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BW Businessworld

The Reform Rush

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A subsidy burden that keeps bloating every year and increasing the fiscal deficit; an out-of-control inflation hitting the common man; slipping industrial growth and GDP; foreign investments slowing to a trickle; and a frustrating wait for economic reforms for over eight years. Put all these together and you have an economy under siege. So what does the government of the day do? For the first time in nearly a decade, it does not fall back on its old excuse for inaction — compulsions of coalition politics. Last week, it got down to business with some politically unpalatable but economically sound decisions. It announced a Rs 5 per litre hike in diesel prices to contain the fuel subsidy bill, and capped the number of subsidised cylinders an LPG subscriber can get in a year. It also sent out a welcome message to global investors by allowing foreign direct investment in aviation and multi-brand retail sectors. But these measures do not seem enough. BW asked corporate leaders and economists to give their prescriptions for putting the economy back on track. Read on to find out what they are:


Rajan Bharti Mittal

THE measures announced are a great starting point. It tells us that the government is committed to reforms, and has taken the first set of actions. I hope the next set (including the insurance and pension bills), which may also require parliamentary approval, are in the offing.

While these reforms give hope, others need to follow. The GST (Goods and Service Tax) is a key reform that needs to be implemented. It will change the landscape of goods movement within India. Work on GST has been on for a while; but every time we hear of a consensus, some states oppose it. Hopefully, these states will see the advantage they got from the value-added tax (VAT). Another issue that needs to be tackled is that of the Direct Taxes Code (DTC).

The reforms, however, may not help us reach the projected GDP growth rate of 7-7.5 per cent. But there is no reason why we should not be looking at 6.5 per cent growth. It is not just about a target; it is also about not being where we are, at 5.3-5.5 per cent. In some way, fiscal management is also taking shape with disinvestment. If we can hit 6.5 per cent growth, we have moved in the right direction. Things will start picking up then.

Meanwhile, the Reserve Bank of India is also looking at a trade-off between inflation and growth. I believe that we have to keep the growth momentum going, especially in manufacturing and infrastructure, where interest rates need to be reasonable. With the latest cut in cash reserve ratio (CRR), there is hope that as growth picks up and inflation comes down, there will be more intervention.

The growth momentum takes a long time to crank up once it stops. If capital formation is low, growth, investment and capex will be low too. If the momentum starts building, we can adjust accordingly. While attracting FIIs is important to keep the momentum going, it is even more so for FDI, since it has a long gestation. With sectors opening up, it will be important for us to re-engage with people who want to invest in India.

On the domestic front, we need to focus on propping up manufacturing. For example, we have set aside Rs 193,000 crore in our national budget for buying defence equipment. And about 85 per cent of the equipment is imported. Why can’t we start some of the manufacturing in India? It will give a boost to many other sectors and, being a core industry, the stakeholders who support it.

There are many moving parts in manufacturing — infrastructure, rate of interest, power and labour. Power is expensive; infrastructure is weak; and labour laws outdated. Those are challenges that the new manufacturing policy needs to tackle. More industries need to come around for manufacturing to grow.

The other core area that needs attention is agriculture. About 600 million people are engaged in farming, but it contributes only 18 per cent to GDP. This needs to improve. And for that to happen, the value chain has to move up, the intermediaries’ role has to change, and investment has to be made in back-end operations to minimise wastage. Food processing is another area that needs investments.

Opening up retail is a positive for the agriculture sector. Now, we also need to amend the Agricultural Produce Marketing Committees (APMC) Act. It must allow companies to buy directly from farmers, who will also benefit with better sales and prices.

Retail, like telecom, is a long-term play. It spurs investment in many back-end areas like cold storages, cold chains, reefer trucking and packaging. As more states get on board once they see the benefit of it for farmers, employment, too, will increase. Retail can pull enough investment into India.

Yes, there are states that object to organised retail. But, I think it will settle over time once they see that other states are enjoying good quality food, employment and agricultural growth. This process will take some time, but I am sure it will follow a logical conclusion.

