grown reforms—not new, but with Indian characteristics, as they were carried by Indians themselves. The reforms also did not include parts of established Washington Consensus thinking, such as privatisation. Policymakers were also very cautious about opening up capital accounts.

The second lesson was that highly participatory democracies forced gradualism in reform implementation. The complexity of the reforms forced planners to rethink and redesign policies after their implementation. He admitted that much of the reforms moved too slowly and should have been quickened. He noted gradualism minimised the pain, but also postponed the benefits, allowing reform opponents to mobilise.

The impetus for privatisation came from within the country, said Ahluwalia, as many public sector enterprises were losing revenue, straining the exchequer. It took time to privatise vigorously, but it happened with consensus.

The third lesson was that the complexity of some reforms compelled continual redesigns. Infrastructure was weak, and public sector constraints meant that infusions of quick capital were no longer feasible.

The fourth lesson underscored the importance of sequencing for broad based reforms, especially in the context of gradualism. Sequencing was important for tariff reform and liberalisation of the capital accounts, and he provided some background on the issue of capital accounts.

The fifth observation established the importance of the role state governments play in the reforms process. Resources go to where conditions are favourable in a liberalised environment, he noted. Enlightened state governments go after these resources and implement reforms more aggressively, and have done well. Reform implementation and results have been chequered if reviewed within the context of state implementation.

This is a nation of glaring contrasts. There is dream-like wealth right in its midst of mind-numbing poverty. Its population is massive, infrastructure sparse, opportunities Limited and aspirations high. Three-fourths of its people still live in villages, literacy is slow to catch up and education, health and banking are largely limited to cit

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