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MoCapitalism 2016

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The political virtues of going gradual

After almost a year of hectoring at the hands of the opposition, in late December, Prime Minister Narendra Modi held a meeting of his Council of Ministers. Through the year—and earlier as well—a united opposition refused to support the Government’s reform-oriented legislation in Parliament on various grounds. From a high in May 2014, the end of 2015 led to a fear of the Modi Government being gripped by a fatal disease that had killed the previous one: policy paralysis.

Far from being gripped by this fear, Modi told his ministers that they had no reason to be disappointed at their performance. The Prime Minister felt that plenty of positive action was taking place in different ministries; what was missing was a communication drive to convey what the Government was doing. He asked his ministers to fan across the country after the second week of January and spend time in various constituencies, explaining what the Centre was up to in a kind of a mass contact programme.

On paper, this has all the markings associated with a propaganda exercise. But in reality, the National Democratic Alliance (NDA) in power has indeed notched up some successes at the executive level, ones that go underappreciated. The Government’s failure is one of poor communication. Three ministries in particular have taken steps that even two years ago would have been inconceivable.

Over the past year, the Petroleum and Natural Gas Ministry has carried out what are probably the country’s widest ever subsidy cuts in recent years. On petroleum alone, the plan is to close the fiscal year with this expense figure halved: from a high of Rs 60,341 crore in 2014-15 to Rs 30,000 crore in 2015-16. “The fall in global prices helped us. We have also deregulated diesel prices and even after we had to end up paying a subsidy for six-and-a-half months last year, we have ensured savings of Rs 14,000 crore. Direct Benefits Transfer, de-duplication of consumers and de-subsidisation are ongoing matters, and all this has helped us contain our bill,” says Petroleum and Natural Gas Minister Dharmendra Pradhan, speaking to Open. “Our goal now is to address the issue of kerosene subsidy. We are taking states along with us as partners and hopefully we will make progress,” he adds.

The efforts to reduce fuel subsidies exemplify the problems and mindless systems established over the decades in India. For example, the subsidy on LPG in 2015-16 is estimated at 2.6 times that of kerosene (in absolute terms). Yet, it is easier to get rid of the bigger subsidy—this year, all households earning above Rs 10 lakh per annum will stop getting subsidised cooking gas—than the relatively small one on kerosene. The reason? Kerosene is a ‘poor person’s fuel’ and is politically toxic to touch. In some places—Chandigarh for example—it has been possible to substitute LPG for kerosene without any political hitch. Chandigarh is a Union Territory and does not have complicated politics. While the savings are small, about Rs 300 crore, the impact is big.

For a ministry where fuel price adjustment—once a routine administrative practice—was a ‘difficult’ political issue, ending the riotous run of subsidies is an achievement. “We are an economic ministry, but we are very conscious of our responsibilities towards the poor,” says Pradhan, “If we are trying to reduce subsidies, we are also giving LPG to poor persons. Why should they be deprived of it?”

Just across the road from Pradhan’s office is another classically populist ministry. Famous for its heavy expenditure and for being a home to recklessly handout-happy politicians almost since the dawn of Independence, another Modi minister is trying to untangle issues that are a nightmare.

When Suresh Prabhu assumed office at the Ministry of Railways, his spendthrift charge was expected to consume 92.5 paise of every rupee it earned. While it may appear piffling, he has ensured this came down to around 91 paise. For an organisation that is the single largest public sector employer, this is not a trifling sum. Much like hydrocarbons, even the mere mention of a tariff increase in a speech would be sufficient in the old days to precipitate a political crisis. In contrast, on the first day of 2016, the Ministry invited comments on the setting up of an independent railways regulator.

The regulator—which was first mooted by the erstwhile UPA Government and then just wished away—will have the power to fix passenger tariffs and also ensure a level playing field for private investment in the sector. If the regulator does materialise, it will be one of Independent India’s biggest acts of depoliticisation of policymaking. In the meantime, passenger tariff revisions are no longer a taboo.

“Worldwide, the railways earn 30-40 per cent of their revenues outside their core activity. In India, it is less than 3 per cent. It is my ambition to expand this proportion. It would give us additional resources and at the same time not burden the passenger and freight traffic. At present, the only recourse is to raise tariffs. This is not sustainable. Which is why we are pursuing modernisation of railway stations with zeal,” Prabhu tells Open.

