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Big reforms: Will the steam last?

T he tide may or may not be turning, but the mood has certainly changed for the better. As if suddenly waking up from a deep slumber, the government swung into action and announced a slew of long awaited measures to curtail deficit, attract foreign investment and boost morale all around.

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Published: Mon 17 Sep 2012, 10:36 PM

Last updated: Tue 7 Apr 2015, 12:29 PM

In less than 24 hours, it hiked diesel price, capped subsidy on the cooking gas, cleared FDI in aviation, multi-brand retail, broadcasting and power exchanges and announced disinvestment in four blue chip public sector undertakings.

Cynics were quick to suggest that this unexpected bout of braveness was motivated by a burning desire to divert public attention from an uncomfortable debate on coal mines and other corruption scandals. The kinder critics saw an effort to avoid rating downgrade.

Without unduly worrying about the government’s motives, industry captains and financial markets wholeheartedly welcomed the initiatives. The stock market saluted the measures, with excited bulls pushing up the Sensex by 443 points or 2.5 per cent. In the currency market, the rupee shot up by 110 paise to Rs54.3 against the dollar.

Will the party continue? Right now, all eyes are on the RBI governor Dr D Subbarao. Any easing of monetary policy will be welcomed by industry and go some way in boosting the investor sentiment further.

Several observers have pointed out that the economy continues to be in dire straits, facing severe problems on the internal as well as external front. What has been done so far, though important, will do little to change the weak fundamentals of the economy.

For one, industry is stagnating. The index of industrial production edged up by a paltry 0.1 per cent in July and also during April-July 2012. The central government’s fiscal deficit in the first four months of 2012-13 had already exceeded half of the budgeted limit for the full year. To compound its woes, the corporate tax collections have been shockingly poor. The real fiscal spoilsport is, of course, subsidies. Spending on major subsidies including fuel, fertiliser and food is likely to hit 2.4 per cent of GDP in the current fiscal year, says the finance minister.

The recent hike in diesel prices will have a limited impact on the size of the deficit. The hike in diesel prices may yield about Rs105 billion to the government. Even this small amount will be partly offset by the simultaneous reduction in the excise duty on petrol.

Of course a repo rate cut, if followed up by banks with a base rate cut, would immediately benefit all borrowers, easing cash flows in a tough environment. But there is no guarantee that the lower cost of money would spur companies into immediately rolling out new investments because structural reforms are missing. The government needs to put in place proper policies, whether relating to land acquisition, environment, taxation and the allocation of natural resources, because companies cannot be expected to add capacity in an uncertain regulatory environment.

Whether government has the will and the tenacity to take up that broader reform agenda will be known from its response to the resistance provoked by some of the decisions from allies and opposition parties. The FDI in retail is likely to see fiercest opposition. If the government stays the course and boldly goes ahead to take up other more necessary reforms, it will strengthen the economy and boost confidence of investors, both indigenous and foreign. If it buckles under pressure, it will lose all credibility and the stock market rally will fizzle out.

Views expressed by the author are his own and do not reflect the newspaper’s policy