India reform is unfinished business

Posted on July 24, 2016

Indian Prime Minister Narendra Modi gestures as he delivers a speech during a mass yoga session to mark International Yoga Day at Capitol Complex in Chandigarh on June 21, 2016. / AFP PHOTO / PRAKASH SINGHPRAKASH SINGH/AFP/Getty Images©AFP

Indian prime minister Narendra Modi

Twenty-five years ago, India introduced an emergency budget that began the process of opening up its long-closed economy. Circumstances forced its hand, as India’s foreign exchange reserves fell to barely three weeks’ worth of imports. But the results were dramatic, launching an unprecedented process of economic reform.

Today, India has the highest rate of growth of any major economy. But it will not remain immune to a global slowdown or increases in oil prices. The reforms begun in 1991 remain half finished. The question, therefore, is how India will prepare for the next quarter century. Will Narendra Modi, the prime minister, move tentatively or aggressively?

    Four themes or challenges stand out. The first is efficiency. India needs to use its resources more productively. Mr Modi has moved in the right direction in the past two years. Efforts to auction spectrum and mining licences, a renewed focus on infrastructure and attempts to cleanse the banking system are all good. Yet the to-do list remains lengthy.

    Take labour reform. In India, a rigid, organised labour force of 30m constrains the growth of formal manufacturing, and hurts the employment chances of hundreds of millions of unorganised workers.

    The public sector, the last remnant of India’s lengthy romance with central planning, continues to sap its energies. Public sector companies, which dominate areas from banking to energy, earn an average return on equity of 5 per cent, less than half that for corporate India as a whole. A new wave of privatisation is required, not just to help the government’s budget but also to release deadweight.

    The second theme is institutions. Research by the economist, Dani Rodrik, has shown that the strength of institutions explains much of the economic divergence between developing countries. Institutions trump differences of political ideology, natural resources, or lack thereof, and economic cycles. Institutions buffer countries from short-term shocks and political shifts. The outcry surrounding the recent resignation of
    Raghuram Rajan, the governor of the Reserve Bank of India, gives little confidence that Mr Modi’s government is building strong teams in crucial institutions.

    Indian regulators, from those dealing with foreign direct investment to telecoms and retail, often play catch-up with market realities. Police credibility is so low that the government itself acknowledges its writ does not hold in 83 of India’s 686 districts. Widespread corruption and the credit bubble have their origins in weak institutions.

    India’s Narendra Modi seeks to realise long-awaited tax reform

    epa05420857 Indian Prime Minister Narendra Modi, gives his public lecture at the University of Nairobi with students, Nairobi, Kenya, 11 July 2016. Modi is in Kenya to wrap up his four-nation Africa tour aimed to boost economic ties with the continent. EPA/DANIEL IRUNGU

    Government hopes to push through goods and services tax bill that many think will transform economy

    The solution is not more government but better government. Mr Modi needs to upgrade the government’s regulatory bodies, cleanse the police and streamline the judicial process if he wants India to move up global league tables for ease of doing business.

    The third priority for policymakers is macroeconomic stability. India’s budget deficits have been stubbornly high, especially at state level. The tax machinery is creaking — only 5 per cent of Indian adults pay any taxes at all. Government handout schemes such as those offering rural job guarantees offer short-term relief, but they hurt long-term prospects as they drain resources from job-creating investments.

    Finally, for India to realise its potential, it needs to boost manufacturing. Manufacturing as a percentage of India’s gross domestic product is dismally low at 16 per cent, about half that of China. Benchmarking with Vietnam, a country at a similar stage of development, is humbling. India’s per capita GDP has now fallen below Vietnam’s, while trade as a percentage of GDP is lower. As multinationals diversify away from China, Vietnam is the main beneficiary, not India.

    In 1991 India defied the pessimists. At a time of crisis, it embarked on reforms to rescue and reshape its economy. Will it now, from a position of relative strength, disappoint the optimists? The answer lies almost entirely in India’s own hands.

    The writer is chairman of Dalmia Group Holdings

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