A looming crisis in India

A political override over economic common sense is likely to push India’s tottering economy over the edge. It will then require another decade of repair and rehabilitation to recover from that fall.

The political, economic and social situations in India continue to deteriorate relentlessly. Indian politics has become dysfunctional; ostensibly beyond repair. The economy is tanking. Civil society is ‘uncivil’ — reacting vociferously, occasionally violently, to a disconcerting vacuum in law and order (especially where the safety of women is concerned) as well as the apparent absence of probity, ethics or morality in political, bureaucratic (public) and corporate life.

Increasingly inept, callous and corrupt governance reflects total disregard, if not contempt, for the electorate, with India becoming an “ethics-free zone”. There has been a serial failure of law enforcement in every state and domain (the police and CBI are among the most corrupt institutions in the country).  The ‘street’ is challenging the ‘state’ beyond the limits of the latter’s capacity to react or respond coherently.

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To exacerbate matters, devastating damage (ecological, infrastructural and human) has been inflicted by nature in Uttarakhand and Himachal Pradesh. It is compounding India’s difficulties at a bad time. India’s armed and border protection forces, and its NGOs, are tackling the unfolding tragedy with remarkable dedication, compassion, assurance, competence and skill. That is in sharp contrast to the pathetic, inadequate responses of civilian government at Central and state levels. The tragedy has highlighted two chronic deficiencies that bedevil the country: One, incapacity of government at central, state or municipal level to govern capably, effectively, efficiently, fairly and non-corruptly; and two, the state’s institutional incapacity to regulate economic activity sensibly.

This untimely natural disaster has pushed an overstretched, incompetent, discredited and disabled Union government over the edge. It is now teetering on its last legs. Crucially, the disaster is shifting GoI’s attention away from what it must do quite urgently about an unravelling economy, and a dysfunctional polity. Like a punch-drunk pugilist coping with (largely self-inflicted) body-blows simultaneously on every part of the anatomy, the Government (GoI) and the ruling political coalition (UPA) are reacting incoherently and disjointedly in abysmally slow motion.

 What pervades New Delhi is an inexplicable, unforgivable lack of urgency, imbued with diffidence and indifference that suggest ‘que sera sera’ fatalism.  It bodes ill for a future that must, in the immediate short-term: One accommodate four more state elections and a general election in the coming eleven months, or 3 to 4 months earlier if the Supreme Court rules on July 10th that the PM was culpable of malfeasance in his capacity as acting Coal Minister in the Coalgate scandal; and Two avert in time (though the opportunity is being wasted) a severe economic and external financial crisis that, if permitted to slide further out of control, could come to rival the meltdown of 1991.

The political scene

Indian politics has been stalemated for a considerable period of time. A frustrated opposition (led by the BJP and its NDA allies, but including communist parties on the extreme left, and a few regional parties with no credible agenda, other than populist pandering to garner local votes) has not permitted the Parliament to function for the last six sessions. A large backlog of essential legislation has piled up; over 165 bills are queued in Parliament for debate and passage. It is unlikely that more than 15-20 of these can or will be passed in the coming monsoon and winter sessions of Parliament if previous experience is any guide.

That, of course, assumes that the Monsoon Session will be called. If the Supreme Court is critical of the PM in early July (which is what the Opposition expects and is gearing up for) an early general election may be called instead. Parliament will then adjourn until the next government is in situ sometime in March (if an early election is called) or June 2014. With state elections scheduled in October-November 2013, the Election Commission will not be able to (logistically) prepare for and monitor a general election much before February-March, 2014 –i.e. 2-3 months before the next one is due to be held anyway.

The BJP’s strategy of blind, unthinking opposition to anything the government proposes, its serial demands for the resignations of the PM and FM at every turn, and its militant blockage of legislative activity, might have been justified if the Opposition was credible as an alternative. It is not. The BJP in its recent conclave has elected a controversial, divisive personality to lead the party into general elections (i.e. Narendra Modi, the Chief Minister of Gujarat). There is now considerable internal dissonance within the BJP at senior levels. A few leaders have distanced themselves from Mr Modi. That move has fractured the NDA alliance as a credible opposing coalition to the UPA.