Once again, and just as in the Petroleum Ministry’s case, this minister, too, is conscious of balancing progressive steps with the affordability of services delivered by his ministry. The provision of ruinously cheap travel tickets is an example.

Perhaps the most ambitious reform step taken so far—and one whose outcome will be seen in the years ahead—will be the effort made under a financial restructuring plan for power distribution companies (discoms) at the state level. This is an area where reforms are notoriously tough to implement. State governments are simply not willing to align the price of electricity with its generating cost. That is the rub of the problem. In the past 15 years, two schemes to help these discoms turned into nothing more than bailouts. This time, state governments have been asked to take over the debt of these discoms— which roughly stood at Rs 4.3 lakh crore in 2014-15. If this happens, it will be a huge move forward in injecting responsibility into a sector that has been ruined by populist practices for decades on end.

“I don’t share the pink papers’ views on reforms. For them disinvestment and selling-off alone constitute reform. Maybe it is true in some cases. Our experience in the past 18 months is that if you empower companies, they perform. Look at Coal India. Its performance has been extraordinary. Same is the case with NTPC and NHPC. And UDAY (Ujwal Discom Assurance Yojna) is a win win for all stakeholders in the power sector,” says Piyush Goyal, Power Minister, to Open.

So, does all this show that big-ticket reforms have lost out to gradualism under the Modi Government? That question has been raised a number of times in the past six months. The conventional wisdom is that any government in India has a window of two years from assuming power during which it can take ‘painful’ steps. After that it becomes increasingly difficult to carry out major reforms. The last year, of course, is reserved for just holding the Government and preparing for polls.

The question is misleading. A better way to look at what is happening currently is to try and understand what a regime does in terms of economic policy at any time. There are two axes along which the Government works. One, it passes legislation that smoothens the way for economic growth and development. This is the stuff of ‘big-ticket’ reforms. As mentioned earlier, the Modi Government has tried hard to make these changes. The logjam in Parliament explains why action along this axis will have to wait. The other track that a government works on, one that does not get noticed due to communication failures or other pathologies in modern democracy, is executive action. What steps individual ministries take and the effectiveness of those results make all the difference to the fate of a country. Here, the Centre has fared much better. As highlighted, its economic ministries are taking steps that were unthinkable just two years ago. This important task of governance now attracts the odious label ‘gradualism’. It should not.

“‘Big bang’ or ‘shock therapy’ looks good on paper, but more often you have a backlash when this is put into practice and such policies rarely work. Commentators seem hung up on it. Margaret Thatcher and Ronald Reagan are wrong examples to cite. Thatcher needed a war (in the Falkland Islands) to begin implementing her agenda,” says Vivek Dehejia, a resident fellow at IDFC Institute, a Mumbai think-tank.

The example of subsidy reforms here is relevant. While it makes perfect economic sense to end all subsidies and transfer lump- sums to citizens, this step is now being rolled out but in a carefully calibrated sequence. From LPG to scholarships to pensions, benefits to citizens are being given directly to people. But it is unlikely that all subsidies will be stopped and a single payment given instead. That is simply not workable.

“In a democratic polity where you have to take people along with you, the Government is likely to carry out reforms gradually, in a step by step fashion. Except in a time of crisis— political or economic—when sudden steps are likely, reforms are bound to occur in a gradual manner,” adds Dehejia, whose doctoral work at Columbia University in the 1990s focused on the ‘shock therapy versus gradual reforms’ debate in Eastern Europe and the former Soviet Union.

Any government in India has an additional complicating factor to handle. In most economic matters, state governments form an additional layer and have to be taken on board by the Centre. The differing fortunes of ending subsidies for LPG and kerosene illustrate this point. While the LPG subsidy, which is directly administered by the Union Government, has seen a radical reform, reducing the subsidy on kerosene is not only a political economy issue but one of taking various state governments along. So instead of a clean, technologically driven solution, the Centre has to consider the capacities and constraints of various state governments while designing a changed subsidy regime. This has never been easy for any government in New Delhi, and the Modi Government is no exception.

While any government can plead helplessness when it comes to policy constraints in revving up the economy, weakness in ensuring a pick-up ultimately makes these constraints seem no more than excuses. The Modi Government is not in that danger, yet. Even with the current legislative paralysis, the consensus is that the Government can do a lot when it comes to executive action.

At the moment, the key issue for the Indian economy is reviving investment growth. India finds itself in a benign international (and domestic) environment. Global commodity prices are low and India has kept its monetary policy powder dry in case it needs to stimulate the economy with interest rate cuts. What is needed is a strong push from the Government to lift investment growth.

