It would be tempting (and facile though understandable) to dismiss the principles, aims and objectives of reform (enunciated earlier in this series) as just another wish list incapable of being implemented, rather than an action programme that can be. Doubtless many will do that. What turns wishlists into actions is political will, public consensus, and executive commitment. It is not that we do not know what needs to be done to secure India?s future. It is that we have neither sufficiently wide nor deep political understanding of the urgency of reform, nor the will, nor the executive capability or commitment to create a public consensus in favour of reforms and make them happen. India?s political and administrative leadership does not lead anymore as it did in the crisis of 1991-93. It seems incapable of performing that function. Instead it panders to the compulsions of vote-bank politics. Its perception of reforms is one based on short-term political losses and gains in terms of electoral outcomes. It is like the apocryphal story of the mayor of a garrison town at the time of the French Revolution who asked his aide to find out where the mob was going so that he could rush there to ?lead? them.
The agenda outlined is ambitious, wide and deep. While simultaneous action is needed on multiple fronts, the reality of limited capacity and resources compels prioritisation, selectiveness, focus and sequencing for rapid progress on a few key fronts, with action on others being slower. For the remainder of this government?s term (i.e. until 2014) the priorities that suggest themselves are:
* Closing the infrastructure deficit along with its proper regulation
* Liberalising the financial system and freeing it from RBI repression
* Correcting public financial imbalances through budget control and privatisation
* Reforming labour laws to encourage rapid employment growth
RBI has become an obstacle to reforms
On all these priorities what needs to be done is clear. Innumerable recommendations have been spelt out in great detail by a number of expert committee reports in each case. Unfortunately, they are gathering dust instead of being distilled and acted upon with a sense of urgency. In the case of two of these priorities (2 and 3 above), it has to be recognised that little will be achieved unless the role of the Reserve Bank of India (RBI) is altered to suit the circumstances of the 21st century rather that those of the early 20th century when the current RBI Act was passed and those of the 19th century in which most of its senior managers still seem to dwell.
RBI has been, through most of its history, an institution led occasionally by stalwarts.
Together, they have often cushioned India from the impact of severe government follies at state and Central levels. Without some of its actions, India may well have suffered the ignominious fate of Latin America and Africa in the 1980s and that of East Asian debtor countries in the 1990s. But, after an excellent start in 1991-93, RBI has become an obstacle to reform of India?s financial system rather than a bulwark protecting it from an uncertain fate.
Financial system reform is, of course, the key to unlocking India?s future. Without such reform it will be impossible to finance India?s infrastructure, restore the integrity of its public finances, accelerate the development of India?s public and corporate debt markets, or meet the increasing demands and risk-management needs of India?s producers, consumers, investors and depositors. In resisting financial system liberalisation and reform by any means possible, using time-honoured techniques of obfuscation and foot-dragging to exhaust opposition, RBI (like all central banks) now seems most concerned about protecting its turf. Recently, it has propagandised absurd interpretations of supposed lessons from the ongoing global financial crisis, misleading the public at large in the process. At the same time it has applauded its own alleged brilliance in protecting India from the worst effects of the crisis, i.e. by ensuring that its financial system remained underdeveloped and dysfunctional. It has engaged in these feints to support its untenable stance on a host of issues concerning regulation, systemic stability and financial market/ product development.
…with a Stockholm syndrome
In considering reforms, RBI refuses to countenance any change in its role no matter how appropriate or necessary. It insists on establishing eminent regulatory/supervisory domain over not just the banking market but over all key capital and commodity markets/products (i.e. for debt and derivatives) where by logic and by right RBI should defer to Sebi. It has difficulty in differentiating between what is good for India vs what is good for RBI. In part, that is due to the internal culture of RBI, which is overwhelming and impossible to comprehend in its self-serving insularity. Extraordinarily capable and reasonable minds enter RBI as leaders and executives. They exit as brainwashed Manchurian candidates suffering from Stockholm syndrome.
