INDIA: Pace of change
The unveiling last month of India’s boldest reform package in a decade took many by surprise. But fanfare alone will do little to boost a deteriorating economy
In just 24 hours this September, the Indian governments ruling coalition announced more important reforms than it had in its previous eight years in power. The Congress Party-led government offered, on the face of it, a change of landscape.
They began on a Thursday night, with a hike of Rs5 ($0.09) around 14% in the price of diesel. This is a politically volatile issue, as the subsidies to diesel, cooking gas and kerosene are immensely popular with Indias hundreds of millions of poor people, who vote in great numbers. That said, the reform had been vociferously advocated by business leaders, markets, economists and the Reserve Bank of India as a way to help close the countrys gaping fiscal deficit.
The following day the buzz from Thursday wearing off in the face of data that revealed annual inflation was running at 7.5% in August came a flood of further changes.
Four major public-sector companies Hindustan Copper, Oil India, MMTC and Nalco were to be opened up for stake sales, allowing the government to close the estimated 6% fiscal deficit by up to $2.76 billion.
Foreign direct investment would be expanded or opened up across four sectors, including elements of broadcast and power exchanges, but centring on the permission of foreign airlines to invest directly in local carriers up to 49%, and the opening up of multi-brand retail to 51% FDI by foreign grocery giants including Walmart from the US, Carrefour from France and the UKs Tesco.
It was a turnaround from the week before. Then both houses of parliament in the August/September monsoon season shifted between chaotic scenes of protest and long periods of adjournment as the government tried to deal with yet another multibillion dollar corruption scandal.
Any prospect of much-needed fiscal reforms had long since been abandoned by most observers, drowned in the din of shouting and sloganeering. Such stalemates have come to define modern Indian politics, especially as 2014 national elections draw nearer, and it is unlikely a new slate of politically potent reforms is going to quiet the storm.
On the Friday night, business news anchors seemed elated, perhaps keen, after a dismal 2011 and most of 2012, finally to be discussing some good economic news.
But others were not so pleased, including West Bengal chief minister Mamata Banerjee, a member of the ruling coalition who had succeeded in rolling back FDI in multi-brand retail when it was first proposed late last year, as well as a proposed railway fare hike. She promptly declared that she would take to the streets to protest, and a week later had pulled her partys support from the government she was quickly, and thankfully to many of the reform-minded, replaced by another regional party.
The possibility that some of the reforms might be rolled back is one reason why economists didnt quite share the medias elation another is what the reforms were designed to do: convince ratings agencies and the Reserve Bank of India that the government was serious about fiscal consolidation.
Earlier this year, ratings agencies Fitch and Standard & Poors both cited the fiscal deficit and the governments inability or unwillingness to enact reforms as key reasons for downgrading their outlook for the country to negative earlier this year.
But even the latest slate of reforms many of which economists, business leaders and markets have been clamouring for may not be enough for the country to avoid becoming the first major Brics (Brazil, Russia, India, China and South Africa) country to see its debt downgraded to junk status.
Takahira Ogawa, S&P director for sovereign ratings, says the reforms effectiveness comes down to their implementation: We believe that the governments recent announcement on foreign direct investments is an encouraging development, but at this stage it is still uncertain whether these measures can be implemented or not.
Moodys, which did not downgrade its outlook for India, cited the relative tokenism of the fiscal reforms: namely, that they were designed to send a signal that the government was serious about reform, rather than these being serious reform efforts in and of themselves.
The effect of the announced reforms on the governments credit profile is minimal because they are either too small to have material sovereign credit benefits or carry implementation or rollback risks that outweigh any credit positive benefits, says Moodys, adding that the proposed diesel subsidy cut will bring the fiscal deficit down by just 0.1%.
That is hardly the sort of boost the Indian economy needs right now.
In the quarter ended in June, GDP growth fell to 5.5%, marginally higher than that of the previous quarter, which, at 5.3%, was the lowest since the same period in 2009, immediately following the fall of Lehman Brothers. Few expect growth to climb higher than 5.5% during the current fiscal year, which ends in March 2013.
The fiscal year that ended in March 2011 was disastrous: growth slowed to 6.5% far below the 9% the government had earlier forecast industry flat lined, foreign inflows dried up, inflation hovered near double digits, the Indian rupee was Asias worst-performing currency, and the countrys current account, fiscal and trade deficits all reached or were near record highs.
Those hoping for a rebound in 2012 have so far been left wanting, as inflation remains above 7%, and while the governments reforms have boosted investor sentiment marginally, they are unlikely to produce medium-term results unless they are followed up by further, robust and sustained efforts.