Given the UPA’s dismal, corrupt record over the last four years, the BJP’s travails may not necessarily guarantee a third UPA victory by default. Given the UPA’s dismal record over the last four years, the BJP’s travails may not guarantee a third UPA victory by default. If a Congress led UPA-3 coalition continues running the country as it has, since 2009, it might prove to be disastrous. State elections in Karnataka and elsewhere confirm the public propensity to oust corrupt governments, coupled with an incapacity to install cleaner alternatives, that do not seem to exist in the Indian political space.

The probability is increasing that a different coalition (the mooted Federal Front) may come into being at the next election comprising regional parties i.e. TMC, JDU, AIADMK, SP or BSP (both cannot co-exist) possibly the Left (but not if the TMC is at the core of such a coalition), and smaller regional parties from Bihar, Orissa (or Odisha), Andhra Pradesh and smaller states. These parties are led in rare instances by stalwarts (e.g. Nitish Kumar of the JDU or Navin Patnaik of the BJD) but more often by mercurial, unstable personalities (e.g. Mamata Banerjee, Mayawati, MS/AS Yadav, etc.).

Such a coalition might cobble together a majority of votes without the support of the two national parties. Current psephological betting is that neither BJP nor Congress will win more than 125 seats in the 545-seat Lok Sabha. But such a third front would have no credibility, no viable national agenda and no durability. India has faced such situations before (in 1987-91 and 1996-1999).  In no instance has a non-Congress or non-BJP led coalition survived more than 18 months. India has had two interregnums of revolving door governments. Were this to happen now, at a time of fatal weakness in the economy, it would set India back for at least five years if not a decade in terms of lost opportunity and growth.

The unfolding economic debacle

Since it was re-elected in 2009, UPA-2 has mismanaged the Indian economy. That is in stark contrast to the stellar performance of UPA-1 in 2004-09 when growth surged to over 8.5 percent per annum. To be fair UPA-2 had a global economic recession to contend with. But that should have depressed growth to around 7 percent. India’s growth is less dependent on exports than other BRICS. Instead, real growth has fallen below 5 percent as a result of falling investment and capital formation; severe infrastructure bottlenecks impeding output in every sector and exacerbating production/inventory costs; and pervasive corruption that has affected investment and growth in minerals, hydrocarbons, and services like construction, transport and telecoms.

Corruption has a pernicious effect on increasing frictional transaction costs while depriving GoI of badly needed revenue. To make matters worse, India now has high embedded structural inflation which is proving difficult to expunge, exploding twin deficits in the fiscal and current accounts that have spiked to unsustainable levels, causing a collapse of the Indian rupee.

The fiscal deficit has been brought down from 5.2 percent to 5 percent of GDP while the current account deficit (CAD) still ranges from 4-6 percent of GDP. With declining capital inflows (likely to worsen as the collapse of foreign investor confidence in the India story continues) the CAD is becoming increasingly difficult to finance. And India’s short-term external debt burden is pushing it into a precarious corner. Reserves of USD 290 billion now appear distinctly inadequate to protect against continued external unwinding or oil price shock. The INR has depreciated vs. the USD by over 12 percent in the last six weeks and almost 50 percent over the last four years.

A declining rupee has a negative feedback impact on domestic inflation by increasing the cost of essential energy, intermediate, and consumer imports. Continued devaluation might theoretically make Indian more competitive in manufacturing and service exports. But India is ill-placed to benefit from the first. It has not reformed its labour market policies nor its infrastructure development and other structural policies to be a competitive force in the global economy outside of IT enabled services. Moreover its implicitly hostile stance on FDI, and its absurdly ingrained Nehruvian protectionist aversion to a greater role being played by global multinationals in the Indian economy, seriously constrains its ability to compete in the world’s marketplaces for trade in goods and non IT services. Also, a continually declining INR must put off potential FDI that sees its nominal and real value being eroded by ever-materialising currency risk.

