?It will require a 10% growth to overcome poverty?

The divide between the ?two Indias? can be overcome in time. Author of Political Economy of Federalism in India, Professor Nirvikar Singh, also Director, Business Management Economics Programme, University of California, Santa Cruz, who was in the capital recently to deliver the Sage-MSE Lecture 2009, gives a perspective to Sarika Malhotra on the realities and the drivers of India?s economic development and the challenges it faces.

How do you think global and internal perceptions of India have been and continue to be shaped?

Economic success has been important for forming favourable impressions. Post-1991, liberalisation, allowing private enterprise to grow and participating more in the global economy, has had a profound impact. In particular, the success of India?s IT industry and of Indians in Silicon Valley (and corporate America more generally) have had an outsized effect on perceptions. They showed that India?s performance can be world class. India?s political commitment to democracy has also led to favourable impressions globally. Indian culture (high and popular) has always had a fascination for the West, but was previously outweighed by perceptions of poverty and economic failure, which are gradually changing.

How do you analyse the Indian financial sector, its interaction with other sectors and the resulting implications for growth?

The Indian financial sector has some notable bright spots. The banking sector is relatively sound. The equity market functions quite well. At least for large firms, it does a reasonably good job of getting credit to those who can use it productively. More can be done to expand the financial sector, both at the level of making Mumbai more of a global financial centre and in terms of increasing access to credit for a greater proportion of people. There are two excellent reports (reports by the Mistry Committee and Rajan Committee) that provide road maps for improving regulation and enabling financial markets to function more effectively. There is evidence that a strong domestic financial sector spurs growth and this is an important area for policy attention.

You have mentioned in your earlier works that beyond projecting aggregate outcomes of India?s fiscal policy adjustment, there are issues of distributional impacts and hence of politics. What are these and what are the measures to combat them?

Fiscal adjustment has differential impacts across income groups as well as across different states and regions, or between the Centre and the states. India has not done a good job of expenditure control. On the other hand, tax reform has progressed well and continues to go forward. Tax reform also has impacts, for example between the Centre and states. There is no unique or perfect solution, but the Centre can often construct policies to compensate for potential losses in a reform policy. For instance, in the introduction of VAT, the states were assured that their revenues would be protected in the short run.

What are the institutional impediments to fiscal restructuring? Are they legal, constitutional or reflective of social norms?

One problem is the intergovernmental transfer system, which creates soft budget constraints for the states. I would favour assigning more tax authority to the states and giving them less in transfers, especially at the margin. In general, it is hard to enforce fiscal discipline at the national level because the government can always borrow. Reducing public ownership in the banking sector and the financial sector more generally, will place more limits on the national government?s ability to run deficits. Changing tax authorities will require constitutional amendments, but often the impediments are lack of imagination, or of institutional mechanisms for bargaining, though these have been developing over time.

You had pointed out that ?the problems with India?s system of financial intermediation are deeper and broader than are suggested by (RBI Deputy Governor) Rakesh Mohan?s memorable phrase lazy banking?. What are these problems and what can be done to stem them?

Banks have incentives to minimise risks by holding government paper. They also are not used to assessing risks well and making loans to small and medium enterprises effectively. The lack of proper bankruptcy or loan recovery mechanisms through the legal system is also a problem area. India also needs a proper corporate bond market and venture capital framework. All of these can be achieved through regulatory reform, institutional design and implementation. What was done with the stock market can be done with other segments of the financial sector.

Do you think deeper problems of poverty can be overcome in time?

Yes. Growth at 10%, with concentrated attention paid by governments (Centre, state and local) to basic health and education can make a huge difference in a few decades.