The Death of Manmohanomics

Not so long ago, India’s emergence as a tiger economy was seen as a done deal. Today, double-digit growth looks a forlorn dream. What went wrong?
Economy
Welfare schemes like NREGS have highlighted the contrary pulls in government: Sonia’s pro-poor line versus Singh’s pro-growth mantra

On 14 November, top Finance Ministry officials made a crucial PowerPoint presentation to the global credit rating agency, Moody’s. Scared that the latter may downgrade India’s sovereign rating, as it had done with the country’s banking sector the previous week, the bureaucrats listed out a dozen big-ticket reforms that UPA-II had initiated in the recent past. It was an aggressive attempt to conclusively prove that there was no policy paralysis within the Government.

Ironically, and shockingly, the items that the bureaucrats discussed confirmed quite the opposite. The exercise established that Manmohan Singh and his A-team were unable to push through critical but politically sensitive decisions. It indicated that in the current political atmosphere—characterised by corruption scandals, squabbles among Cabinet ministers, bureaucratic coma, and fear and loathing within India Inc—governance and policymaking had lost almost all traction.

The fact is that most of the ‘reforms’ flagged were merely on paper. Moody’s was told, for instance, that petrol prices had been ‘decontrolled’ in June 2010; what wasn’t revealed was that India’s oil companies still took orders from the Petroleum Ministry on such decisions as price hikes. A committee of secretaries had cleared 51 per cent foreign direct investment (FDI) in the multi-brand retail sector, but the Union Cabinet had not had the nerve to accept it. A few measures mentioned, like the Land Acquisition Bill and New Telecom Policy of 2011, were merely proposals.

More importantly, UPA-II’s spiel to Moody’s reflected another malaise: a huge chasm between intent and action on the regime’s part; it wanted to implement several reforms, but was unable to pursue them to their logical ends because of extraneous political factors. “The Government does not know whether it should opt wholeheartedly for reforms, or focus largely on welfare schemes and ‘inclusive’ initiatives,” says Barun Mitra, managing trustee, Liberty Institute, a Delhi-based think-tank.

The Government is caught between 10 Janpath and 7 Race Course, between the pro-poor demands of Congress President Sonia Gandhi, through her National Advisory Council (NAC), and the wishes of Prime Minister Manmohan Singh, perhaps India’s greatest reformer ever. Kishore Biyani of Future Group, India’s leading retail business, feels that India has slipped back to “acting like an electocracy rather than a democracy”. Most policies, as a result, are aimed at wooing poor voters.

Before we proceed further, let’s take a look at the quicksand that UPA-II finds itself in. The Indian economy will be lucky to achieve a growth rate of over 7 per cent in 2011-12, a far cry from the optimistic estimates of over 8 per cent being made until a few months ago. Annual double-digit growth is out of the question over the next five or six years.

The Planning Commission’s Montek Singh Ahluwalia has ruled the prospect out despite Finance Minister Pranab Mukherjee’s claim last year that it would be possible by 2014.

Inflation, especially food inflation, hovers around 10 per cent. All moves to bring it down have failed miserably. India Inc’s second quarter (July to September) results this fiscal year are dismal. Sectors such as aviation, power, steel and mining are caught in a rut; Kingfisher Airlines’ plea for a bailout by State-run banks is not the first, nor will it be the last. Thanks to the global recession, and the debt crisis in the Eurozone and US, India’s exports have slowed down.

Government revenues have taken a hit, and since its expenditure—especially on welfare schemes such as the National Rural Employment Guarantee Scheme (NREGS)—has not reduced, this has widened the fiscal deficit, the gap between expenses and revenues. In the first six months of this fiscal, the deficit has reached 70 per cent of the Budget estimate for the entire year. Meanwhile, India’s trade deficit (the gap between imports and exports) has widened further, FDI outflows (Indian firms investing overseas) have out-stripped inflows, and the rupee has weakened to an unprecedented level (over Rs 50 to a dollar). 

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How did India find itself staring at this economic abyss? Only two years ago, policymakers were confident that the Great Recession would not affect India, the economy would grow at a rapid pace, perhaps even outperform China’s. What happened in the interim? Who is to be blamed for this muddle? Who should be held to account? Is there reason to conclude that whatever happened to the India Story was beyond the control of this, or any other, government?

Pratap Bhanu Mehta, president, Centre for Policy Research, has a radical answer for some of these questions. He concludes that a part of the puzzle is that since 2004, or even earlier, there were no underlying dynamics to explain India’s economic progress. It was thought, as with the East Asian Tigers of the 1990s, that if India’s overall savings rate stayed above 30 per cent of GDP, the so-called ‘demographic dividend’—a burgeoning young workforce—would add 2-3 per cent to economic growth; the savings-population momentum would push the economy onto a high trajectory.

