HALF way into Manmohan Singh's second term as prime
minister, the so-called India Shining story is unravelling. Having weathered
the 2008 financial crisis better than almost anyone predicted, projections that
the country would soon be growing faster than China at 10% or more a year had
become the norm.
That confidence has come hurtling back to reality with a
thump.
Admittedly, gross domestic product (GDP) is still expanding
at around 7%, a rate the developed world can only dream about. But big new
investment projects have virtually dried up, the fiscal deficit is heading
towards 6% of GDP and the rupee was Asia's worst performing major currency last
year while India's Sensex stock market index fell 25%.
What's more, inflation remains stubbornly high despite 13
interest rate hikes over the past year-and-a-half. Some even joke that the “I”
in Bric, the club of rapidly developing economies, should now be Indonesia
rather than India.
Political infighting and inertia bear much of the blame.
Singh, who launched the economy on the road to liberalisation when finance
minister 20 years ago, has lost the will and the ability to reform. His
government's energy has been sapped by corruption scams. And he has been unable
to push through even those reforms that he promised because coalition partners
keep threatening to pull the rug from under his government.
How badly will this political paralysis hurt the economy's
immediate prospects? What's the best way of tackling the endemic corruption?
And is India's long-term growth story still intact?
Wasting a good crisis
In India major reforms tend to follow economic slowdowns. It
was a balance of payments crisis in 1991 that kicked off Singh's original
reforms. Yet this time, instead of springing into action, the political system
is paralysed. The best it can offer is handouts and subsidies, which will
further exacerbate the country's economic problems.
The failure to enact structural reforms in Singh's first
term as prime minister from 2004-2009, as well as since he was reelected, is
one of the reasons the country's productive potential has not grown as fast as
it might have. Demand, though, has been strong - driven both by the growing
middle classes and deficit-financed cash handouts to the rural population. The
snag is that, with demand outpacing supply, inflation remained above 9%
throughout 2011.
The Reserve Bank of India has tried, only partly
successfully, to tackle the inflation by pushing interest rates up to 8.5%.
While demand has slowed down, it's investment that has been hit more than
consumption - and that's an unhealthy mix for the future.
For the moment, investment - which was 35% of GDP last year - doesn't look too bad. But large new investment proposals fell to a five-year
low in 2011, according to data from the Centre for Monitoring Indian Economy.
Unless investment picks up, the country's productive potential won't rise as
rapidly as it could and it will face renewed inflation whenever it tries to
press on the accelerator.
The hike in interest rates isn't the only factor restraining
investment. Many new projects, especially anything to do with infrastructure or
exploitation of natural resources, require government approval - and the
machinery of government is operating at a snail's pace.
That, in turn, is partly because several people have been
thrown into jail in connection with a telecoms scam, where radio spectrum was
awarded to cellphone companies at a fraction of its value costing the state an
estimated $39bn in lost revenue.
Officials across government are reluctant to sign off on new
projects because they are afraid they may get incarcerated too. Hopefully, the
bureaucratic stasis will only last until government transitions to a cleaner
way of operating. But in the meantime, it is gumming up the economy.
Business confidence has also taken a hit. Industry is
worried about the paralysis in Delhi. The government's habit of spending more
than it raises in taxes - and then mainly on things that boost consumption
rather than infrastructure - is also crowding out the private sector.
Business has in recent years tapped foreign sources of
capital to help plug the gap. But the euro crisis has made it harder to borrow
from abroad. Indeed, some companies such a Reliance Communications and Tata
Motors are ruing the day they loaded up with dollar loans only to find that the
plunge in the rupee means their debts are bigger in their home currency.
Power is an example of how a cat's cradle of government
policies is messing up a vital sector. The main source of energy is coal, which
is abundant in India and made available to generators at about 45% less than
global prices. So private sector groups such as Tata Power, Sterlite and
Reliance Power started investing in new coal-fired power stations, financing
them mostly with borrowed money.
The snag is that new coal mining projects have been delayed
by environmental concerns and so the power producers don't have enough cheap
local coal. Buying expensive imported coal, on the other hand, is uneconomic
because the price at which they are allowed to sell electricity is capped by
the state. Some of the power producers look like they will need a debt
restructuring. India may soon have insufficient electricity to drive growth.
