Reforms during the time of crisis

Issue 25 - Apr 2009

Mukul G Asher & V Anantha Nageswaran

THE GOVERNMENT to be formed after the coming general elections in India will face serious economic challenges, which if not handled competently, and in a result-oriented manner, could significantly affect India’s future progress. Extraordinary focus and competence are required to handle the domestic fallout of the ongoing international economic crisis and at the same time, push forward an agenda for better governance for an inclusive India.
It is now evident that the high real economic growth of around 9 percent in India achieved during the era of financial capitalism in recent years was not sustainable. That was largely due to a benign global growth and interest rate environment. An important but under-appreciated disadvantage with which the next government would assume office is that it would have a distinctly unfriendly external environment.
The world is undergoing what is arguably the severest global economic crisis in over seven decades, with global GDP and global trade expected to decline by 3 to 5 percent in 2009. There has also been a massive erosion of asset values in capital markets and in real estate. Thus global stock market capitalisation declined from $58 trillion in May 2008 to $29 trillion in January 2009, a decline of 50 percent. The corresponding figures for India were $1.3 trillion and $0.6 trillion, a decline of $0.7 trillion or 54 percent.
Largely due to the crisis, there are also distinct prospects of India’s balance of payments registering a deficit. In the third quarter of 2008-09, net invisible surplus financed only 60 percent of India’s trade deficit, as compared to 83 percent for the corresponding period a year ago. In the third quarter of 2008-09 the capital account turned negative for the first time since the first quarter of 1998-99. When both current and capital accounts are negative, drawing on foreign exchange reserves becomes a major source of financing balance of payment deficits. Given the current tough external environment, India’s foreign exchange reserves, which have fallen from $315 billion in May 2008 to $254 billion by March 2009, require close monitoring.
Since coming to power in 2004, the UPA government has been unable to utilise the high-growth period and favourable demographic phase of rising share of working-age population to total population to undertake essential structural reforms in infrastructure, agriculture, education, health, labour markets, and in budgetary and administrative systems of the country. In spite of the high growth period, India’s budget deficit in 2009-10 is expected to reach pre-FRBM (Fiscal Responsibility and Budget Management Act) levels passed in 2003 of over 10 percent of GDP. The Reserve Bank of India (RBI) has little space left to finance government deficits beyond 2009-10.
As monetary and fiscal policy are severely constrained by past acts of omission and commission, India can sustain high growth only through further economic reforms (as distinct from and in addition to economic liberalisation) and through application of knowledge in improving economic efficiency.
India can emerge with greater influence and leverage globally if it responds to the crisis with focus on improving its economic, technological, and resource bases. Keeping that in mind, we have devoted the following pages to areas that, in our view, are critical for the medium-term economic and social stability and prosperity of the country.

Knowledge is the turbo engine for a rising India
Knowledge as a product and as an instrument of social change will be the foundation for competitiveness of individual businesses and nations in the 21st century. Research findings reliably suggest that knowledge as a factor of production explains a substantial proportion of economic growth internationally. The next Indian government should therefore pursue policies, which enable the country to create, apply and diffuse knowledge in all areas, and by public, private and not-for-profit sectors.
India’s scientific and technical manpower was deemed, without adequate verification, to be its strength. However, few years of high growth laid bare the weak foundations of that claim. Skill shortages, unsustainable high wage growth and labour turnover in the knowledge-intensive sectors revealed both quantitative and qualitative deficiencies in many knowledge sectors.
The National Knowledge Commission (NKC), an advisory body to the prime minister, was set up in 2005. It has made several practical and worthwhile suggestions for revamping the education sector. Petty political and bureaucratic rivalries and lack of vision in relevant ministries such as Human Resource Development (HRD) have shelved the recommendations. Tragically, the Prime Minister who played a key role in bringing the NKC into being has not exerted sufficient political influence to break the impasse.
The next government must urgently address the unclear and dysfunctional policy and regulatory environment applicable to the education sector. Simply setting up new universities while conspiring to diminish the role of merit in selecting students as well as university faculty and administrators is not in India’s national interest.
Those currently blocking liberalisation and modernisation of the education sector, without which India will fail to become a global power in the 21st century, should not be permitted to return to such position of power after the elections.

Infrastructure needs public-private partnerships
The need for financing physical and social infrastructure is such that a partnership between government, private and not-for-profit sectors has become essential. Thus, the next government must lend urgency to efforts by ministers and public enterprise managers to learn the skills of initiating, implementing and sustaining Public Private Partnerships (PPP).
The 2009 budget speech of the railway minister illustrates the importance of PPP. He categorically ruled out any privatisation of the railways. But the Minister stated that the contribution of PPP in the Indian Railways in the period 2007-12 will be $35 billion (out of total investment of $80 billion), a 360-fold increase over the previous period.
The new government must avoid excessive ideological commitment to the public sector. Instead, it must take advantage of the complementarities between the different sectors that exist. This will also reduce adversarial relationship between different stakeholders in advancing India’s future prospects.

