India’s economic growth has slowed rapidly to 5 per cent in the last couple of years and there is little sign of it meeting the 8 per cent target set by the Planning Commission for the 12th Plan any time soon. Nurturing the green shoots of long-term recovery will be arduous unless some critical pending reforms are implemented. TEAM INCLUSION attempts to diagnose the reasons for the economic slump and chalks out an action plan to reinvigorate the growth momentum
In the past, India too chased that imaginary horizon, defined by socialism and central planning. The result was the Hindu rate of growth: the disparaging term described the 3.5 per cent trend growth rate of India from the 1950s to 1980s, while per capita income averaged 1.3 per cent. During this period, the percentage of population living below the poverty line increased from 45.3 per cent in 1951 to 47.3 per cent in 1979-80. In fact, the Hindu growth rate got us nowhere near the socialist ideal of egalitarian society; rather, it pushed the swelling ranks of the poor into the trap of deeper poverty. The imaginary line indeed moved off into the distance when the country tried to get closer.
An old Soviet joke says it all. A speaker tells his listeners, “The socialist ideal is already on the horizon.” The audience musters the courage to ask: “What is a horizon?”
The answer: “A horizon? It’s an imaginary line where the sky comes together with the earth; it moves off into the distance when you try to get closer.”
In this issue of INCLUSION, Finance Minister P Chidambaram, a key architect of India’s reform story, gives us a glimpse about how Kafkaesque the licence-permit raj era was, and the clarity of vision it took to reform India’s trade policy in 1991-92. Of course, the watershed event that changed the narrative of India’s economic history was the economic liberalisation programme started in 1991 as the country threw off its socialist-inspired economic policies and started opening up the economy to greater foreign investment. Over a decade later, the Indian economy was the envy of the world, with the GDP growth averaging 8-9 per cent. For three consecutive years from 2006 to 2008, the economy grew at 9 per cent, and a new term was coined to describe the growth momentum: ‘the India growth story’.
Sustained high growth lifted millions of the poorest from abject poverty, substantially raised the standards of living of many Indians and helped the government build social safety nets. High growth rates have also enabled the government to introduce a number of programmes for the much-needed infrastructure development. In short, high growth rate was the enabler of the country’s new-found self-confidence.
However, in the past two years, the growth momentum has faltered due to a variety of factors, the two main being global economic slowdown and policy logjam at home. Gross domestic product rose just 5 per cent in the 2012-13 fiscal year, after falling to 6.2 per cent in 2012-13 from annual rates of over 9 per cent for a row of years before the global financial crisis of 2008. The sharp decline is blamed on a slowdown in manufacturing and services sectors. Data showed growth in manufacturing output slowed to 1 per cent in the last fiscal year from 2.7 per cent the year before. Growth in services slowed to 8.6 per cent from 11.7 per cent while agriculture output growth slowed to 1.9 per cent from 3.6 per cent. Worse, foreign direct investment into India has fallen, while the amount of corporate money fleeing the country is on the rise.
Why the growth story spluttered suddenly after having clocked 9 per cent growth rate? Of course, manufacturing and services sector deceleration are the key elements that have choked it. However, experts believe that the roots of macroeconomic problems assailing the economy run much deeper
A vortex of business regulations and the delay in speeding up economic reforms continue to drive investment away and delay chances of economic recovery. Meanwhile, high inflation, combined with fiscal and current account deficits, has hammered the currency to such levels that a major business daily editorialised that “the expression ‘historic low’ has stopped being meaningful in describing the sharp descent of the rupee”.
While growth of 5 per cent would be high for a developed Western economy, such a rate is insufficient in India to create enough new jobs for a young workforce. One cannot take people out of poverty at 5 per cent growth, too. Suddenly, the famed India growth story is under a cloud; all kinds of questions and doubts are raised about its viability. Was the growth story of the past decade simply a flash in the pan or are we witnessing just a passing phase of deceleration before growth picks up again? With battle to remove poverty and social inequalities remaining undone, and the dream of reaping India’s demographic dividend a higher priority than ever before, there is little room for complacency. The growth has to be inclusive, it must lead to reduction in poverty and has to be environment friendly, as Chairman of Prime Minister’s Economic Advisory Council C Rangarajan cogently puts in an article in this issue.
“For the 12th Plan in order to achieve 8 per cent growth, two important things must happen. First, tax-to-GDP ratio has to rise it by 2 percentage points roughly. Through better administration and more efficient tax administration using a simplified rate structure, it is very much possible to increase by 2 percentage points. Secondly, rationalisation of subsidies is imperative. Subsidies as a percentage of GDP has risen quite a bit predominantly because of petroleum subsidy.”
