Will exit of Left speed up economic reforms in India?

THE Indian stock market celebrated the departure of the Leftist parties from the ruling arrangement with a spurt of 615 points in the Sensex, before worries over economic realities took over. Now that the perennial nay-sayers are out of reckoning, there is a great expectation that the government would move fast on economic reforms.

By Virendra Parekh (India Monitor)

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Published: Mon 14 Jul 2008, 11:58 PM

Last updated: Sun 5 Apr 2015, 12:49 PM

From the viewpoint of the economy at least, the exit of the Left has not come a day too soon. As the economy is tossed around in a sea of troubles by headwinds of high inflation, industrial slowdown and burgeoning deficits, as the Sensex plunges to newer depths every week and as the confidence of businessmen, investors and consumers gets knocked from all sides, people are wondering when the government will decide to govern. The darkening clouds of political uncertainty in recent weeks have only added to their nervousness.

In just three months, economic scene has undergone a dramatic change for the worse. The economy is reeling under a series of bad news, suggesting that the outlook for the world's second fastest-growing economy is no longer as rosy as before. It is buffeted by a combination of maladies-industrial slowdown, mounting inflation, falling currency, impact of the US slump and global credit crisis-that makes the situation far worse than if all these factors had not come together. Policy response has become a challenging exercise because the attempt to deal with any one of the problems tends to aggravate the other.

A major source of trouble is, of course, a doubling of oil prices in the last one year. Although oil prices have reacted from their peak levels, there is no prospect of an early slide back, or of any reduction in India's import dependence. The really nasty surprise, the single largest factor behind the mood change, is the sudden spurt in inflation. Inflation has been moving up steadily since March and now stands at a very uncomfortable 11.89 per cent, with the finance minister asking the people to grin and bear it for a while.

Measures to control inflation have, ironically but unsurprisingly, only aggravated the woes of the economy. The sharply rising inflation rate has forced the Reserve Bank to raise interest rates at a time when the economic tempo is slowing down and there is a case for lowering rates. Raising interest rates at such a time exacerbates the slowdown. Recent numbers confirm this: industrial growth down to 3.8 per cent in May 2008, from 10 per cent in May 2007; growth in six core industries down to 3.5 per from 7.8 per cent.

No wonder, growth forecasts are being revised downwards. With tighter monetary policy squeezing growth, few observers agree with the government and RBI in expecting a GDP growth of 8.5-9 per cent in 2008-09. Most of the independent analysts expect the outcome to be in the seven to eight per cent range, with a growing number favouring the lower side of this band.

To make matters worse, the fiscal situation has suddenly turned quite dire. The domestic prices of fertilisers, petroleum products and rationed grain were frozen by the government although global prices have been skyrocketing. This price freeze has hugely raised implicit and explicit government subsidies on these items. As a result, the combined fiscal deficit of the centre and the states threatens to shoot up to 10 per cent of the GDP, the level seen in 1990-91 which brought the economy to the verge of bankruptcy.

Apart from inflating the fiscal deficit, the surging international prices of oil, fertilisers and food are also widening the deficits in foreign trade and the current account of the balance of payments. If world oil prices average around $ 130/bbl in 2008-09, India's commodity trade deficit is likely to be in the order of 10 per cent of GDP and the current account deficit close to four per cent of GDP.

This very briefly is the outline of an economic situation that makes people yearn for swift corrective measures. As economist Subir Gokarna perceptively observed in Business Standard, all the rosy prognostications about India's economic future are largely conditional. The future is contingent on economic reforms continuing to provide the same kind of facilitation to businesses, workers and consumers that they did since 1991. If reforms were to end, so would the India story, maybe after some lag. The current situation would not have become so acute if the constraints of infrastructure, skilled labour, fiscal discipline and public investment in agriculture had been addressed in time by appropriate reform agenda. If China is "condemned to grow" because of its economic fundamentals, India is "condemned to reform" because of its economic deficiencies and deformities.

If the government is serious about pushing reforms, there is no shortage of work to be done. The Pension Fund Regulatory and Development Authority Bill that would end the monopoly of the Employees Pension Fund Organisation in the pension funds business has been on hold for three years. There is the State Bank of India Amendment Bill that seeks to reduce government holding in the bank from 55 per cent to 51 per cent. The bill to allow foreign investment in single-brand retail can be expected to get cleared. A banking reforms bill that allows greater voting rights for investors, up from the present cap of 10 per cent, may also be easy to pass. The insurance FDI bill and the foreign education providers bill (neither of them introduced yet) also can now perhaps muster legislative majorities.

There are other such bills and, therefore, a lot of scope to push economic reforms. Indeed, news reports now speak of the government wanting to raise the foreign equity cap in areas like telecom and insurance. A number of share issues by state-owned companies and banks may also be possible, though the stock market is not offering great valuations just now. In short, this is a chance for the Manmohan Singh government to reclaim its reformist credentials and demonstrate that it has more than the Indo-US nuclear deal to show for five years in office.

The question is: will the government show the same enthusiasm for reform that is expected of it and, indeed, is the need of the hour? The answer, unfortunately, depends on a number of factors that have nothing to do with the economy.

Assuming that it survives the trust vote in the house on July 22 (as is likely), its first priority will be to sign the nuclear deal on which the Prime Minister has staked so much. The second priority will be to prepare for the forthcoming elections to several state assemblies and then the Lok Sabha elections by May 2009. Therefore, priority number three would be not to court fresh controversies. That rules out quite a few of the reform proposals being bandied about. Also, if the ruling coalition does badly in the three state elections, then illogically but inevitably, reforms would become a dirty word for it. Moreover, governments in India typically dislike late-in-the-term policy changes.

Yes, there are a number of measures, which were blocked by the Left so far, that could be taken without creating controversy. These, however, would need support of the opposition. But after what is likely to be a tense fight for a trust vote, will the government ask for the opposition's support and will the opposition oblige it? The excitement about reforms after the Left's departure from the ruling arrangement is understandable. But it is not well-grounded in political realism. Economic policy making, alas, continues to be hostage to political considerations.

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