Open Economy, Sealed Fate

The author investigates whether the proposed reforms in India’s financial, energy and retail sectors really make a difference to the economy which many have said has ‘bottomed out’ this fiscal year. 


By Yayaati Joshi, 12th March 2013

To begin with, I deem it appropriate to describe the proposed reforms and the purported merits of those reforms in the financial, energy and retail sectors of India, and mention briefly, the state of the affairs of the Indian economy. The growth of the GDP in the last 5 years has been less than encouraging, to say the least. Looking at the trend of the GDP from 2004—that’s when the Prime Minister Manmohan Singh, the key figure of the 1991 Economic Reform, has been shouldering the responsibility of running the country—it has resembled a sine curve, with the crests and troughs rising and falling dramatically in 2010 onwards.

One would have satisfied oneself by imagining, that the crests and troughs represent the inevitable movements of the business cycle, but the cycle seems to be moving only in one direction after 2010: downward. The GDP growth fell sharply from 9.6% in 2010 to 6.9% in 2011, and the growth rate slipped to a dismal 5.5% during the first quarter of 2012.

In response to the slowing of the growth rate, the government of India has decided to take a few measures to revive the economy. Chief amongst them is the plan to change the regulatory structure of the financial markets. Currently, there are as many as four regulators in the Indian financial markets, namely: the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund and Regulatory Development Authority (PERDA). However, the efficacy of SEBI, the most important of the regulators, has been under question ever since it was found that a whole-time member of SEBI acted as a whistle blower regarding its inability to handle effectively the cases of corruption against some players in the market. To address this, the Financial Sector Legislative Reforms Commission (FSLRC), recommended reducing the number of regulators to just one.  Under the proposed plan, a sole regulatory body will help integrate the regulations of the entire market, thereby ensuring expediency in doing business and in facilitating free exchange of liquid capital assets. This will be important, as capital is increasingly becoming more stateless, in the sense that the world is moving towards the concept of Capitalism 3.0, and “integration” is now the key to not only regional, but also global economic prosperity.

This reduction in the number of regulators is most interesting, as its effect will not be limited to the financial sector.  Recently, the government has, amid much hullabaloo, approved infusion of foreign capital. Simply put, this decision will open up India to companies like Walmart (a multi-brand retail operation) as well as IKEA (a single-brand retail operation). Despite all the optimism, the fact that the organised retail sector accounts for only 5% of the entire retail market cannot be ignored. By encouraging foreign investment, India is looking to be at par with other countries in Asia such as Japan, where organised retail sector accounts for over 60% of the retail market. In the long run, the growth in the organised sector will produce externalities, which will be beneficial for the economy as a whole.

Liberalisation of the energy sector remains to be a key reform in the country.  The power failure in Northern India in July 2012, an indelible blot on the face of the Indian government, gave impetus to the predominant policy of attracting foreign investments. The privatisation of the energy production sector through foreign direct investments (FDI) is intended to ensure reliable and consistent access to power. About three months later, the government proposed the restructuring of the debts owed by the states in India. Although the power producers and the states themselves breathed a sigh of relief, government intervention in debt payment showed the inability of the states to produce electricity in such a way that the demand does not outstrip the supply. While the government itself knows that there can be no, “one step solution” to the problem of electricity, foreign investments have been earmarked as essential.

Re-examining the events that led to the economic reforms in 1991, we can surmise that the reforms were as much a result of IMF’s suggestion as they were of the Finance Ministry’s own volition. Notably, a Balance of Payments crisis occurred in 1991, forcing the government to take IMF’s advice of suspending import tariffs, moving from a fixed to a floating exchange rate as well as deregulating the industrial sector. As per the plan, Quantitative Easing was implemented, and profit-making public sector undertakings were promoted and prevented from being privatised. Now, 22 years later, the government faces a similar situation — that of fiscal deficit — and people are looking at Mr. Singh’s prowess to redeem the Indian economy once again. The (literally) million-dollar question is – will liberalisation work a second time?

In a speech, Prime Minister Singh stated that the government had been voted twice “to protect the interests of the aam aadmi” (Hindi for common man). In the same speech, he made it a point to remind the nation that “money does not grow on trees”— a reference to the growing fiscal deficit and the obligations that it places on the government. In order to finance those obligations, the government needs to make certain unpopular decisions, i.e. increasing fuel prices. This rise in prices is a self-defeating policy for an Economist who claims his approach to be inclusive growth.

Similarly, it is quite clear, that despite Mr. Singh’s assurances, foreign direct investments in retail would hamper the well-being of the local retail trade. Walmart would look to backward and forward integrate its processes, and eventually, to eliminate any middleman costs and supply chain debacles that they face. Perhaps, realising this himself, Mr. Singh has given veto power to the state governments, whether they want to fling open their doors to foreign investment in their respective retail sector. By doing this, he has, on paper, done the right thing as far as the economy is concerned.  Politically too, he has done the right thing, by letting the states decide for themselves — if they want to prioritise local retail industry over the foreign retail giants.

India is composed of various states, differing in culture, economy, geographical conditions and connectivity, and even more so, on the merits and pitfalls of foreign capital.  This never ending struggle that the government faces of choosing either its votes – by making decisions which will not help the economy from bouncing back – or its economic principles, following which, is the only way to improve the state of affairs. Stuck in this quandary, the government will always have to temper its difficult decisions by including more populist elements in the strategy, such as this one in which it is the state governments that ultimately decide the fate of foreign investment.

The reforms that have been planned by the government are all long-term measures, as opposed to some slapdash policy meant to create only momentary benefits. However, the chances of the same government being re-elected are slim, owing to the media exposés of various scandals involving some government ministers.

For instance, FDI in the retail industry, while presumably dampening the local retail industry to begin with, will in the long run, produce more jobs, result in higher wages and reverse the effects of the vicious circle of poverty. Therefore, for these reforms to be truly effective, the common man will have to get rid of the myopic view he has of “growth”. In fairness, the concept of delayed gratification is hard to explain to a nation, with 40% of its people earning a daily income of less than $1.25.  More importantly, the common man, for whom the government claims to be working for, will have to forget and forgive its misdeeds and give the government another chance to prove itself.

One remembers former UN Secretary-General Kofi Annan when he said that “good governance is perhaps the single most important factor in eradicating poverty and promoting development.” Mr. Singh needs to be re-elected in order to finish what he started. Sadly, due to the political machinations, it is believed that even if the UPA is re-elected, Mr. Singh, the Oxford economist, is unlikely to become the Prime Minister again.

In the absence of a figure who can oversee and truly understand the implementation of the economic reforms and policies discussed above, chances are the benefits from the reforms will remain an unrealised dream, and their effects will be limited, and will tend to favour only those who possess the wherewithal to see the bigger picture. And that’s akin to making a medicine, that will cure a disease, but only of those who have some special, innately endowed, genetic advantages.


The views are the author’s own and do not necessarily represent the editorial position of InPEC. 

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