Union Budget: Reforms are no longer 'optional' in India

Updated: Jul 7 2014, 22:19pm hrs
Sustainable long-term economic growth rate can be achieved using three golden metrics - increase capital investments, enhance labour force and improve total factor productivity.

But, if the recipe for growth is that simple, why has India not been able to harness its long-term growth potential

Well, since the stars have got nothing to do with it, the answer has to come from policy introspection.

Years of mismanagement by past governments has weakened India, leaving its citizens hankering for growth that once seemed inevitable. High inflation, ballooning trade deficit, a near-crisis situation in currency markets, falling investments, and poor industrial production numbers have eroded investor confidence in any Indias growth story.

However, all is still not lost. The 2014-15 Union Budget shows a glimmer of hope.

Expectations from the Narendra Modi-led government to deliver a non-populist budget that tackles pressing issues facing the economy remain high. Indias benchmark index, the BSE Sensex, has returned 22% since the beginning of 2014, including 6% since Modi was sworn in as Indias prime minister.

To keep the momentum going, however, we need to deliver on the promises made.

While previous policies focused on bolstering a welfare state through populist schemes such as MNREGA, we need a dose of Thatcherism today. We need to focus on free markets, restrained government spending, tax cuts and a new wave of privatisation to help India get out of this rut like Britain did in the 1980s.

First on the list of reforms should be the labour market. Current Indian labour laws, in their arcane form, remain the biggest hurdle in developing the manufacturing sector. These laws create friction in the labour market by complicating adjustment of wages or reduction of workforce at large firms. This creates a vicious cycle. On one hand firms have no incentive to grow. On the other, lack of ability to grow prevents economies of scale, making it difficult for small firms to exploit new technologies.

Second on the list should be banks. The need of the hour is to rid balance sheets of bad debts. Though the initial costs may be high, we need to prepare banks to finance the new cycle of investments. Financial market reforms should focus on broader sources of finance, including development of the Indian corporate bond market. This will help firms attract investment to drive long-term economic growth.

Third on the lists should be privatisation of state-owned industries and more avenues for foreign investments. Proposed FDI in defence could be a good start. SEBIs recommendation to dilute PSU stake by 25% should also be taken as a priority within the government. Simplifying the tax code should also be a priority to reduce complexity and boost Indias tax to GDP ratio.

All economies in the world today are competing for global capital and talent. These reforms are no longer optional if India wants to assert its place on the globe.

By Jatin Gujrati, Indian School of Business

NOTE: The views expressed are those of the author