The new finance minister, P Chidamb-aram, has made it a point of stating that the government will be both reform-minded and investor-friendly, and insists that the new slate of measures will not be rolled back.
But both the Congress Party and the opposition Bhartiya Janata Party not to mention Indias many strong regional parties have a keen eye on 2014s national elections, and though it may now seem to have succeeded in slipping through one small part of its reform agenda, if its political fortunes suffer, Congress may be less likely to propose them in the future.
The Reserve Bank of India, for its part, had a chance, however indirectly, to comment on the governments efforts mere days after the blockbuster reforms were announced. Having a weekend to mull over the reforms which it had actively and repeatedly advocated the central bank demurred, continuing its focus on the countrys elevated inflation by holding interest rates steady at 8%.
In its policy statement, the central bank acknowledged the governments efforts, but maintained its focus on inflation: As inflationary tendencies have persisted, the primary focus of monetary policy remains the containment of inflation and anchoring of inflation expectations.
In this context, the governments recent actions have paved the way for a more favourable growth-inflation dynamic by initiating a shift in expenditure away from consumption (subsidies) and towards investment (including through FDI).
Of course, several challenges remain, one of which is persistent inflation. But, as policy actions to stimulate growth materialize, monetary policy will reinforce the positive impact of these actions while maintaining its focus on inflation management. Only this will ensure that the economy derives the maximum benefit from the recent, and anticipated, fiscal and supply-side policy measures.
Further reforms are needed, and whether the government will have the will to push for new initiatives opening FDI in pensions, and raising the cap on FDI in insurance, as well as land acquisition reform, and a uniform goods and service and direct taxes code, which had not been approved at the time of writing while simultaneously defending potentially unpopular ones like diesel price hikes and FDI in multi-brand retail, remains to be seen.
Yet another key reform, Universal ID which aims to digitize ration cards and provide Indians with individual government account numbers, taking easy-to-filch cash out of the subsidy system aims to help cut down on corruption and graft, but it, too, remains dormant.
The inefficiency of social programmes is stretching the governments coffers even further. For example, just 41% of the food set aside for distribution to the countrys many poor, through a nearly 50-year-old government programme, reached the needy in 2005, according to a World Bank study released last year. In some states, the number was as low as 20%.
Then there is the question of whether a reform like FDI in multi-brand retail will even take root, considering that the government has left it up to companies to find states willing to accept their investments. Many, including Bihar, West Bengal and Indias largest state, Uttar Pradesh, have already ruled it out only one, Maharashtra, has come forward to embrace it wholeheartedly.
Chidambaram, who held the finance portfolio from 2004 to 2008, seems to be confirming what he indicated in his first statement to the media upon starting the job in early August: that he understands the problems facing the country and, more importantly, Delhis lack of action.
Fiscal policy and monetary policy must point to the same direction and must move in tandem, he said at the time. Government will work with the Reserve Bank of India to ensure that inflation is moderated in the medium term.
Chidambaram is making all the right noises. He has indicated that further reforms are in the offing, including the goods and service tax and the streamlining of cumbersome project approvals processes. He has also said he would support the postponement of the implementation of anti-tax avoidance rules and reviewing retrospective tax rules that many had seen as anti-business.
The key to restart the growth engine is to attract more investment, both from domestic investors and foreign investors, he said. Since investment is an act of faith, we must remove any apprehension or distrust in the minds of investors.
The government has taken other steps recently to tackle its macro woes including doubling the import duty on gold to 4% to cut down on imports of the precious metal. Gold, which Indians buy by the tonne during the festival and wedding seasons that last from roughly mid-September to late-January, is the third-largest of its merchandise imports, behind crude and capital goods and helped balloon the current account deficit to a record 4.5% of GDP in the quarter ended in March.
Our gold and silver numbers are largely inelastic, and when you have high international commodity prices and inelastic gold and silver demand, youre bound to have a balance of payments problem, says Anis Chakravarty, a senior economist at Deloitte.
The import tax increase, according to the Bombay Bullion Association, helped halve demand in the months after its March implementation.
The governments recent gestures toward reform are seen as welcome signs, but Samiran Chakraborty, chief India economist for Standard Chartered, says the economic pain is likely to continue in the near term.
India has to do all the right things from the central government side, but that doesnt mean investment growth will come back in one quarter it will be a slow process, he says. Even if we take all the right steps today including reduction of fiscal deficits and all kinds of supply-side reforms it would be nice if there were an immediate response, big projects coming, but thats not going to happen.
But if we take the right steps now maybe in 20132014 we might see the results, he says. Just in time for those national elections.