With expectations running high the chances of disappointment were as high. But it didn?t happen. The government in its first official communication on policy priorities delivered a carefully balanced agenda on growth, equity, and transparency.
After last month?s game-changing elections, the nation awaited the government?s reform agenda. Meanwhile equity prices soared and capital inflows surged on the new found confidence in the economy bolstered by prospects of a return to reforms. But the reform agenda would depend on what lessons the government drew from the election results. While it was clear that ?inclusive growth? would be the underlying theme of the agenda, where the government drew the line between growth and equity was the question. In 1991-92 virtually the same policymaking team responded to the fiscal crisis with far-reaching domestic and external liberalisation and lost the next elections. In 2009 it delivered on social policies and reaped electoral rewards. Though deceiving, the simplicity of the logic has appeal. And if the government took it seriously, one could be in for an unsustainable rise in public spending and little else, or so the bears argued.
Several elements in the agenda were broadly in line with expectations. The stress on fiscal prudence (haven?t really come across a government that announces the opposite, it just happens), short-term support to the economy, and rolling out the GST.
Much was expected from the government on increased infrastructure spending. And the economy truly needs it even if the global shock had not occurred. But direct spending of such size from the budget looks difficult. So notable was the subtle stress on easing financing constraints?presumably by extending existing refinancing facilities and government guarantees?for ongoing infrastructure projects rather than increased spending. This is the right approach in the near term. For the medium term, the continued emphasis on PPP projects and their early approval, added emphasis on energy generation, expansion of existing rural infrastructure programs were also largely anticipated. The new national program to expand urban low-income housing should be an added fillip to the construction sector. Similarly, food security for families below the poverty line and the expansion of the rural employment guarantee scheme (NREG) were widely expected to be announced.
Now the surprises, the pleasant ones first. The clarity on the policy towards FDI and divestment stood out for me. There were no caveats! FDI would be encouraged and listed PSUs would be divested up to 51 percent. While the only sector explicitly mentioned was insurance (and a foregone conclusion) the clarity was important. India?s future growth as in the past five years depends on the revival of the investment cycle, which in turn needs capital at a low cost. The cost of financial intermediation in India is higher than in developed countries and thus foreign capital is needed. Not because India does not have the savings to finance its investment, but because it does so inefficiently and thus at a high cost. In the same vein, the large public debt overhang is likely to exert upward pressure on interest rates in the coming months as private credit revives with the turnaround in business confidence. To manage liquidity and the stock of public debt, divestment is a critical element of any medium-term fiscal consolidation strategy.
Equally assuring was the expanded attention to public health and education. After many years of mostly lip service it would appear that the government is seriously addressing the large gap in the provision of these services. Encouraging was the explicit statement that in higher education the government would be guided by the recommendations of the National Knowledge Commission. If this happens then the sector could see major changes in the coming years.
India?s mega infrastructure projects appear to have navigated the liquidity crunch reasonably well. Those that are facing financing problems are urban infrastructure projects. Their woes are largely due to high implementation risk brought on by the spaghetti bowl of archaic and often contradictory state and city laws. Here the government?s plan to place the new Land Acquisition Act in this session of Parliament should help to clarify the legal framework to acquire land for commercial use, which has been a major execution risk.
However, what was truly significant was the series of steps planned to increase accountability and transparency of governance including setting up an Independent Evaluation Office for the government?s flagship programs and quarterly reporting of progress by the relevant ministries. These changes could turn out to be as fundamental as the RTI.
So what was missing? For me, the lack of any explicit statement on financial sector reforms. The President?s speech is not the place to put people to sleep talking about bond markets or exchange traded interest rate futures. There are many other occasions. Public opinion worldwide?justified or unfounded?has turned against financial sector liberalisation. However, India needs to continue to liberalise its financial sector. And the argument is simple: to increase investment, capital cost need to fall. This can happen only if the cost of financial intermediation is lowered through liberalisation. In its absence the high cost of funding in India will perversely increase Indian corporates dependence on external funding. A statement as clear as that on FDI and divestment on the government?s take on financial reforms was conspicuous by its absence.
Much will be made of the agenda in the coming months, especially the price tag of many of the programmes and the seeming infeasibility of implementing many others. And surely the devil will be in the details. But let?s wait for the details.
The author is chief economist India, JP Morgan Chase. These are his personal views