At present, organised retail is only about 5 per cent in India. There is enough space for competition as no one company can cover all of India. We need other people to come and invest in the sector. Tesco, Carrefour, Metro and Spar are already here. They will only enhance their position.

The argument that organised retail will affect kirana shops is unfounded. In Punjab, Bharti Retail operations employ about 6,000 people. But they have not displaced even 60 people. It is there for everyone to see that there has not been any displacement. A kirana store is no more than 500 sq. ft, employs two people and has 400 SKUs. It has probably been in the neighbourhood for eternity. On the other hand, an average Bharti Retail small format outlet is 3,000-4,000 sq. ft in size, employs 17 people and has 3,000 SKUs.

If Indian retailers do not displace kiranas, how can foreign investors? Nobody has an answer. Moreover, if large retail brands bring technology and investments, they will also source out of India, boosting our farms and factories.


Adi Godrej:
After a lack of reform for quite a while, these are very refreshing developments. But these are only the first steps. The government has announced that over the next month-and-a-half, it will take further steps. We look forward to them.

If the government had not taken these steps, India could have been de-rated, which would have been terrible because it could have led to a vicious cycle. The reforms will elicit an early response from investors. Perception about India had deteriorated. The reforms, and the Parthasarthi Shome committee report on GAAR (General Anti-Avoidance Rules), will change that. This is important to create more investments and confidence.

by ADI GODREJ CHAIRMAN, GODREJ GROUP as told to BW’s Rajeev Dubey (BW pic by Subhabrata Das)
Clearly, these are very good signals and the stock market has reacted appropriately. Inflation is on the wane. Global commodity prices are coming down. Inflation will come down further in due course, and growth will improve from the third quarter.

I do not expect any rollback from the government; I hope there are no rollbacks. Whenever the government is bold, it asserts itself, and it does well politically too. Earlier, when the communist parties had resisted the nuclear deal with the US, the same prime minister had resisted them successfully. But I am surprised and disappointed that the Opposition and some political parties are opposing economic reforms, which are really very good for the country and the aam admi.

Why restrict foreign investment to any sector? The more you open, the more investment you will attract and the more competition you will create, which is good for the economy. Why do we want to be restrictive?

Anyway, foreign investment in modern retail would not have gone to smaller cities. It will first cover the larger cities, and then it will go further. Structures will be required for compliance with the regulations, but the industry will take it in its stride. I expect Mumbai and Delhi — the two most important markets in India — will be opened first. Then, there will be several states that will join in. To my mind, in a year or so, the states that do not sign up initially will realise that they and their consumers and farmers are missing out, and will also come on board.

If a large part of the pending reforms programme, especially the goods and services tax (GST), is implemented, we can get back to 8-9 per cent growth rate in the next financial year. This fiscal, I expect better growth rate in the second half because of the reforms process and the base effect. The first half will not be good.

The RBI’s CRR (cash reserve ratio) cut is welcome, but banks should also cut interest rates, which will further fuel growth. If growth improves, the rupee will appreciate. If the rupee appreciates, inflation will reduce.

The increase in diesel price is a step in the direction of reducing subsidies but further steps are required to ensure that the subsidy bill is reduced so that the fiscal deficit is brought down.

If the perception improves, the foreign investment scenario will improve too, provided more steps are taken. More investments will reduce the foreign exchange gap, which will also help the rupee appreciate. One of the major causes of inflation is the depreciation of the rupee.

Once you show signs of reforms, consumer sentiment improves. If you keep on the reform path, the consumer sentiment will grow. The stock market will help improve consumer sentiment as well. As businesses gain confidence, they will employ more people, and this will further boost confidence. Fortunately, consumer confidence in India had not seen a steep fall despite the economic difficulties.

With the reforms, industrial investments will restart. Statements made by various chambers reflect that the turn in sentiment has already come about. I know there is a fear that there is a very small window (of a few months) within which the government has to make reform-related announcements. And after that they may have to go back to the aam admi mode. I do not agree with that general view. It is a wrong perception that reforms are not good for elections. These reforms will help the Congress party in elections because people are waiting for them to happen. In all states where reforms have been implemented, the political parties concerned have been re-elected. People appreciate reforms; the electorate appreciates economic progress.