“The Government assumed 8 per cent growth as its birthright,” says Mehta, “It felt it was its entitlement, and treated it like an iron-clad law.” The Centre was convinced, albeit subconsciously, that it did not need to catalyse growth, that the twin foundations of hopes and wishes were quite enough; no great planning was needed to fix the economy. Liberalisation had been done. All attention, therefore, could now be turned to pushing Sonia Gandhi’s ‘poor’ agenda.

So, for the larger part of UPA-I’s tenure, ‘welfare’ was the buzzword. Launched in 2006, the NREGS, which guaranteed employment to the rural poor at a generous minimum wage, was believed to be the perfect cash-disbursal mechanism to lift them above the poverty line. It was expanded across the country; last year, the Government spent Rs 40,000 crore on the scheme, and this year, it hopes to match that figure. To be fair, despite a few allegations of corruption, it has worked.

That was one part of the grand plan. The other, good governance, was to be provided not by the ruling coalition, but through the Right to Information Act. The PM portrayed it as the panacea for all evils; it would enable citizens to question administrators at every level, pinpoint responsibility for non-performance, weed out corruption and inefficiency, and deliver the desired development results. Economic reforms, in all this, were relegated to dusty shelves in forgotten corners (with the Left cheering on).

When the UPA returned to power in mid-2009, it was so full of misplaced confidence and arrogance that it had no clue how to tackle the economic and political crises that engulfed it soon after. The UPA-II Government seemed sure that problems would sort themselves out on their own. At the same time, a belief took hold that there was no need to understand the crises or actively manage their impact. “It gave the impression that the Government had little idea of what to do,” says economist Bibek Debroy.

Consider, for instance, UPA-II’s response to the inflation-growth conundrum. To bring inflation down, the Reserve Bank of India (RBI) has been hiking its policy interest rates at regular intervals for several quarters to suck money out of the economy. Apart from the RBI, the Finance Ministry, Planning Commission and PM himself have announced over and over again that inflation would be curbed within the ‘next three months’. However, prices—especially of food items—have kept rising unabated.

If the rate hikes were a monetary reaction based on the assumption that rising prices could be checked by less money chasing more goods, the assurances of lower inflation rode on a conviction that it would happen on account of good rains, higher foodgrain production, and, above all, the statistical relief of the ‘base effect’: since inflation is calculated on a point-to-point basis, any figure this year would show up relatively low if the ‘base’ of the corresponding week last year was particularly high.

“No one understood the rationale for the inflationary impetus,” feels Debroy, who explains that inflation generally has three components—prices of food items, manufactured goods and global commodities. In the case of India, the bulk of the problem lay with the first, given the changing consumption patterns in rural areas and higher rural demand due to wage increases (caused by the NREGS) and debt waivers for farmers. “In such a situation,” according to another economist, “interest rates don’t matter, as they impact manufacturing goods, and the theoretical logic is irrelevant.”

Unfortunately, what the regular hikes in interest rates led to was an industrial slowdown, especially in the manufacturing sector; India’s Index for Industrial Production (IIP) grew a mere 1.9 per cent this September, the lowest in two years. Although policymakers sensed this would happen, they optimistically expected the impact on overall growth to be a decline of less than 0.5 per cent, not more than 1 per cent. The net result: the RBI now appears to have decided not to tinker with interest rates any further.

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Associated with such problems was the fact that neither the UPA-I nor UPA-II had forethought the after-effects of its so-called perfect prescription, the NREGS. Or, perhaps, they thought it didn’t matter much. “Everyone knew that the [scheme] led to a build-up of unproductive assets. I saw it with my own eyes during my travels through Andhra Pradesh. In one district, workers deepened an irrigation tank. But then the area was designated for the building of a housing society, which implied that the tank would be filled up and become unusable. Thus, the work done under the scheme was a wasteful exercise,” says EAS Sarma, a former finance secretary who wrote a letter to the PM on this.

Over time, the Agriculture Ministry realised that the scheme was resulting in labour distortions as well. Rural workers, especially women, satisfied with the newly set minimum wages, did not feel the need to migrate to agricultural states to work as farm labour. Even industrial towns that depended on seasonal migrants for their workforce found it difficult to woo contract workers. Now, the Agriculture Ministry has proposed halting NREGS projects during harvest times.

With both agricultural and manufacturing growth reeling under the twin-impact of higher labour and capital costs, there were no other macro-economic policies in place to counter the consequences. “The much talked-about second Green Revolution has not taken off,” says Mehta. And it is only now that the Government has laid out details of a new manufacturing policy. What the country has ended up with is 7 per cent growth as a distinct possibility this year, perhaps even lower next fiscal.

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In the middle of all this, UPA-II finds itself confronted with a series of political crises, many of them of its own making. A series of scams—2G telecom, Commonwealth Games, Adarsh Housing, illegal mining, among others—has eroded its credibility. Most of its administrative machinery has geared itself since to shield its key ministers, including the PM, who could have been drawn into the 2G vortex. And the media and civil society are in no mood to relieve the pressure.