Talking of putting the growth rate back on track, Rangarajan says: “We need to have fiscal consolidation as part of our effort to sustain high growth. In doing that, containing subsidies plays an important part. The government aims to take it down to 2 per cent of the GDP in the next fiscal and further down to 1.6 per cent. To take the fiscal deficit down to 3 per cent, we need to act on both revenue and expenditure sides. On the revenue side, there is still scope of taking the gross tax revenue-to-GDP ratio to the 2007-08 level.”
India’s economic slump has hit a fresh low, but has it touched the bottom? Deputy Chairman of Planning Commission Montek Singh Ahluwalia says that every economy experiences ups and downs caused by the domestic and global factors. It’s understandable. But he underlines that India’s medium-term growth would depend on how we shape the recovery. “The state of global economy for the next five years will be wobbly, as the recovery is still at a nascent stage. For India, what is most important is that we need to address the policy bottlenecks that hinder sustainable high growth rate. There are macro imbalances that need to be corrected. Without that, foreign investment would trickle down. It’s also important to bear in mind that our economy is dominated by the private sector — about 75 per cent of its size is contributed by sectors like micro, small and medium enterprises (MSMEs), agriculture and the corporate sector,” he says.
His words echo what Prime Minister Manmohan Singh noted at an industry body meeting in April: “The Government is not the prime mover of growth. In a private sector-led economy — and I repeat, we are a private sector-led economy, with 75 per cent of investment being in the private sector, which includes farmers, small businesses and the corporate sector — the driver of growth is indeed private investment. But the private sector needs an environment in which enterprises can flourish and create both jobs and stimulate growth. It needs an environment which will ensure that this growth is inclusive.”
The bottomline is, India started the current fiscal year on a sluggish note, and it is very unlikely that it will meet the 12th Five-Year Plan’s growth goal for the second year. Why the growth story spluttered? Of course, manufacturing and services sector deceleration are the key elements that have choked it.
“We need to have fiscal consolidation as part of our effort to sustain high growth. In doing that, containing subsidies plays an important part. The government aims to take it down to 2 per cent of the GDP in the next fiscal and further down to 1.6 per cent. To take the fiscal deficit down to 3 per cent, we need to act on both revenue and expenditure sides. On the revenue side, there is still scope of taking the gross tax revenue-to-GDP ratio to the 2007-08 level.”
Moreover, the government’s moves to toughen tax laws had triggered an outcry from global industry groups and were blamed for a drop off in investment flows to the country. The tightening of the transfer pricing norms and the policy flip-flop in retrospective taxation are two prime examples. The Finance Act, 2012 has expanded the scope of transfer pricing regulations to such an extent that the norms have not gone down well with multinationals operating in India. The transfer pricing regulations also scare away potential investor companies. Legal wrangling over the unexpected tax demands from the authorities have tremendously increased the costs of doing business in India, and that’s the main reason for the ebbing investor morale.
Announcing the 2012-13 Union Budget, the then Finance Minister Pranab Mukherjee had gone overboard with the General Anti-Avoidance Rules (GAAR). The proposed amendments to the Income Tax Act, 1961 enabled the authorities to raise tax demands with retrospective effect on long-concluded offshore mergers and acquisitions that result in transfer of Indian assets. Even though GAAR was put on hold later in 2012 under pressure foreign investors and governments alike, the move had raised prickly questions about the capricious nature of the country’s laws and regulations.
Source: Cabinet Secretariat, Government of India
It’s not easy to strictly categorise the growth-enhancing reforms in India. While many dub the post-1991 economic measures as first generation reforms, some trace them to the Rajiv Gandhi government (1984-89). Former Finance Minister Yashwant Sinha once told INCLUSION that “the first generation reforms consist of articulation of new policy and management direction typically, but not always issued by a newly elected government. The second generation reforms consist of following through — steering of continued implementation of the reform process by the government. The third generation begins at the point of transition of political process.”
Much of India’s growth story owes to the first generation economic reforms initiated in 1991 to thwart a severe balance of payment crisis. Spearheaded by Manmohan Singh, the then Finance Minister in the Narasimha Rao government (1991-96), it dismantled the country’s highly restrictive trade policy and liberalised it, freed the private sector and buried concept of a bloated public sector for good. It marked an end to the notorious era, opened up the economy to foreign investment and introduced tax reforms. The reforms were carried forward by the United Front (1996-98) and NDA governments (1998-2004) that followed the Narasimha Rao regime. It went on to produce a GDP growth average (5.6 per cent) that looked impossible during the Hindu growth rate era.
