Waning growth expectations and the decline of reform

R K Roy

The finance minister shrugs off the assessment of Moody’s and of Standard and Poor’s: the two foreign raters recently downgraded India as an investment destination. Spokesmen of Indian business have added that the foreign raters lack understanding of India’s reform process.

But the investment prospect, viewed from within, is discouraging. Domestic private investment remains unduly shy. The share markets are down; offerings of equity—primary or rights—attract few takers. Unsecured bond issues by the financial institutions are no longer taken at face value. Bank deposits surge as savers seek the safe haven of banks.

Apparently, the problem is that second generation reforms remain stalled. The failure to correct electricity tariffs may deter foreign investment in power. But some domestic players seem willing to go into power, for example, in western India. If and when India gets power tariffs right and zeroes power theft, power to industry will be cheap (since industry will not be required to subsidise the rural, household, and commercial consumer). But as of now the high cost of power does not seem to be the key deterrent to new investment.

Yes, railways should not keep raising goods tariffs to subsidise passenger fares; but high rail freight hurts the railways, not business users per se. Domestic manufacture is protected by fairly high import tariffs (talk of reaching East Asian levels ceased long ago) and can absorb high power and freight costs.

Second generation reforms are important. Downsizing the public sector and its privatisation are necessary to boost efficiency. However, tardy progress of this or that aspect of second generation reform does not explain flagging foreign and domestic greenfield investment. (Despite shortcomings in reforms, MNCs have been active in mergers and acquisitions across the industrial spectrum.)

The trouble is that the government has not been able to sell reform to the masses. Reform spells higher power and rail passenger rates; jobless growth; hire and fire; protects the entrepreneur’s right to close down production units (but derates compensation for job severance, including payment of due gratuity).

But why jump to second generation reforms? The major achievement claimed for first generation reforms is the liberalisation of the financial sector. Right? Now consider the goings-on in the financial sector. IFCI, IDBI and ICICI have been downgraded by rating agencies. The non-performing assets (NPAs) of the first two, it is known, are rather large; but that of the last, a private sector entity, are by no means small: according to the grapevine, in excess of 15 per cent (in the wake of the failure of a clutch of dotcoms backed by it). This apart, all three financial institutions have been wounded by brick and mortar companies.

None of the commercial banks seems able to cope with NPAs. In year one, NPAs are heavily provided for, and a loss is reported; in year two, profits show a respectable growth over the previous (loss) year; but year three sees NPAs rise again. Banks have become over-cautious lenders; and this hurts the real economy.

The financial sector is in dismal shape. The Unit Trust if India as also most private sector mutual funds are shaky. Not just the hoi polloi, the middle class investor in shares, units and bonds, hurt by losses, is wary of reform.