To observers in the US, EU and Japan, a growth record averaging 5 percent annually in 2009-2013 may seem laudable rather than a cause for concern. But, given its demographics, structural characteristics, and public/external debt dynamics, a growth rate of 5 percent in India is equivalent to a growth rate of 0-1 percent in the developed world. It has the same deleterious impact on the country’s capacity to generate sufficient tax revenue to meet its debt/expenditure obligations, create employment rapidly enough to absorb its burgeoning (but grossly unskilled and therefore unemployable) labour force, as well as ensure its economic health, overall global competitiveness and safeguard the outlook for its future generations. In relative terms, India has to run faster than others on the global treadmill just to stand still. Instead it is running slower than it should and falling behind.

It is clear in retrospect that the main failure was UPA-2 appointing the wrong Finance Minister (now President) in 2009. During his disastrous three year tenure, his lack of judgement, peculiar hostility towards foreign investors, and absurd obsession with maximising revenue at any cost, dented the confidence of investors (foreign and domestic) in the probity, intent, credibility and reliability of GoI and MoF. Investor confidence was also diminished by the outcome of Supreme Court intervention in the 2G scam resulting in the cancellation of all awarded licenses and again by serial uncovering of suspected corruption in the allocation of coal blocks and other mineral/forestry rights.

The FM who replaced this human disaster in 2012 was P Chidambaram. He was the (capable) FM when the economy was booming under UPA-1 and should never have been moved to the Home Ministry. He now has a herculean challenge in turning the sinking Indian super-tanker around and steering it into calmer waters. And still GoI and MoF keep sending out confused, contrary signals. On the one hand they try to talk up the attractiveness of India to foreign and domestic investors. On the other, at the same time, they put the same investors off totally by actions contrary to their words.

For example, having used a considerable amount of political capital, and indulgence in gross political chicanery, to get the FDI in Multi-Brand Retail Trade Bill passed through the Parliament, the DIPP has since come up with substantively untenable, and absurdly micro-prescriptive rules and regulations about what incoming investors must do after they have invested. The result has been no inward investment and no movement on this front.

Similarly, when the external situation demands that GoI/MoF do everything possible to attract FDI and FII, the government has failed to exert enough effort to get the pending amended Insurance and Pensions Bills passed; though these would bring in immediate inward investments of USD 1-2 billion and much more later by way of associated indirect FDI and FII. It has permitted the Opposition, LIC and a few powerful domestic vested interests in the private insurance industry, to delay and block passage of such essential legislation which has been pending since 2008. Worse, the signals sent out suggest that GoI as a whole and MoF/DIPP in particular remain hostile to accommodating the legitimate interests and concerns of foreign investors.

In the face of growing economic turbulence generated by external and internal forces, UPA-2’s tenure has been marked by a bizarre, untimely propensity to increase central and state fiscal burdens. These are now unaffordable and untenable. It has introduced large income subsidies for the poor; but before doing enough to reduce the fiscal burden caused by misdirected, and entirely unnecessary, producer price support and consumption subsidies for energy, fertilisers and food.

The UPA government introduced the National Rural Employment Guarantee Act (NREGA) for the rural poor. It has proven unaffordable in fiscal terms though it has had the beneficial impact of supporting low rural incomes and increasing aggregate demand. Its downside has been to distort and overprice agricultural labour markets (especially in the critical sowing and harvesting seasons) thus raising farm production costs and fuelling food price inflation. Given endemic corruption in the lower reaches of bureaucracy at state level, it is widely accepted that around 30-40 percent of the resources allocated for NREGA do not reach intended beneficiaries but are siphoned off by Central and state-level political and bureaucratic functionaries instead.

