It's no policy paralysis, stupid!

India isn’t faring as badly as is being projected by corporate houses and media hell-bent on opening up the economy for big business, come what may

Akash Bisht Delhi 

On the eve of the UPA government’s three years in office, Prime Minister Manmohan Singh said that difficult decisions would have to be taken on both spending and revenue mobilisation. Ominously, he added, “Let us wait. Sometimes, something will be obvious.” 

A day later the implications of his statement were abundantly clear. Public sector oil marketing companies announced the biggest ever hike of Rs 7.54 in petrol prices. If earlier statements by Finance Minister Pranab Mukherjee in Parliament are anything to go by, the price hike is just the beginning of similar steps the government might take to fight the "economic crisis". Whatever the outcome of these latest decisions that are supposed to fight the "drift and policy paralysis" that seems to have taken hold of Singh’s government, what is apparent is that this cruel and crushing hike in the price of oil is feeding a summer of discontent. This might decisively undermine the credibility and continuity of UPA II. 

Three years ago, when the UPA got a second term with bigger numbers, it did not seem that the much celebrated "India growth story" would lose its way so quickly. Asia, it was tom-tommed, had decoupled from the West and all the big investments and growth would take place in China and India. India, it was suggested, had to stay the course and maintain its enviable growth rate of 9 per cent. 

All that hype looks rather distant now. Gigantic corruption scandals and lack of certainty in the policy and regulatory environment has created an impression that a "weak"  Singh is just not able to run his government. He has been trampled all over by the judiciary and auditors for failing to protect public funds under his watch. The quantum of scams runs into thousands of crores of rupees. The prime minister, dubbed a man of "impeccable integrity", is being tarred and pilloried as the man on top who could not protect public money from the looters. 

What is happening in the government? Is it because Singh has become too old and is losing control? Or, is it a manifestation of the lack of support from a section of the party  keen to get Rahul Gandhi installed as the next prime minister? Is the "economic crisis" being hyped to force the government to open all its doors for FDI in retail, on which there is no national consensus, and unleash other pro-liberalisation "reforms"? Or is it the same old game being played by wily Congressmen and their friends in the industry to get Singh removed and appoint someone else? 

Be that as it may, the economic crisis would extract its share of sacrifices. 

A close look of a failing economy would make it clear that India may be staring at a very grim crisis.

The rupee has been on a free fall against dollar. Both fiscal and current account deficit have spun out of control. Manufacturing is down, Foreign Institutional Investors (FII) have been withdrawing money from the market and the Mumbai sensex looks out of sorts. The government’s problems worsened by the collapse of the Euro Zone and the abysmally slow rise of the US economy. The credit rating agencies, the scourge of many European countries last year, have also hammered India. 

Standard and Poor's declared India’s ratings as negative. Suddenly, the spectre of 1991 is being raised again when the country was forced to mortgage gold witht the Bank of England. Experts are quick to point out that the economy has gone down the tube and it would be a matter of time when vulture funds would hover over us. 

Economists blame the "policy paralyses" for this mess. They claim that the government has not shown resolve in dealing with its own allies to facilitate passage of key policy initiatives. Also, the current regime does not want to take any harsh decisions lest it hurt their electoral support base. The 2014 Lok Sabha election also weighs heavily on the mind of a beleaguered government, argue critics. 

The private sector too has been scathingly critical of this inaction. Some top Indian industrialists have openly criticised the government for displaying a misplaced calm when they should be dynamically fire-fighting. Soon after UPA II celebrated its three-year anniversary, Kiran Mazumdar-Shaw, chairperson of Biocon, reportedly said that if she had been in UPA II, she wouldn’t have celebrated since the government has neither performed nor delivered. 

In an interview to a leading news channel, Shaw said, “The xenophobia in dealing with tax matters is not conducive to bringing in FDI and the government is not putting in place any policies to improve confidence of foreign investors.” Several other corporates have joined the anti-UPA bandwagon and are severely critical of the fact that key liberalisation reforms that would "boost growth prospects" have been put on hold. 

So what is this policy paralysis and what are these "reforms" that have brought the economy on its knees? 

Mukherjee had earlier promised passage of several key reforms. He had assured that he would take some tough decisions, including rolling of Goods and Services Tax, the Direct Tax Code, FDI in retail and aviation, diesel decontrol, review of various subsidies, the insurance amendment Bill, pension fund regulatory Bill, banking amendment Bill and sugar decontrol reforms, among other measures. However, opposition from not only rival parties but also its own allies forced the government on the back-foot and all these reforms had to be put on the back-burner. 