All this is happening when the global economy is slowing and
the euro crisis is raging. India isn't as much exposed to trade as, say, China
is. But its reliance on foreign capital makes it vulnerable to any seizing up
in financial markets such as the one which followed Lehman Brothers'
bankruptcy. What's more, if the euro did explode, the government's own deficit
means it wouldn't have many ways of cushioning the blow.
Political games
Ideally, the government would respond to the slowdown by
launching supply-side reforms to boost investment and the country's productive
potential. Top priorities would include curbing the fiscal deficit, rooting out
subsidies, liberalising the power sector, simplifying regulations on land use
without which few enterprises can get going or expand – and, of course,
combating corruption.
In fact, the government's only significant liberalisation
move – a relatively modest plan to open up the country's retail sector to
foreign investment – has fallen flat on its face. Just days after announcing
the move in November, which would not only have brought in foreign money from
the likes of Tesco and Walmart but also helped modernise the supply chain and
curb inflation, Singh had to shelve the plan.
The reason? Mamata Banerjee, the powerful chief minister of
West Bengal on whose support Singh's government relies, refused to back it. She
also incidentally torpedoed an anti-corruption bill in the dying days of 2011.
Instead of reform, the government's main proposal has been
for a new food security bill which involves giving about 800 million out of the
country's 1.2 billion people access to virtually free rice, wheat and coarse
grains. There's nothing wrong with a plan to curb malnutrition. After all,
India has worse rates of child undernourishment than sub-Saharan Africa.
But the new plan is badly targeted, covering two-thirds of
the population. It may double the cost of food subsidies, taking them to 2% of
GDP, at a time when the deficit is already too high.
The scheme also looks like a fertile new ground for
corruption. What's more, the government's need to acquire huge quantities of
grain will push up food inflation. It's hardly surprising that many observers
think the main motivation for the plan isn't to combat malnutrition but to buy
votes ahead of the 2014 general election.
It's not at all clear that 79-year-old Singh really believes
in what the government is doing. But he is hemmed in from two sides. One is his
fractious coalition partners; the Congress Party, which he is part of, has only
206 out of 543 seats in parliament.
The other is Sonia Gandhi, the standard bearer of the
Nehru/Gandhi dynasty who runs the Congress Party. She is considered to be less
of a reformer and more of an old-fashioned socialist. A common quip in New
Delhi is that Gandhi has power without responsibility, whereas Singh has
responsibility without power.
Spring hopes
Amid all this gloom, industrialists and political pundits
cling to the hope that things could get brighter in the spring. Part of the
hope derives from the fact that inflation is at last falling. It is expected to
come down to between 6% and 7% by the end of 2012, according to UBS estimates.
Though that's still high, it should allow the central bank to ease interest
rates a bit which, in turn, could encourage business to invest.
But the bigger hope hangs on elections in five key states in
March. If Congress does well, it could reassert itself. There's a particular
focus on Uttar Pradesh (UP), the largest state with over 200 million people.
Congress is not in a position to win this state. But it may
be able to form a coalition in UP with the local Samajwadi Party (SP). As a
quid pro quo, the SP may then be prepared to support Congress in New Delhi,
allowing it to dispense with Mamata Banerjee as an ally. Because Congress and
SP would each have a hold on the other, such a coalition might be more stable
than the current one.
In this rosy scenario, Singh would then be free to relaunch
his reform agenda. He'd bring back the plans for opening up the retail sector
to foreign investment and combating corruption; he'd push through draft bills
on mining and land acquisition; he'd get the machinery of government moving
again; and he'd rein in the fiscal deficit.
The main way of doing the latter would be to curb fuel
subsidies, which cost the government 3.5% of GDP according to the Organisation
for Economic Cooperation and Development. Such a move, which was heavily hinted
at by Singh in his New Year's address, would help pay for the new food
subsidies.
All this would be great if it happens. But it does rely on
the state elections going the way Congress wants, as well as the government
deciding that it really wants to push through another dose of reforms which
would be unpopular and involve overriding vested interests. And, of course, it
depends on Singh or another reformer being prime minister - which, given Gandhi
remains the power behind the throne, cannot be guaranteed.
- Reuters
* Jeff Glekin and Hugo Dixon are Reuters Breakingviews
columnists. The opinions expressed are their own.