A freedom movement for farmers
For PPP to be an effective instrument for delivery of infrastructure goods, clarity on land-use rights including ownership and disposal is an imperative. The events in Nandigram and its aftermath hold important lessons for industrialisation. As Barun Mitra wrote in Mint in February 2008, if the government has stopped acting as a broker in industrial or corporate mergers and acquisitions, it stands to reason that it does not broker land transactions either.
As Mr Mitra argues “farmers may freely agree to sell their land if the offer is attractive enough. But they should be equally free not to sell, and instead give the land on lease or rent, and earn an assured return. The industry could also offer shares or bonds in lieu of land. Or even provide alternative land if the farmer decides to continue with his vocation.? Only then would agriculture and industry become truly equal partners in the process of economic development, rather than being pitted against each other.”
Recently, the Liberty Institute released the third International Property Rights Index (IPRI). In the report covering 115 countries, Finland again topped the IPRI ranking while Bangladesh ended up at the bottom of the list. India’s rank has gone down considerably from 36th in 2008 to 46th in 2009.

Agriculture needs a productivity revolution
It is widely acknowledged that for India to achieve near double-digit growth, which also improves real income and consumption of the people, annual agricultural growth rate (which averaged 2.6 percent per annum from 2000-01 to 2007-08) would need to be raised to at least 4 percent. There is a vast imbalance between agriculture’s share in GDP at around 17 percent and its share in employment at 60 percent. Enhanced agricultural productivity and improved employment prospects in non-agriculture sectors will correct this structural imbalance.
At 11.5 percent, India’s share of the world’s arable land is second only to the United States. India has the largest share of irrigated area in the world. It however lags considerably behind other countries in yield per hectare of different crops such as cereals and pulses.
Specific actions to improve agricultural productivity include energising the ATMA (Agricultural and Technology Management Agency) initiative; reviewing agricultural marketing, risk management and supply chain arrangements; rationalising agricultural subsidies with a view to improving productivity and supply. Linking decentralised solid waste management practices, which could provide organic fertilisers for agricultural production, also holds promise. The National Rural Employment Guarantee Scheme (NREGS) has to be revamped to reduce the excessive focus on unskilled labour. The scheme should be reoriented towards building human and physical capital in agriculture while reducing benefit-cheating and transaction costs.

Pension reforms brook no delay
The Pension Fund Regulatory and Development Authority (PFRDA) Bill, which has been awaiting Parliament’s approval since 2005, must be passed expeditiously. This is essential as India is experiencing population ageing, exemplified by increasing life expectancy and greater proportion of the elderly population. The number of people above 60-years of age is expected to grow from 100 million in 2010 to 330 million by 2050; while an average Indian can expect to live for nearly 20 years once reaching the age of 60.
India is currently in a favourable demographic phase, with working-age population to total population increasing. However, the challenge is that a substantial number of economically productive jobs and livelihoods must be generated by the economy. Given the dimension of the ageing problem, and the large share of the informal sector workers in the economy, substantial share of retirement financing will need to be generated through household savings. Since retirement financing is for the long-term, a policy and regulatory environment in which individuals have confidence is needed. The PFRDA can help provide such an environment. It is therefore essential that the PFRDA be given the formal statutory mandate to undertake this task.
Due to elections, launching of the NPS on a voluntary basis nation-wide was deferred. The next government should permit the voluntary NPS to be launched as early as possible. If more young are encouraged to save for retirement this will have several economic benefits. First, household savings in financial (as compared to physical) form would increase. Since these are long-term savings, domestic financial institutions can use them to increase their share in capital markets and mitigate excess dependence on FII transactions. Second, infrastructure bonds, and municipal bonds (once the markets develop) could be an asset class for domestic provident and pension funds, thus deepening financial and capital markets and helping to reduce market volatility.

Governing in national interest
Preparation and presentation of a budget will be amongst the first major tasks of the new government. The budget will signal the new government’s priorities and set the tone for its performance. Hence, it will be of extra significance. Simply more government spending is not a substitute for reforms.
To illustrate, for 2008-09, as of early February 2009, the centre had released just 59 percent of the funds allocated under the Rashtriya Krishi Vikas Yojana (RKVY) and 57 percent of the funds granted under the National Food Security Mission (NFSM). This suggests low capacity to use funds even for such high priority areas.
The new government must demonstrate firmer commitment to the FRBM goals; and effectively communicate it to the domestic and international players to manage risk perceptions. An even greater challenge is ensuring that expenditures provide commensurate outcomes. Our budgetary processes do not encourage managerial performance and accountability.
India is thus continuing to rely on twentieth century governmental structures and procedures to meet the challenges of a rising India of the twenty-first century. The administrative and civil service reforms, including how civil servants are recruited, trained and promoted, should be reform priorities. There is no prosperity without accountability; equally, poverty is a consequence of unaccountable governments.
India’s political parties have been remarkably successful in creating and sustaining loyalty by fostering groups based on narrow identities. Rising aspirations and mounting internal and external challenges are proving such strategies both to be politically counterproductive and nationally harmful. Leaders who grasp this shift will earn the gratitude of present and future generations of Indians, secure a rightful place for their nation in the comity of nations and cement their own place in history.