The xenophobia in dealing with tax matters is not conducive to bringing in FDI and the government is not putting in place any policies to improve confidence of foreign investors’

While the market hailed these proposed reforms, others raised serious doubts over their viability and their effectiveness in providing a fillip to the economy in the long run. Independent voices have even played down the alleged "paralysis" and believe that the term is being used to force the government to adopt measures that could push the economy deeper into an anti-poor/common man abyss. 

“What policy paralysis are they talking about? Under the garb of big- ticket reforms they want to promote privatisation, open up natural resources and land, and provide legal protection to the multinationals. If they are talking of austerity then they basically mean cutting of social sector expenditure. What growth are you talking about when most of the people in this country are still struggling to avail of basic amenities of life? Nothing has changed for these people in the last two decades when economic growth has been at its peak,” says senior journalist Praful Bidwai. 

 He believes this policy paralysis is only for projects such as Vedanta and Posco, among other big business groups, in the mineral rich tribal hinterland and the like. “Jairam Ramesh, as environment minister, had given clearance to 93 per cent of the projects. The government is trying very hard and there isn’t any policy paralysis,” he says emphatically. 

Referring to a recent report by the Prime Minister’s Office (PMO)  proposing the setting up of a special purpose vehicle (SPV) for pumping investments into infrastructure, mineral resources, and oil and natural gas exploration sectors, Bidwai argues that these are not signs of a thaw in policy matters. The internal note of the PMO on SPV read: “In a way, the SPV would be hand-holding project proposals, bringing them to a certain level of maturity and then push them into bidding pipeline. So would be the case with licenses for exploring/extracting petroleum and natural gas or other mineral resources.” 

The other major concern for the government has been the depreciating rupee. While many believe it to be a result of unsound economic policies and burgeoning fiscal and current account deficits, there are others who say it is unfair to blame only faulty policies for the fall in rupee. The weakening of rupee is also being attributed to rising commodity prices,  especially of oil, in world markets. It is widely perceived that the currency is bound to see a drop when oil prices are high. Adding to this, the Euro Zone crisis is fuelling the demand for dollars as it is considered  a safer bet compared to other currencies.

“Thus, the Indian rupee’s weakness, the flip side of which is the strength of the US dollar, is as much about the investor’s desire to park their assets in dollars, and shun volatile emerging market currencies, while the global economy is in turmoil,” writes Vivek Dehejia in The New York Times blog. Dehejia, professor of economics at Carleton University, Ottawa, adds that there’s nothing inherently good or bad about a currency going up or down as its value is determined in foreign exchange markets. “Sometimes, in their zeal to see a fact as evidence of their favoured policies, analysts forget the most basic lesson of all that economics has to teach: often, it is as simple as supply and demand,” he writes. Additionally, the depreciation of currency isn’t confined to India. Several other emerging economies like Brazil, South Africa and Mexico are witnessing similar trends. 

‘What policy paralysis are they talking about? Under the garb of big-ticket reforms they want to promote privatisation, open up natural resources, and provide legal protection to MNCs. If they are talking of austerity then they basically mean cutting of social sector expenditure’ 

The increasing trade deficit is also to be blamed for the rupee’s volatility as imports have grown by nearly a third in 2011-12 while growth in exports has shrunk by 50 per cent from the last fiscal year. The rising demand for crude oil is widening the deficit, but imports of other commodities like edible oil and gold are also playing havoc with the economy. Touted as the second biggest exporter of edible oil, India imported Rs 38,000 crore worth of oil in 2009-10 to meet the high demand. Also, in the last fiscal year, the country imported gold worth $60 billion that has added to the growing trade deficit. 

“The outgo of Rs 38,000 crore in terms of dollars (it would be much more in 2011-12) could have been easily avoided if the government had followed the right policies. Why I am saying this is because it was in 1993-94 that India had turned almost self-sufficient in oilseed production following the launching of the Oilseeds Technology Mission by Rajiv Gandhi. It was then that the commerce ministry started reducing import tariffs, and actually brought the import duties to almost zero. The imports picked up in the process, and the oilseed farmers were forced to move to other crops in the wake of cheaper imports. It was therefore a double whammy. Farmers suffered, and imports (and the import bill) grew manifold,” says agriculture expert Devinder Sharma. 

Earlier in May, the markets tumbled  after Standard and Poor's lowered India’s rating outlook to negative and warned of a downgrade in two years if there is no improvement in the fiscal and current deficits. Soon after, corporate honchos and trade analysts raised a hue and cry over the move and how it could impact the investment mood in the country. However, leading experts, including Planning Commission Deputy Chairman Montek Singh Ahluwalia dismissed the downgrading and stated that the economy would still grow at a healthier rate. 