If many of the reforms suggested above are to bear fruit, RBI must be turned into a monetary authority. Responsibility for regulation/supervision should be delegated to a separate, single financial services regulator. At the same time, RBI should follow the model of most other major countries and be made independent of the finance ministry. Its governor should have senior cabinet rank, with the institution reporting to Parliament rather than to the government of the day. Without those interrelated steps being taken, there will be no hope of meaningful financial system reform. Therefore, there will be no hope of public finance reform or of enhancing India?s ability to finance large infrastructure and industrial undertakings by using the capability of domestic and global financial markets more intelligently. If it cannot do that, India will not grow as it should.
Crisis in public finances
Perhaps the first and most urgent institutional reform required if India is to achieve its potential and become a developed global power within the next 50 years is to reform RBI as a prelude to reforming government, parliament and the judiciary. But it is only the first step among many that have to be taken, as indicated earlier.
A second equally urgent step concerns government?s approach to public finances, especially to exercising its ownership rights over productive assets and their custodianship. The Indian state has been running too high a consolidated fiscal deficit (including that of Centre, states, PSUs and off-budget sheet items like oil and fertiliser bonds) for far too long. This year that deficit will amount to over 13% of GDP resulting in public debt stocks exceeding 90% of GDP and continuing to rise unless something drastic is done to restore balance. Under present circumstances the government has deprived itself of discretionary fiscal headroom to achieve anything useful, leave aside inclusive growth. Over 80% of its expenses are predetermined and non-discretionary in just meeting payroll expenses and interest on public debt. Yet it chooses to maintain unaffordable producer price subsidies, expand its programme of poorly designed income subsidies, increase the capitalisation of state-owned banks (SOBs), and build up strategic capability all at the same time. Continuing down that path will simply lead to another crisis in public finances.
The only thing that can be done to prevent that outcome?not for reasons of ideology or preference but out of sheer financial necessity?is to unload GoI?s stake in PSUs and SOBs in a meaningful and decisive rather than timorous, marginal manner. Divestment and privatisation must yield not just capital proceeds but significant efficiency gains through improved private asset management.
Recognising the reality of its precarious predicament, GoI has announced that up to 10% of its shareholding in profitable PSUs will be sold on the open market. The proceeds will go towards deficit reduction which, for reasons explained, violates accounting principles and will be disastrous in its long-term impact. At the same time, it has announced that several billion dollars will be borrowed by GoI from the World Bank and Asian Development Bank to finance a hike in the public capitalisation levels of SOBs when these should be privatised instead.
What GoI is doing to address its fiscal problems is absurd and contradictory in both principle and intent. If these are the kind of expedient and inconsistent actions that GoI is inclined to take in managing an acute public financial situation, then there is little hope that India will indeed secure a more confident future.
GoI desperately needs to create fiscal headroom in order to focus on making growth as inclusive as possible. But it is eschewing that prospect by proceeding in a half-hearted, ham-handed manner. GoI?s approach to privatisation is a key element in determining whether India will grow as it should in an inclusive and efficient manner. But portents are that it will bypass what is sensible to do what is sub-optimal, in the name of politics. If that remains GoI?s modus operandi the prospects of India fulfilling its destiny will become dimmer than ever rather than brighter as they should become.
What the electorate demands, by 2014
The actions outlined above are the first that must be taken in a series of sustained and intelligently sequenced reform for the remainder of the UPA-2 term. They do not constitute an exhaustive and mutually exclusive list of everything that must be done. Economic reform is not a finite process with a clear destination. It is an ongoing journey?of learning from the past and correcting errors in the future?that never ends. If that journey does not resume from its long hiatus in 2010, it will be a major opportunity forgone, especially when the Left has been marginalised by the electorate and the BJP has rendered itself comatose through electoral defeat and internal disintegration. And economic reform needs to be accompanied simultaneously by parliamentary, judicial and law and order reforms of equal weight and intensity. Doing all that is a tall order, which will challenge the political system and the administrative bureaucracy to their limits. But it is not impossible.
The Indian electorate is unlikely to forgive, and probably will even punish in 2014, a government that failed to deliver decisively on its mandate to do what was in India?s long-term interests when it was not hamstrung by its coalition partners nor thwarted by a strong Opposition.
(Concluded)
The author is an economics and corporate finance expert