A note dated 5 January by HSBC has something interesting to say in this context: ‘Analyzing 613 stalled projects (carefully chosen to include those that can be revived, and not the graveyard ones) suggests that there is ample government action needed, as about half of them are still stuck due to policy related issues. Also, contrary to popular belief, we find that three- quarters of projects stuck due to policy issues do not seem to face immediate land acquisition issues. Rather, their problems are led more by clearance delays and raw material availability, which can be addressed largely by executive action. The point here is that much can be achieved, even if parliamentary decisions are moving slowly.’

This is the classic stuff of what a government can do. It is important that the Modi Government show some determination on this front. Otherwise it runs the risk of getting into the kind of paralysis that had come to haunt the UPA Government in its last few years.

The two weak links in the investment story—the key to raising overall economic growth—are, first, the inability of banks to lend further funds to potential investors, and second, the poor shape of corporate earnings and related weakness of the private sector to take on more projects. The solution to both these issues lies with the Government.

It is no secret that Indian banks are stressed and the number of non-performing loans is very high. This is a structural issue that will unwind only slowly on its own—unless the Government injects more money into banks. The plan for such an equity injection last year, while welcome, was not sufficient for the task. The other option, which the Government has not yet deliberated on, is to weed out weak banks and allow the right kind of mergers and acquisitions in this sector. The problem of finding capital for banks can be easily addressed by going in for aggressive disinvestment of state-owned banks. Two birds can be killed with one stone: on the one hand, disinvestment will yield sufficient money to inject capital into banks that need it (and the ones that deserve it); on the other, it will send a powerful signal to investors that this Government is on the track to reforms.

The other way to fight weakness in growth is for the Government to step up public investment. Here, some action is likely. On 5 January, Finance Minister Arun Jaitley said the Government would boost public spending. “Public investment has been stepped up in the past year and it will continue to remain stepped up. When you fight a global slowdown, public investment has to lead the way,” Jaitley has said.

“Unfortunately, the Congress has embraced the politics of obstructionism. This is making decisions linked to legislative changes difficult. But most people forget that a lot can be achieved through executive action. And you will see the Government unveiling more measures in the coming weeks,” Jaitley tells Open.

The only thing debatable on the matter is the nature of this spending. Historically, the distinguishing feature between Congress-led and Third Front governments and the NDA has been that the BJP-led coalition spends money on investment projects while the former use money to give a consumption-led boost to the Indian economy. India has massive infrastructure shortfalls that hold back economic growth. It will be better if the planned public spending that Jaitley has hinted at is concentrated on the building of roads, ports, bridges and railways.

The Finance Minister has been brave in saying what he did about stepped-up public spending. But this is a double-edged sword. Unchecked (and wasteful) spending will only bloat the Centre’s fiscal deficit, letting out other problems that have barely been suppressed (inflation for example). It will also scare away potential investors. Fortunately, there is a solution that is within the Government’s power: disinvestment. This can work wonders not only in the case of banks, it can also help the NDA meet the necessary expenditure for its investment programme.

Disinvestment programmes in India are usually marred by poor planning on when to offload the Government’s stake—the last few years have had plenty of instances when the Life Insurance Corporation was used to bail out a disinvestment plan, making nonsense of the idea. The way forward is not to have ambitious and unrealistic disinvestment targets that cannot be met. At the start of the budget year, a realistic target can be fixed—that should not be too hard—and then stuck to. Once that happens, investors will get the signal that the Modi Government is serious about taking India onto a higher economic plane.

Finally, the single biggest weapon in the Modi Government’s armoury remains unexplored. This is one option, which, if exercised, can even bypass its parliamentary troubles. Almost all the reforms that have remained stalled in Parliament—land law reform, labour laws, etcetera—can be addressed at the level of state legislatures. Under Article 254 (2) of the Constitution, any law passed by a state legislature that runs counter to a Parliamentary law has to be reserved for the President’s consideration. The Modi Government can selectively bestow financial and other incentives on state governments that pass such reform laws. This won’t be a political matter: many states, irrespective of the party that rules them, are in financial trouble. From this perspective, states being in financial trouble is probably not a bad thing at all. The Union Government can dangle plenty of carrots to these states in return for reforms. This will truly be a federal approach to a country-wide challenge of reforms. What is needed now is a strong dose of political will by the Modi Government.