Analysts are unanimous that some of these first-generation reforms related to factor and product markets, if implemented, could potentially change the India story, but have remained sceptic about the countrys ability to build political consensus in their favour. It is, therefore, pointed out that India is unlikely to bite the reform bullet unless and until pushed to the wall. Hence, reforms can be expected when a growth slowdown persists.
Having grown at an average 8.5% and above for eight years since 2003-04, the economy slowed down considerably in the last three years, dipping below the 5% level. Expectedly, this should have provided an ideal opportunity to revisit the menu list of reform measures left unaddressed, stimulating debate to build political consensus on some of the key issues. Unfortunately, though, we have managed to deflect our attention away from these first-generation reforms towards issues termed as policy paralysis resulting from poor governance.
Summarily, in the current context, policy paralysis refers to government failure in timely project clearances, mostly related to infrastructure and stalled on land acquisition, environment and forest right issues. The perception that has gained currency is that if these projects are cleared somehow, all else remaining the same, growth would begin to rebound. Unsurprising, then, that the present government spent considerable time and effort to build institutional mechanisms like the Cabinet Committee on Investment (CCI) and Project Monitoring Group (PMG) to get things back on track. Initial successes are often flagged by way of number of projects cleared, amount of investment unclogged, etc, creating a perception that investment revival could soon begin.
Is this perception correct Will mere pending project clearances restart the growth engine Speaking in broader terms, is governance reform all that a new government needs to focus upon to return the economy back to an 8% growth path A careful analysis of the current economic environment, domestic and global, indicates the chorus-like focus upon policy paralysis is rather narrow in scope and that governance reform may turn out to be fairly inadequate to kick-start investment.
It needs underscoring that India was no exception amongst its emerging market peers in being affected by global recession; notably, prominent economies like Russia, Turkey, Thailand, China and South Africa experienced even sharper slowdowns than Indias (see table). What is noteworthy though is that most of these countries are responding by several measures of structural reform, while in India most of our political capital is centred on the one idea of governance reforms as key to investment-growth revival.
How was this conclusion reached Because experts said that Indias growth was largely driven by a domestic demand-oriented investment boom; unlike China and several other emerging markets, India relies less upon exports and, therefore, it was explained that an external slowdown played a minimal role. Growth decomposition exercises and econometric studies reaffirmed this view, attributing the investment slowdown as the major cause.
Once facts about government sitting on the files related to large infrastructure projects emerge into the public domain, it was readily inferred, sine qua non, that a paralysed government let the economy to drift into non-action. Domestic policy uncertainties rather than global recession, it was concluded, had forced businessmen to abandon ongoing projects and even scrap future plans. Analysts persuasively argued that even fiscal contraction combined with tightening monetary policy to squeeze demand had but a marginal role to play where businessmens decisions to scale down investment were concerned.
It is unfortunate that few cared to highlight the extent to which tighter global financial conditions, weakened balance sheets of firms from successive exchange rate shocks from mid-2011 and banks reluctance to lend due to rising NPA stress combined to accentuate the process. An underplaying of the role of these other key elements, it seems, led into a narrow lane of thought to guide the current political discourse towards governance reforms. Whatever might be the merit of such a view, emerging economic conditions are making it increasingly clear that a disproportionate faith in governance reform could leave India stranded, while its emerging market peers focus upon efficiency and productivity boosting structural reforms to restore competitiveness.
Consider this counter-factual: if the new government was to clear larger shares of pending projects at double the speed, which is what the current government has been trying to do in these past months, will investment restart While policy paralysis hypothesis proponents would answer in the affirmative, the tepid progress in implementation of projects approved in the early phases raises concerns. There is apprehension that some of these might have now become unviable because of huge cost overruns; another large chunk may not materialise or get delayed as balance sheet stress of infrastructure firms has little scope to absorb the strain of any further investments.
Two major exchange rate shocks, rising wage bills, high input and interest costs have led infrastructure firms to consolidate balance sheets rather than consider fresh capacity addition. Domestic financing is constrained as banks are reluctant to lend to overleveraged firms; risk-aversion is high from escalating NPAs and large exposures to infrastructure sector. Access to global financial markets is harder, more expensive due to negative depreciation effects upon existing foreign currency exposures. With both monetary and fiscal policies deployed to stabilise the economy, the near-term revival of domestic demand is highly uncertain. Faced with this environment, businessmen have little doubt the doors for new investments are but almost closed on many fronts.
How to overcome such stiff economic conditions One line of suggestion is that the new government stimulates investment by focusing upon one big infrastructure project, parallel in scale and grandeur to the golden quadrilateral national highway project of the NDA regime. In fact, the current UPA government has lined up the East-West Railway Corridor that could match the expectation in scale of investment and multiplier effects. However, it is not clear if such an exercise will reinvigorate a virtuous cycle of private investment and growth when the economic environment is clogged with supply constraints. To the contrary, one suspects that excessive infrastructure spending may potentially reignite inflation at a juncture when macroeconomic stability remains delicately poised.
It isnt the aim to undermine urgency of governance reforms; surely it tops the must-do list, as recapitalisation of banks to re-enable lending and debt-restructuring to repair corporate balance sheets. Nor is this a case against public investment in big infrastructure projects. What is worrying is the lack of appreciation of the reality; that fiscal and monetary policies cannot be used to stimulate investment and growth, other than for short periods of time.
Investment revival, therefore, would hinge critically upon structural reforms to drive efficiency and productivity gains. There should be an urgency to revisit the menu of first-generation reforms left pending for far too long. The list is long, well-documented and need not be repeated. Nor do we intend to prioritise those. The past record does not inspire confidence: Partisan political positioning has either stalled reform initiatives (for example, FDI in retail), or caused undue delay for not so convincing reasons (for example, GST introduction). Each state in the federation has a different take on energy price reform and that of agriculture markets. Labour market reforms have rarely found a place in any political manifesto. In the over-enthusiasm about governance reforms, political debate and views on second-generation reforms have remained less articulated.
It is in this context that we need to introspect if too much of political capital has been spent upon issues that might not yield the dividend everyone is looking forward to. And, in doing so, has an opportunity to build political consensus on some difficult structural issues that could have ensured long-term growth returns been missed
Renu Kohli is a New Delhi-based macroeconomist