John L. Flannery:
It is that time of the year, when months of monsoon-driven rains and stormy weather give way to sunny skies and a sense of renewal. Perhaps this can serve as an analogy for the recent reform announcements made by Prime Minister Manmohan Singh. Certainly, no one can argue against the notion that for India, 2012 has been an economic washout. Widespread concern around corruption, serious fiscal challenges, paralysis on reforms as well as some worrying policy decisions (that is, retrospective rule changes) have led to a contraction in investment by both Indian and multinational players. Like all countries, India too must compete for investment capital that flows globally to the areas of greatest opportunity and the most certainty and predictability. In this ‘war for capital’, India lost a lot of ground in 2012.

Despite the ongoing challenges, the recent reforms announced by the Prime Minister, if sustained and amplified with further actions, could well be the cause of sunnier days ahead. Investors still see current and future potential here — and, by and large, they still want to invest. We believe these reforms and the ensuing investments will strongly benefit the four corners of India and its trading partners. This is not a zero sum game.

To sustain this positive momentum it is important for policy makers to focus on three main issues: 1) solving the crisis in the power sector; 2) accelerating the implementation of infrastructure projects; and 3) continuing to create an atmosphere conducive to foreign direct investment (FDI).

It is hard to address India’s aspirations when the lights are out and the factories are not running; and right now, the Indian power sector is broken. A healthy system requires an integrated approach where power generators produce enough supply to meet demand, distribution companies are healthy enough to pay for that power while investing in the grid and, finally, tariff rates are set at levels that make the entire system financially viable. India’s power system has issues on all three levels. Generators lack the fuel (coal and gas) necessary to produce the required power. In our customer base alone, we have almost 6 GW of capacity (enough to power the Delhi metro area) that is essentially idle due to lack of fuel. Immediate steps must be taken to allow more production and import of coal, to increase exploration and production from current and prospective gas fields and, to allow ‘pooling’ of imported coal and LNG with domestic supplies. Producers also need to be able to ‘pass through’ the changes in fuel costs to energy consumers.

At the state level, a very high percentage of the state electricity boards is bankrupt with negative net worth and staggering debt. They cannot pay for power and they are not investing enough in grids. Capitalisation is necessary to settle existing loans and free up capacity to invest. States can fund this directly or through the privatisation of certain aspects of the business. Finally, many states have recently increased tariffs, many of which had not been touched in eight years or more. Ultimately, the market price of electricity has to reflect the real cost of production and distribution.

Accelerating infrastructure development is another area that needs government focus. We strongly endorse the creation of a National Investment Board, which could be led by an ‘infrastructure czar’ reporting directly to the Prime Minister. This Board could prioritise, say, 20 key projects, and ensure that ministries collaborate to get these done. There are a number of ‘shovel ready’ projects that could be launched almost instantly.

Finally, increasing FDI is critical and we are encouraged by the recent steps in aviation and multi-brand retailing. In addition to improving market access, policy makers can also encourage FDI through reduction of fiscal deficits and an increase in the certainty levels around policy.

On the fiscal front, the reduction in the diesel subsidy was a bold but essential reform, and this should not be rolled back. In fact, it should be increased in a phased manner over time. In terms of increasing investor visibility and predictability, we think the government would be well served in stepping back from any retroactive policy decisions, especially those that seem to negate the findings of India’s highly regarded judiciary.

Opening up key sectors of the economy to FDI has a far-reaching positive impact. It paves the way for global best practices and new technologies to come into the country, creates jobs and fosters a healthy competitiveness in the market. New ideas and technologies make the economy more vibrant and innovative. When these are combined with India’s unsurpassed entrepreneurial spirit, the result is solutions created in India for India at affordable costs.

For now, investor opinion inside and outside of India is unanimous — this was a much-awaited positive step, but more needs to be done, and soon. 

Ajit Ranade:
THE Economic Survey is an annual report card on the economy, and a statutory submission to Parliament. In recent years it has also served as a window to the mind of the government, revealing what the policy makers are thinking about economic reforms. Whether these reforms get implemented either by executive decisions or though bills tabled in the House is a different matter. But those ideas do enter the public domain, and become more robust through debate. The need to allow FDI into multi-brand retail was articulated in this year’s Survey.