The real economic growth momentum was generated by the second generation reforms (carried out by both the NDA and UPA governments). These were financial, tax, regulatory, education, land, labour and infrastructure sector reforms, among others. As Raghuram Rajan, Chief Economic Advisor to the Ministry of Finance, points out, the success of first phase of reforms created demand for the second generation reforms in areas like education, telecom, banking, etc. The demand for skilled workers post-first generation reforms created a huge market for higher education. The same goes with input markets such as land, labour and minerals. The second generation reforms were about taking reforms down to the states, districts and below. The reforms pushed up the growth rate to over 8 per cent for some years, but the economy has lost the trajectory since 2011. High growth with equity, it seems, brooks no delay of implementing the third generation reforms.
According to Yashwant Sinha, these are reforms that trigger socioeconomic and governance transformation. What about this bunch of reforms? Here is a quick stocktaking on some crucial areas where third generation reforms should be applied:
From the Gopalswami Committee in 1949 to the Second Administrative Reform Commission in 2008, a staggering number of official reports have recommended options and strategies to overhaul the colonial administrative set-up, but with little success to check the discretionary and sometimes arbitrary powers wielded by the bureaucracy. According to Gurcharan Das, a well-known author and management guru, “The bureaucracy has become a prime obstacle to development, blocking instead of shepherding economic reforms…. Indians think of bureaucrats as self-serving, obstructive, and corrupt, protected by labour laws and lifetime contracts that render them completely unaccountable”. A series of right-based laws (from information to education) act as poor substitute to real administrative reforms.
India’s legal system looks out of sync. There are at least 10,000 laws that exist on all kind of issues and many of them are of colonial vintage (industrial, labour disputes). There are no effective laws to check corruption in the entire judicial process. Judges are armed with antediluvian contempt of court laws, which silence any criticism aimed at them. Millions of cases choke the judicial system, even as thousands of vacancies go vacant. For the most part, judiciary and criminal investigation processes have yet to embrace information and communication technologies to improve their performance. Progress on key bills such as Judicial (Standards and Accountability) Bill is stalled.
Decentralisation remains more of a constitutional promise. The progress on both 73rd and 74th Constitutional Amendments is not encouraging, despite a few bright spots (Kerala, Karnataka and West Bengal). As Mani Shankar Aiyar, former Union Minister of Panchayati Raj, wrote in the last issue of INCLUSION, “After the economic reforms process was launched, governance reforms through Panchayati Raj were also enacted by Parliament. The plan was to yoke economic reforms and institutional reforms together so that the chariot of progress could run on two wheels. Sadly, what has happened in the last two decades is that while the wheel of economic reforms has progressed very fast, the wheel of governance reforms, or what the Prime Minister calls institutional reforms, has either been punctured or allowed to be fall apart from the chariot altogether.” A recent expert group report of Planning Commission revealed that many states have failed to devolve the 3Fs (funds, functions and functionaries) to Panchayati Raj institutions. The case of urban bodies with regard to their finance base and capacity-building is even more alarming.
Despite the advantages of a large domestic market, cheap labour and proximity to the fast-growing Asian markets, productivity growth has a long distance to go before it catches up with the ‘Tiger’ economies of Asia, including China and South Korea. This requires greater emphasis on flexible labour laws. Many of the provisions in the existing laws (at 160, we have too many of them) are archaic and could be changed without compromising genuine labour interests. We need to make our labour markets flexible while strengthening social safety nets. This will encourage investment in labour-intensive manufacturing. Rigidity in labour laws is a big reason why India has not succeeded in setting up robust labour-intensive manufacturing export sectors, as China has done.
It is the most crucial sector that has remained outside of the economic liberalisation. Even much remains to be done to improve the productivity of agriculture through scientific research and improved dissemination of knowledge, there are areas like marketing where reforms are badly needed. Equally important are the modifications to Agriculture Produce Marketing Committee Act to facilitate procurement of agricultural products, particularly fruits and vegetables, directly from farmers. India must move towards a more liberalised trade policy with respect to agricultural products, maybe with the exception of foodgrains, with no quantitative restrictions and minimal duties on exports and imports. Improved market structure for agricultural commodities, competitive pricing, greater investment in warehouse facilities and construction of more rural roads to enhance connectivity with urban markets can ameliorate the problems facing the sector.
