Not risen to the challenge

Business Standard, 1 March 2016

We know that the Indian economy is facing exceptional difficulties, if GDP data is taken with a pinch of salt. Investment and exports are sluggish, and there is stress in one third of the corporate balance sheet and two thirds of the banking balance sheet. Exceptional times call for exceptional actions. The budget speech has taken a weak stab at the problem.

The budget speech began by saying that GDP growth has accelerated to 7.6% in real terms. It is hard to reconcile this with the fact that in the Oct-Dec 2015 quarter, the net sales growth of non-finance non-oil companies was essentially zero in nominal terms. An array of independent and trusted measures are showing there are significant problems in the economy. When we form a sense of the state of the economy, we should not rely excessively on the CSO. The disquiet in places like Gujarat or Haryana is likely to be related to recessionary conditions. Our top priority should be to undertake the policy actions which would turn things around.

The balance sheet crisis in the firms and in the banks is a drag on GDP growth. Private estimates for the requirement for bank recapitalisation run between 4 and 8 trillion rupees. The Indra-Dhanush program plans for Rs.0.7 trillion of public money and Rs.1 trillion by selling shares to private persons. The budget speech plans to stay on the Indra-Dhanush trajectory. If conditions in Indian banking are closer to what private analysts believe, a bigger reforms program is required to solve the problem.

Two elements of the required reforms are in the pipeline: the bankruptcy code and the resolution corporation. These are important developments. Here, the political problems seem under control, and the devil is now in the details. Will a well drafted bill get enacted? Will the required State capacity get created? The government will need to ensure that top quality teams get put into place. We hope these important projects will succeed. But addressing the banking crisis requires much more than this.

Indra-Dhanush envisages selling shares to private persons worth Rs.1 trillion: this seems difficult. And, private estimates for the problems in banking are much larger. Sound estimation of the magnitude of the problem is required, by neutral third parties. These need to feed into fiscal planning.

Every time taxpayers are asked to pick up the tab for a mess, the bargain has to involve reforms. Government has to ensure that trillions of rupees are exchanged for a commensurate program of reforms of RBI and of PSU banks. There is a small beginning on the latter, with the establishment of the Bank Board Bureau (BBB), though not of bank privatisation. There is no beginning on the former.

Even if there was excellent execution, getting Indian banking back to health will take a few years. In the meantime, corporate investment and growth can be salvaged by building a bond market. The measures announced in the budget do not address the problems of the bond market.

How to reform RBI, and thus obtain technically sound banking regulation and supervision, and how to reform the bond market: this journey has been worked out. The Percy Mistry Committee of 2007, followed by the Raghuram Rajan Committee of 2009 and then the Financial Sector Legislative Reforms Commission of 2013, have given full understanding and a work plan. Two parts of this strategy are now in motion -- bankruptcy code and resolution corporation. The remainder are also required.

The larger looming problem is private corporate investment. In 1991, the Congress government unleashed a new wave of private investment by showing a game plan for open minds and open markets. Private persons (local and foreign) felt that India had a great future, and invested bountily, which helped make that great future happen. A similar great outburst of investment took place from 2002 to 2008, following important progress in reforms by the first NDA government. This was done by showing fundamental reforms in field after field: telecom, equity market, highways, indirect taxes, FRBM, etc.

The heart of the question is about how to produce effective and competent government, for doing the things that government has to do, and dismantle government interference in the things where government is not required. The new government has as yet not shown an intellectual framework and a strategy for change on these questions.

As an example, there was a time when there was agreement about the strategy for tax policy. We were chipping away, year after year, going towards a simple tax system with strong economic logic. It is useful to recall the years of slogging that Yashwant Sinha put in, in reducing the number of rates and getting closer to a single rate. Simplicity in a tax system is related to sound economic thinking (other kinds of taxes, and multiplicity of rates, hamper GDP) and about practical considerations (complexity breeds cost of business, litigation, corruption, etc). This clarity has increasingly been lost. First, the UPA brought in the securities transaction tax and the education cess. Now things are being made worse, with a tripling of the STT on options, additional cesses, and other complexities. This is taking us closer to the tax system of the 1980s.

The media enjoys cute phrases. The private sector is more demanding. The possibilities in India are boundless, but we need to go from abstract possibility to tangible optimism similar to 1995 or 2005. What is required from government is intellectual framework, strategy, work plan and teams. It requires the willingness to put political capital behind reforms, for changing things will always offend incumbents. The Bar Council is the biggest barrier to making the legal profession work; Indian Railways is the biggest barrier to successful railway reform; RBI is the biggest barrier to financial sector reforms. When the private sector respects and trusts the reforms process, it will respond with bountiful investment growth, and asset markets will translate future GDP growth into immediate gains of asset prices.

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