Some other notable ideas are also worth mentioning. To deal with the dilemma of food inflation amidst record foodgrain stocks, the Survey had advocated selling small quantities throughout the year. This is in contrast to the present practice of selling through a tender process to large wholesale traders only. This continuous dribble sale of small quantities puts a bearish pressure on prices. Though the idea is three years old, it has seen the light of implementation only now. Another reformist idea was the use of smart cards in the sale of fertilisers, so as to better target beneficiaries, and reduce the ballooning subsidy (the fertiliser subsidy last year was approaching Rs 1 lakh crore).
Another suggestion was the removal of perishable items like fruits and vegetables from the purview of the APMC Act. This has only been done piecemeal in some states. Reform ideas in the public distribution system include the use of cash transfers. The idea is several years old, but only this year, Maharashtra became the first state to start using cash vouchers for sale of kerosene in public distribution system outlets, on a pilot basis.

The above are only some examples from food management and agriculture. Another idea in the Survey relates to reforming the incentive structure applied to tax collectors. To get the entire list of pending reforms one has to simply take the extract of the relevant chapters of all the recent Economic Surveys.

The journey from idea to implementation of reforms is arduous and unpredictable. Even when an idea is well ‘roasted’ by debate, it still may not see the light of day, due to coalition compulsions. This is a generic diagnosis; sort of like saying coalitions are allergic to reforms.

But the need for reforms is undoubted. Achieving higher economic growth is necessary for large-scale job creation and for being able to fiscally afford greater social inclusion. Even Amartya Sen, who is not known as a frontline votary of economic reforms, recently wrote about the importance of achieving high growth to fund social programmes.

The UPA regime pursued inclusive development by legislating several social rights (like right to education, right to work-NREGA, and now right to food), all of which have fiscal costs. The high growth of 2003 to 2007 made us believe that we could pursue and afford inclusive growth. That growth is now at a decadal low, and is putting great stress on public finances.

The outlook for the world economy is clouded, with slowing China and Europe burdened with unsustainable sovereign debts.

But these clouds have a silver lining in India. During 2011-12, India had some spectacular achievements. The inbound FDI was the highest ever at $48 billion. The rather ambitious export target set by the commerce minister in April 2011, was not only achieved, but exceeded. The foodgrain production at 252 million tonnes was a new record. During April to June 2012, oil prices dropped sharply by 37 per cent, much more than rupee depreciation of about 20 per cent. This was a positive for oil-dependent India. And the rupee itself, in relative terms is 20 per cent more ‘competitive’ vis-à-vis the Chinese RMB.

Unfortunately, these silver linings were insufficient to prevent an outlook downgrade by the rating agencies. Moreover, all these significant positive sparks occurred in the midst of sharp decline in industrial investments, high deficit and high inflation.

The Prime Minister is aware that investment spending, especially from the private sector, needs to be desperately revived. That can happen only with a helping booster dose of economic reforms (which are already articulated in the government’s own report card, the Economic Survey).

Hence, the decision to open multi-brand retail to foreign investors is to be welcomed. The decision was taken by the Cabinet in December 2011, but its implementation was withheld to garner a stronger consensus. But with the threat of a possible rating downgrade, the government does not have the luxury of time for further consensus building. This is to be seen as a pro-farmer reform, and not anti-kirana reform. The kirana shops will survive well into the future, but they are not expected to invest in cold storage chain or back-end infrastructure.

Other decisions on raising FDI caps are also to be seen as growth-promoting. As for the decision on disinvestment and raising diesel prices, those address fiscal concerns. The diesel increase, however, could have been done in smaller doses of successive Re 1 increases over several months. But it was overdue. India is possibly the only country where rail has lost to road freight consistently. Rail freight share may fall to 15 per cent if there is no investment in railway infrastructure. This is a pity, because it entails loss of efficiency, burning of fossil fuels and is ultimately very expensive for the economy. Investment in railway (as in China and now in the US as well) serves multiple goals: creation of a public good, saving of fuel, increase of efficiency and creates more jobs.