Cutting across various sectors, land acquisition and environmental clearances have become critically important in economic governance in order to expedite the time taken for translating investment decisions into investment on ground. The law relating to land acquisition and compensation needs to be passed as early as possible. Many infrastructure projects are held up because of lack of environmental and forest clearances. Environmental concerns are certainly important but it’s a governance challenge to formulate a holistic, problem-solving approach to this issue without harming the basic needs of protection.
Despite a whole hog of reforms, India’s police organisations have remained the same more often than not: insensitive, corruption-ridden, brutal and not citizen-friendly. While a modern economy expects its police force to be professional and responsive to help the state enforcing legal/commercial contracts and rule of law, the country’s police forces are at odds with changing socioeconomic realities. There are chilling statistics about misuse of powers, false cases, top-to-bottom corruption and protection rackets that scar the reputation of our police organisations. Given the fact that policing is a state subject, efforts to reform the area have made little progress.
E-governance means seamless, effective, responsive and efficient governance. India is not yet ready to fully tap the advantages of e-governance, and the slow movement of the national broadband network is a key reason. Notwithstanding the success of Bhoomi, Mee Seva and e-Gram in providing million of citizens access to basic services and getting them closer to governments, e-governance projects have been very slow to make the impact envisaged in the National e-Governance Plan.
Nevertheless, experts believe that the roots of macroeconomic problems assailing the economy run much deeper. Even the 12th Plan document is quite frank; it says sustainable 8 per cent growth is possible only if India is able to take bold and politically difficult policy decisions in core areas of the economy.
What are these policy decisions? Experts say the difficult policy decisions range from sprucing up investment climate (reviving investor sentiment, easing business environment, cutting red-tape on investment decisions), fiscal consolidation (reduction of current account and fiscal deficits, and control of subsidies), removal of foreign investment caps, and reform of land acquisition, agriculture and labour laws, among other legislations that keep hanging fire. Lack of progress on these fronts have resulted in the overall dissipation of domestic business and foreign investor enthusiasm in India’s economy.
Though economic slowdown in the West has affected our economic growth, the persisting climate of political indecision at home is no less a cause of concern. The government’s key priority should be to take firm policy decisions to do away with the procedural and institutional irritants that come in the way of big-ticket investment. A big push to pending infrastructure projects will reverse the slide in investor confidence. How realistic is the government’s hope of Cabinet Committee on Investment (CCI) speeding up clearances for large projects? Is the current policy direction in sync with the core objectives of the Plan document? What micro and macroeconomic policy changes and follow-through measures are needed to achieve the 8 per cent growth objective? Will it open up sectors that were out-of-bounds to foreign investment? Will the government push big-ticket reforms as 2014 general elections near? Can the government stick to its fiscal consolidation plans? Can a slowing economy create the required 10 million new jobs a year? These questions should serve as the frame of reference for revitalising the near to mid-term growth.
For sustaining the high growth path, improving the foreign investment climate and increasing the absorptive capacity by bringing in the real sector reforms would be critical. The governance system must be improved to ensure that where investment approvals are still needed by the government, they are given speedily and transparently. At least in the case of large projects, an integrated view is required to be taken, as an integrated approval will help speedy implementation of projects. This is particularly true of projects in the infrastructure areas.
Ashishkumar Chauhan, Managing Director & Chief Executive Officer of Bombay Stock Exchange, is spot-on when he says that for India to realise its true potential by creating hard and soft infrastructure and industry, “training our people and giving them jobs, and fast-tracking of investment approvals are absolutely important”. He says, “Each year of the next two decades, India needs to create a staggering number of jobs. Can we create these jobs in medium and small enterprises, large companies, infrastructure, export-oriented firms, through internal consumption, and in agriculture? We have to worry about creating new jobs.”
“Large projects can not only create huge jobs on their own but also ancillary jobs. We need to create those ancillary industries as well to help the small and medium enterprise sector to feed into them. Somewhere, we have kind of missed this opportunity, but we still have time to make up by kick-starting large projects — whether it is Posco or any other,” he adds.
Ashima Goyal, Professor of Economics in the Indira Gandhi Institute for Development Research, feels that administrative constraints and scams are dampening India’s growth momentum. But she sees some bright spots. “Last year, the Union government set up a high-level investment committee to fast-track a
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Inclusion is the first magazine dedicated to exploring issues at the intersection of development agendas and digital, financial and social inclusion. The magazine makes complex policy analyses accessible for a diverse audience of policymakers, administrators, civil society and academicians. Grassroots-focused, outcome-oriented analysis is the cornerstone of the work done at Inclusion.