The success of the Anna Hazare movement has pushed the Government into inaction on almost all fronts other than the Lokpal Bill. An earnest display of intent to fight corruption, it feels, will somehow assuage middle-class anger at the state of affairs. The anger is palpable. When Manmohan Singh retorted that he couldn’t do much about the 2G scandal because of coalition pressures, or that a bill was not a solution to the problem of corruption, he was seen by many as an intelligent and honest but crippled and spineless leader.

“The bureaucracy became reluctant to take decisions, as many of its actions in the scams were exposed due to the RTI Act,” observes Debroy, “The political system worked at cross-purposes, and various ministers squabbled with each other publicly.” Taking a cue from 10 Janpath, the former Environment Minister Jairam Ramesh began to stall mega industrial projects, even as Singh and Ahluwalia criticised his decisions as ‘anti-development’. Ramesh was shunted out to the Rural Development Ministry, and some of his decisions were reversed, but India Inc no longer knew what to expect in the near future.

Worse was to come. Telecom Minister Kapil Sibal declared there was no need to auction 2G spectrum, a pronouncement contrary to what the PM had said in 2007. Mukherjee fought with Home Minister P Chidambaram, and the PMO added fuel to the fire by leaking a Finance Ministry note that indicated that Chidambaram could have stopped the 2G scam while he was FM had he wanted to. Almost next door, the Commerce Ministry, lobbying for FDI in multi-brand retail, found itself opposed by others.

The PM and his office became toothless, in a manner of speaking. “Since 1991, we have seen that economic policies have gained precedence only when the PM has pushed them,” says Mitra, “Narasimha Rao gave full freedom to Singh, then FM, to liberalise the economy. Deve Gowda did not stop Chidambaram, his FM, from presenting his ‘dream budget’ in 1997. Atal Behari Vajpayee did the same with Arun Shourie, both as Disinvestment Minister and Telecom Minister.”

Debroy seconds this argument, and says that Singh never really took charge between 2004 and 2011, except during two particular phases. “His first window of opportunity was during the first three months of UPA-I, when he got a consensus on the RTI and NREGA,” he says, “The second was during June-July 2008, when he put his government on the sacrificial block [after the Left parties withdrew support] to get Parliament to clear the civil nuclear agreement with the US.”

Government inaction put investors off. “People felt that decisions were not being taken, and clearances were delayed unnecessarily,” says Debroy. “No businessman was willing to take big risky decisions because he wasn’t sure if he would get the land, power or other things for the project,” adds Mehta, “He had money, but was unwilling to invest.”

Over time, India Inc lost faith in UPA-II’s reformist credentials. In January this year, a group of 14, including leading businessmen (Wipro’s Azim Premji), bankers (Deepak Parekh) and former bureaucrats (N Narasimham, former RBI Gover- nor), wrote the Government an open letter expressing their alarm at the ‘widespread governance deficit in every sphere of national activity covering government…’ On 13 November, Reliance Indus- tries’ Mukesh Ambani, one of the biggest beneficiaries of government policies, said “There is a need for a shift in governance from 20th century to 21st century decision making…”

According to Mehta, “The irony of UPA-II is that one gets the sense that, for the first time, large Indian business houses are hedging [themselves] against political risks. They are making bigger plays abroad, buying foreign assets, because of the domestic political environment rather than strategy or vision.” Worse, it has become harder for small and medium enterprises to conduct business, since they don’t have the flexibility of their larger counterparts to own/lease captive raw materials or borrow overseas at cheap rates.

It has all added up to a climate of complete uncertainty. In fact, proposed private investments this year in India are down by more than 50 per cent over last year.

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In a bid to divert attention from its policy blunders, the Government has blamed global factors for India’s economic woes. It has blamed a global uptick in commodity prices for costlier food items, costlier crude oil imports for higher petrol prices, global recessionary conditions for India’s flagging exports, and so on.
In all, things can only go from bad to worse for the economy. The reason is that the FM has almost no space to provide quick-fix solutions. If growth is stunted, government revenues will remain subdued. If expenditure is unchecked, and it seems that way, the deficit will loom. This will only add to inflation. The FM can reduce subsidies, as he has with urea and petrol, but allowing diesel, LPG and kerosene prices to rise will also fuel inflation (while containing the deficit).

Exports will be hit by the West’s recession, even as domestic manufacturing will face the brunt of lower investments (at least over the next six months). A stimulus package, as was announced after the 2008 global crisis, might have possibly helped, but today, it will only hike government expenditure, widen the deficit and worsen inflation. If welfare schemes are pruned, rural wages will suffer, which could result in mass unrest and perhaps even anger at the Congress President.

“Any country lives on hopes and aspirations for a better tomorrow,” sums up Biyani, “If the Government in power cannot provide that sentiment, it is the biggest [possible] failure of political leadership. Today, there is no feel-good factor for the near future. No one believes that tomorrow will be better than today.” And such negative sentiments may well prove to be the last nail in the coffin of Manmohanomics.