Thus the pipeline of pending reforms is long. Some are easy to digest, some are harder, and some have possible side-effects. Their passage is imperative, and calls for greater articulation and communication to the voters and taxpayers.

We hope that big bang Friday was just the beginning. 

Shashanka Bhide:
An  extended period of slow growth combined with high inflation is a recipe for disquiet. The promise of long periods of sustained high growth has suddenly become uncertain in so far as the industrial sector is concerned. Near stagnant industrial output will have adverse effects on many other sectors, including government finances. Undoubtedly, weak external demand conditions have exacerbated domestic policy constraints. The measures to raise the price of diesel, open up FDI in retail, aviation and in a bunch of other sectors, or capping subsidies in the energy sector are not new ideas. Effects of not making  these reforms are also well known. But will these measures by themselves bring back investor confidence?

Worrying government finances and the need for bridging a widening current account deficit are strong enough arguments for these measures, but recurring opposition to them points to the lack of perception of benefits, especially in the short term. But it is also important that the measures become part of an overall strategy for expanding opportunities for investment rather than one-time measures to ease the macroeconomic pressures.

The recent measures must be a part of a larger set of policy reforms in order to realise their full benefits. The reforms, when limited in scope, should even out the adverse effects of each other. Will the adverse effect of increased diesel price be offset by the liberalised investment regime? In one sense it should: more investment in sectors that improve the supply chain should ease price pressures for the consumers. But often it is not the final beneficial effects that attract attention but the immediate ones.

The need for a broader set of policy reforms has been articulated in the discussion that went on at the time of preparations for the 12th Five-year Plan: clearer policy on use of natural resources, more even benefits across regions and segments of the society, investment in skills, health and education, and so on. However, one of the pillars of the strategy is also strong economic growth.

The 12th Plan is aiming at sustaining high economic growth rates, essential for achieving multiple objectives of development. High economic growth requires high rates of investment which increases productive capacities and employment opportunities. There may be debate on what kind of investment but sustaining investment rates of 35 per cent or more is essential for achieving annual growth rates of 8 per cent or more. Creating opportunities for investment has to be an essential strategy for development.

One of the difficulties in achieving reasonable fiscal balance has been the growing subsidy bill. Large fiscal deficit and the negative consequences of these deficits require measures to make the subsidies effective and sustainable. Therefore, measures to contain petroleum sector subsidies cannot be avoided. Similarly removing constraints on FDI that ease infrastructure constraints are needed to increase production capacities. But there are a number of other equally important measures that are also needed: the GST, increased energy supplies and water conservation. It is also necessary that the reforms provide a sustained solution to the problem rather than just one-time relief.

Why are the benefits of reforms not apparently convincing? There are so many diverse objectives today that the macroeconomic objectives may have lost out to these various other priorities.

One explanation for lack of appeal of a common or uniform framework across the states seems to be the diverse economic conditions there. While the overall problems of fiscal deficit, current account deficit and high interest rates are real, uneven effects these solutions create at local level lead to uneven support to the reforms. The impact of reforms must be, therefore, strong enough to generate overwhelming positive effects. But without the changes in policies, investment seems to hit a bump quickly.

The recent experience of high inflation rate has highlighted the bottlenecks in the supply chain for the food sector. Why doesn’t more investment flow to ease these constraints? Bottlenecks in the energy supply chain are too obvious requiring fresh investments. Either the policies are constraining investment opportunities or there are simply limits to expansion of production capacity. While these constraints are more sector-specific and deep-rooted, there is also a more systemic factor constraining new investments. A surge in investments requires risk- taking; but an increased possibility of reversal of policies or lack of policy measures that would ease the investment road would make the returns more uncertain. To make matters worse, even the relatively more ascertainable road of exports has become more risky.

The need for measures to improve investment climate is very real and immediate. It is in this context that policy measures which could achieve these goals are needed. While the current slew of policy initiatives would certainly have beneficial effects on the economy, their full value would be achieved when the broader reforms are implemented.

(This story was published in Businessworld Issue Dated 01-10-2012)