Next PM must have ear for reforms

What will the Indian economy look like in 2014? The answer will depend on whether the next prime minister and finance minister understand what has gone wrong in the last four years. In particular, it will depend on the objectives of the prime minister, the leader of the House, and the credibility of the person appointed as finance minister.

If they think that the economy will revive automatically, then the economy is likely to disappoint in the next five years. Although a reversal of the governance failures and regressive tax changes during 2010-13 will help recovery in 2014-15, they will not be enough to put us back on a path of sustained eight percent growth.

The next PM’s top priority for his first two years in office must be to restore the Indian economy to its long-term growth potential of 8%+ (about 6.5% in per capita GDP terms) and to communicate this objective credibly to voters and the investment community. An important determinant of credibility will be the finance minister selected by the PM to restore growth. In a global environment marked by great uncertainty and risk, the FM must have the respect of the investor-investment community. This will ensure that the government’s programme to restore growth gains credibility.

During 1981 to 1991, the Indian economy grew in real terms at 2.1% above the average growth of the world economy. The rate of growth of the Indian economy accelerated during 1992 to 2010 because of the 1990s reforms, to 3.6% above the average growth of the world economy. Since then, the real growth differential has collapsed to 1.2%. The entire drop of 2.4% in the growth differential can be attributed to domestic causes. There are two broad reasons: One, deteriorating economic governance, including poor macro-economic management and the re-introduction of regressive rules, procedures and administrative practices (a la Licence-Permit-Quota Raj). Two, failure to introduce policy, regulatory and institutional reforms essential for sustaining growth at the underlying growth potential of 8%.

An improvement in day-to-day governance, in terms of resolution of inter-departmental differences and speed of decision-making within departments, will help revive growth. Three legislative mistakes need to be addressed:

(1) Right to Education Act: Research has shown that the private non-profit sector (NPOs) provides education of quality equal, on average, to that of the public sector at a third of the cost. Requiring the NPOs to double or triple the salaries of teachers will drive them out and do incalculable damage to the cause of education. These clauses need to be dropped.

(2) Right to Food Act: By ignoring the corruption in the Public Distribution System and the Food Corporation of India while expanding the provision of cereals to two-thirds of the population, it does great dis-service to the hungry (1-3% of population) and to wasted/stunted/malnourished children under five (7.5% of population). The coverage of the Food Security Act should be scaled back to the 22% below poverty line, and directed at eliminating hunger. The government’s focus should be on child stunting-wasting, whose major cause is unsanitary conditions.

(3) Land Acquisition Relief and Rehabilitation Act: The extremely laudable objective of fairness in compulsory acquisition of land has been converted into an expansive ecological and social agenda. Purely private voluntary land transactions must be removed completely from the ambit of this law and the enormous bureaucratisation of rules and procedures rolled back.

Among the reforms that can help restore growth to 8% are:

(1) Scale back government consumption expenditures, including subsidies and transfers, to bring revenue and fiscal deficits to zero in five years. This will reduce government debt, the current account deficit and foreign indebtedness and raise the national saving rate, allowing RBI to ease monetary policy and stimulate investment and consumer durables demand without fear of increasing Non-Performing Assets or inflation.

(2) Agricultural Reform: Halt procurement price-led inflation and massive overstocking of wheat and rice, repeal Agricultural Produce Marke-ting Act and Essential Commodities Act. Remove all restrictions on FDI in food retail. Replace the policy of ad hoc agricultural import-export bans by import-export tariff bands that offer transparent protection within limits. These, and related reforms, will reduce Indian food inflation to the much lower levels prevailing globally, and help control overall inflation.

(3) Break up government monopoly in coal and infrastructure sectors (railway, ports, airports, electricity distribution and transmission), convert PSUs in these sectors to public limited companies and set up a professional independent regulatory structure to oversee free entry and to benchmark competition in these sectors. This will set off a cycle of self-sustaining infrastructure growth and productivity improvements.

(4) Sell all PSUs in industries and finance that are inherently competitive (steel, airlines, power/railway equipment, hotels, machinery, banks, insurance). Use the proceeds to reduce national debt. This will stimulate a surge in manufacturing productivity (as in the 1990s).

(5) Repeal exit clauses in labour laws, with existing employees grandfathered.

(6) Empower the poor (including farmers) through a UID-linked multi-application smart card containing all entitlements (food, education, health).

(7) Focus Plan programmes on five public goods and services (a) A quality national road grid connecting every city and every village. (b) A modern drainage, water supply and sewage system with water works, sewage treatment and garbage disposal. (c) Basic education (knowledge of 3 Rs) and job skills for every youth. (d) Telecom (internet) connectivity (for governance, public education, public health, applied technology) and mobile banking to every habitation. (e) Water planning, recycling, training and management for sustainable water use.

(8) Initiate fundamental political/electoral, police, judicial, legal and bureaucratic reforms to address the issue of pervasive, systemic corruption and start restoring good governance. Such a programme of reforms can sustain Indian GDP growth at over 8% for the next two decades in the face of slower growth of world GDP and international trade. Without a clear re-orientation towards employment and empowerment, we are likely to average 6% in 2014, and between 6-7% in the next five years, with reduction in revenues for development and welfare programmes.

(Arvind Virmani is a former chief economic adviser to the Ministry of Finance and India’s previous Executive Director at the IMF. He currently heads the NGO, ChintanLive.org)