 “The diagnosis of economic problems by rating agencies is not the voice of verity that they pretend. It is worth remembering that the record of rating agencies in certifying financial and business institutions preceding the 2008 economic crisis was so abysmal that the US Congress seriously debated whether they should be prosecuted,” wrote leading economist Amartya Sen in The Guardian

A new research paper by two economists of Brandeis University, Massachusetts, and Oxford University has ridiculed the informational contents of these ratings. In their paper, they argue that credit ratings do not contain much information about actual default probabilities. “We first demonstrate that ratings are not an optimal predictor of default probability: they are dominated by a simple default prediction model based on publicly available accounting and market based measures; they explain little of the variation in default probability across firms; and they fail to capture the considerable variation in default probabilities and empirical failure rate over the business cycle. This means that either credit ratings are simply not at the frontier of default prediction or that delivering optimal default probability forecasts is not the sole objective of rating agencies,” Jens Hilscher and Mungo Wilson wrote in their paper. 

'The diagnosis of economic problems by rating agencies is not the voice of verity that they pretend… the record of rating agencies in certifying financial and business institutions preceding the 2008 economic crisis was so abysmal that the US Congress seriously debated whether they should be prosecuted’

 Another striking feature of the debate surrounding the concept of policy paralysis is the use of FDI by various stakeholders who believe it to be the "magic wand" that would breathe new life into the Indian economy. “In every discourse on economy, FDI is being hailed as the next best thing; the data collected over the period reflects otherwise,” says Chalapati Rao, Professor at the Institute for Studies in Industrial Development, New Delhi. 

A study conducted by Rao and Biswajit Dhar illustrates that portfolio investors and round tripping investments have been important contributors to India’s reported FDI inflows, thus blurring the distinction between direct and portfolio investors,  and foreign and domestic investors. “These investors were also the ones who have exploited the tax haven route the most. Besides facilitating a host of foreign financial investors, it also became a conduit for dubious capital flows by speculators, corrupt politicians and even money launderers and middlemen in arms deals,” adds Rao. 

Rao emphasises that after the liberalisation of the economy in 1991, the motive of FDI to bring attendant advantages of technology transfer, marketing expertise, modern managerial techniques and possibilities for promotion of exports was somehow lost. 

He also mentions that India voluntarily withdrew major performance requirements, especially those facilitating indigenous linkages, exports and transfer technology. He believes that FDI is hugely responsible for the mess the manufacturing sector is in as most of the FDI received in India is in the non-manufacturing sector. “Since a good part of the FDI in the manufacturing sector is by way of acquisitions, it only displaces the domestic entrepreneurs instead of augmenting existing production capacities,” he says. 

‘In 1991, the policy makers had said that we will pay for our imports through exports, but we haven’t been able to do that yet. So, why is everybody going gaga over FDI? People are looking for easy solutions without thinking about the problems that may emanate in the long run’

A National Manufacturing Competitiveness Council report of the Prime Minister’s Group in 2008 had raised these concerns. The report mentioned that trade and FDI policies were not adequately leveraged to strengthen manufacturing or manage substantial transfer of technology as in several other countries like South Korea, Taiwan, Singapore, China, and Indonesia. “Technology transfer is considered to be one of the most important benefits of permitting FDI into the country. In India, however, in attracting FDI, the emphasis appears to be substantially on the amount of FDI inflows…There is clearly a need to have a relook at our FDI policy in terms of technological benefits the country needs to drive,” read the report.   

“In 1991, the policy makers had said that we will pay for our imports through exports, but we haven’t been able to do that yet. So, why is everybody going gaga over FDI? People are looking for easy solutions without thinking about the problems that may emanate in the long run. We shouldn’t act in haste and should pause and think,” argues Rao. 

Several economists argue that India isn’t faring as badly as is being projected by corporate houses and media, and several other developing economies in the world are facing similar turmoil. The Euro Zone crisis has certainly compounded the volatility in global markets and India cannot remain untouched by this growing uncertainty. Having successfully braved recession in 2008-09, the Indian economy is perceived as resilient enough to see through the crisis with minor reforms that could propel the stalemate. 

 “We are doing much better than US, Europe and several other countries, so why this hue and cry? Our savings rates are still the highest in the world, our balance of payments fare better than the US and these are not signs of a failing economy. There is  a lot of speculation that is making the scenario look much grimmer,” adds Praful Bidwai. 

 If what has happened now in Europe and earlier in SouthEast Asia is anything to go by, then the currency traders and speculators are so big that they can bring a perfectly healthy economy to its knees. If India blinks, it is a matter of time before the  foreign exchange reserves of $260 billion disappear in smoke in trying to stabilise a devaluing rupee.

This story is from the print issue of Hardnews: JUNE 2012