Such pessimism may look justified, given that the external sector has been one of the major areas where India has registered outstanding success, with buoyant growth of trade in goods and services and larger investments adding to overall growth in demand and output. But such an approach ignores the substantial potential of the domestic economy where there is still a sizeable leeway for boosting productivity and accelerating growth.
This has been pointed out by many studies, including that by the McKinsey Global Institute, which showed a decade ago (in 2001) that India could step up GDP growth to 10% if it can nibble away at the three major barriers to growth, namely the multiplicity of regulations that govern prices and output in product markets, the distortions in the land markets, and the government ownership of business.
The McKinsey study had, in fact, even estimated that these three barriers together pull down GDP growth by as much as 4%, which is much more substantial than the restraints imposed by other structural barriers like inflexible labour market and poor transport infrastructure which together pulls down GDP growth by half a percentage point. So, an innovative reforms agenda that further accelerates growth can help neutralise at least some of the impact of a dip in growth in the developed economies and global markets.
Top on the list of regulatory barriers identified by the study as damaging to competition and productivity growth is the inequitable regulation. Examples of such regulations are the tilted rules that favour incumbents in the power sector, civil aviation, oil, fertiliser and coal industries. Currently, power sector reforms, which incentivised large private sector sector investments in generation, are in danger of being stymied by the slow reforms in the distribution sector, especially the failure to allow open access to new entrants. The result is that consumers continue to be at the mercy of the existing public sector monopolies, who continue to be propped up by state governments despite making huge losses, or their private sector counterparts.
In the aviation sector the private sector players have not only been forced to wait for five long years before flying out to international destinations but also denied permission to make full use of the bilateral traffic rights even when the public sector national carrier is unable to make use of the opportunities. Similarly the oil sector policies, which restrict the large subsidy payouts to the government owned companies, have played havoc with the private sector forays in the retailing space, almost wiping out investments.
The experience has been no different in the fertiliser industry, where the ever increasing subsidies paid out by the government have been cornered by incumbents, who have made almost no new investments, thus forcing the country to be increasingly dependent on high priced imports, which push up production costs in the agriculture sector. Another sector where the impact of regulatory policies has been disastrous is coal, where restrictions of private sector investments have made the country increasingly dependent on imports to meet the needs of the steel and power sectors, despite the abundant coal deposits, which are waiting to be tapped.
Equally debilitating for the economy are the policies that seek to protect the interests of the public sector units in the financial sector, especially in banking and insurance. Despite two decades of reforms, the number of banks operating in the economy has come down by more than a third and entry of new players remains largely restricted mainly to protect the government owned enterprises who dominate the sector. More restrictive are the policies in the insurance sector where the lower caps on foreign investment only serve to protect the turf of the public sector companies. A substantial sell-off of many of these large public sector companies, including those like CIL which is now India's most valued company, will not only help usher in more rational regulatory policies but also simultaneously boost competition and productivity.
The other major hurdle that the McKinsey report identified and which is still awaiting a full government response is the land market distortions, which alone pushed down GDP growth by 1.3% each year. And with the markets failing to deliver land to most greenfield projects across the country, the impact would clearly be much larger now. Though some states have made some headway in providing clear titles, at least in some areas, the country is still far away from setting up a Torrens system that helps provide reliable titles and is the first step for freeing the land markets.
And then there are other much simpler ways to boost external trade even during global slowdowns, like entering into new FTAs, including with the developed countries. The best example is the Asean FTA, concluded in end 2009, which has helped boost India's exports to Asean by as much as 53.1% to $27.7 billion in 2010-11, and that is just one year of the new FTA.