To be fair, UPA-2 has finally acted (after great initial reluctance) to reduce fuel price subsidies. Most of these were misdirected to the urban middle class and rich, yet supported by an opposition illiterate in understanding basic economics. But UPA-2 has not gone far enough or fast enough in the direction of reducing and eventually eliminating market-distorting price subsidies. In fairness, it has probably gone as far as domestic political opposition and middle-class public tolerance will permit.

Yet, in the midst of turmoil and confusion over the unaffordable subsidy component of the central budget, UPA-2 is determined — at this late and entirely inappropriate juncture, given the parlous state of the economy — to introduce another ill-timed massive price subsidy through an all-encompassing Food Security Bill. This Bill guarantees a minimum level of food grain supply (as a basic right) at egregiously subsidised rates to 75 percent of India’s rural population and 50 percent of its urban population. This is odd when UPA claims to have reduced the incidence of poverty to less than 28 percent of the total population.

The current Food Security Bill is a poor draft. It opens the door to more graft and corruption by relying for delivery on a tainted and dysfunctional Public Distribution System (PDS). This will result in even more leakage of resources being diverted from intended beneficiaries. GoI’s defence is that it will increase the fiscal burden by ‘only’ INR 270 billion (or USD 4.5 billion). At a time when the government is bankrupt, having to get aggressive (to a counterproductive degree) on extorting tax revenues, and needs to rein in the fiscal deficit from 5 percent to less than 3 percent of GDP, that argument seems astonishing if not incredible; especially when the real incremental fiscal burden is likely to be twice or thrice that amount. Moreover in seasons with bad monsoons such a food security guarantee will also increase food imports and widen the CAD beyond breaking point.

Yet, despite these obvious and legitimate objections on the part of serious political observers, academic economists (with the exception of a prominent Nobel-winning socialist economist) and senior policy-makers, GoI and the leadership of UPA-2 are gambling all their chips on getting this highly damaging Bill passed through the Parliament or by ordinance.  They are prepared to do so at the expense of more urgent, rational legislation such as the Insurance and Pensions Bills. This distorted sense of priorities is driven by flawed political reasoning. Mrs Gandhi and her son believe that ‘her’ electorate needs to be bribed yet again to vote for Congress and the UPA. But implementing that absurdity detracts from the credibility of GoI; particularly at a time when it faces the kind of economic headwinds that will derail India and diminish it.

Finally, the Arvind Mayaram Panel that has reviewed all FDI caps across the board in all sectors of the Indian economy has submitted its report to the FM. The report has made a few helpful (some inexplicable) observations and recommendations on FDI limits in various sectors. It recommends that in many sectors (including insurance and pensions) FDI caps should be increased from their present level (usually 26 percent) to 49 percent but should never be allowed to exceed that limit. The second part of that recommendation is exceedingly damaging. It has no substantive merit but is based on entirely flawed logic about protecting national interest and national security.

If India does not change its chauvinistically nationalistic but counterproductive political and bureaucratic mind-sets about foreign investment and investors, does not realise how wrong its policy-makers are, and how much they damage India’s long-term interests by being so otiose, then India will never be the force it should be in the global economy.

Instead of keeping foreign investors and investment at bay, supposedly in the national interest, India should be attracting as much FDI and as many multinationals as it can from around the world. It should eventually co-opt, internalise and dominate their managements by providing the most user-and-tax friendly environments for them to operate in for their domestic and global operations. It needs to do so to overcome so many other disadvantages it has in attracting them — not least it’s pathetic infrastructure and its awkward, xenophobic, political and public attitudes.

The Mayaram Report has been discussed by an EGoM (Empowered Group of Ministers) and will be put before Cabinet imminently.

For all of these reasons, policy makers, ministers and government leaders, as well political leaders of the Congress-led UPA and BJP-led NDA coalitions need to be confronted by India’s well wishing external interlocutors with a harsh reality check about what a political override over economic common sense might do in pushing India’s tottering economy over the edge and then requiring another decade of repair and rehabilitation to recover from that fall.

Photo: nuklr.dave