Let the Party Begin: Election 2014

News reports suggest that the entry of Rahul Gandhi and Narendra Modi into the mainstream of the Congress Party and the National BJP respectively is galvanizing their respective party members and traditional supporters.  Most BJP supporters were extremely upset, if not disgusted, by the performance of their party in the last six years as an opposition party.  Many Congress party supporters were in despair at the attack on its integrity and the collapse in economic growth.  Developments in both parties over the past six months or so, have begun to lift the gloom that descended on them, though a certain element of confusion still remains.

     About three months ago, one predicted that the next general election would be a contest between a Rahul Gandhi led Left of Center (LoC) Congress and a Narendra Modi led Right of Center (RoC) BJP.  Analysis in the media has since written about a contest between Rahul Gandhi and Narendra Modi, while others have pointed to various reasons why this cannot happen. Note the subtle distinction between what we are saying and what the media is focusing on.  Our main point is about the clash of ideologies (left of center, right of center), where the protagonists (Rahul Gandhi and Narendra Modi) are merely symbols of this ideology.  In contrast most writers and commentators (pro and against) are focusing on the personalities and their strengths and weakness.  Though both aspects are likely to come up during the election campaign, the former is likely to be more important in the rural areas and the latter in the urban areas.  Political skill in framing the overall message and focusing it on different parts of the electorate will be an important factor in the final outcome.

This prospect has set off a flurry of rethinking and activity among current and former allies of the two parties.  The Akali Dal and the Anna DMK were the only NDA partners of the BJP who indicated support for Modi as a potential NDA PM, suggesting that they saw his entry into National politics as increasing the prospects of a NDA government at the center.  In contrast, other former or potential members of the NDA clearly feel that their party’s election prospects would be hurt if they were part of a Modi led NDA (pre-pol alliance).  Nitish Kumar has showed discomfort with supporting Modi as PM and has gradually distanced himself from a potential Modi led BJP and towards the middle ground between it and the Congress.  His recent statement of a National coalition of backward States (Bihar, Odisha, West Bengal), neatly brings together parties that feel uncomfortable with a Modi led BJP but have to fight the Congress in their home State.  Post poll, however, they may have difficulty choosing between a Rajiv led congress or a Modi led BJP central government!

     Among non-NDA, non-UPA parties, Shri Mulayam Singh Yadav was quick of the mark with a statement that a BJP, not led by Modi, would be a party he could work with. This statement sounds puzzling, coming from the architect of the MY coalition in UP and an outside supporter of the UPA government.  It suggests an astute analysis of the potential negative effect on the support base of the Smajwadi Party of an election defined by Modi.  A contest between a Rahul led LoC Congress and Modi led RoC BJP, is likely to benefit these two parties collectively at the expense of third parties.  In other words the declining trend in the joint vote share of the two parties will be halted and likely reversed. Which party will gain more, from the polarization that this contest suggests, is not clear at this point.   

    Survey data indicates that the Congress has the widest and most diffuse support base among the electorate.  In other words no cast, community, language or religion predominates among its voters, when compared to the distribution of these in the national population.  Interpreted in a positive light it is the closest we have to a “liberal” party.  Thus it is best positioned to attract the new, emerging middle class supporters from the narrow, caste, community, state-regional based parties, if it can fine tune its populist, “think from the heart” policies to their aspirations.  In contrast, the BJP support base is still religiously biased and weighted towards the more educated and somewhat better off .  However, the new aspiring middle class may also be susceptible to the economic message of growth, development and jobs that the so called “Modi model” projects.  Thus, besides the effect on votes of any implicit religious polarization, which party is able to convey a credible commitment to creating a strong, fast growing, job producing nation with equal opportunities for the new /aspiring middle class from every caste, creed and religion, may have an edge.

    Compared to the past, the relative seat shares of the Congress and the BJP will matter as much as if not more than the relative seat shares of the new UPA and NDA pre- poll alliances.  The 2014 election is therefore likely to be followed by hectic post-pol alliance formation, to  form the government.   In fact the far-sighted power brokers are probably already maneuvering to position the different parties for perspective alliances between parties that will fight the elections as opponents.

Political Uncertainty and Reform

   The conventional wisdom on economic reforms is that political uncertainty slows down reforms.  In my view the current political uncertainty, created by the withdrawal of DMK ministers from the Government could be used to accelerate genuine economic reform ( i.e. reform that restores growth and improves the efficiency of welfare delivery). 

    A BJP spokesperson has stated that the country is now in an election mode.  Earlier BJP leaders have asserted that Congress would be thrown out of office during the next election. If the BJP truly believes in these two statements, then it is in their interest to expedite reform legislation in Parliament and vote to pass it.  There are two reasons for it.  Firstly, these reforms are critical to India growing at 8% during the tenure of the next government (whether it is Congress led or BJP led) and second that Congress is likely to oppose the same reforms if the BJP in power, just as the BJP in opposition has opposed reforms that it introduced when it was in power.

    What about the Congress?  The Congress led UPA government has repeatedly stated that it has a majority and will remain in power till the due date of the 2014 election.  Despite the optimistic GDP projections in the Economic Survey and in the 2013-14 budget, growth is likely to be around 6% (+/- 0.5%) in terms of GDPFC and between 5% and 6% in terms of GDPMP.  Thus it is critically important for the Congress to end its current term with an uptrend in growth that is visible and credible, and this is only possible if there is another spurt of reforms over the next six months.

     The Parliamentary affairs minister therefore has two important tasks before him: Get the finance bill and budget approved in the Lok Sabha and work out with the BJP leadership the changes in reform legislation needed to get their immediate approval.  If the Congress leadership approves this course of action, Mr Kamal Nath seems to have (and has demonstrated ) the skills necessary to get this legislation through, with a little help from the Finance and other Ministers.

India-China Relations

     The government has been publicly and repeatedly sending signals to the new Chinese leadership of intentions to maintain, improve and develop friendly relations.  This signals started even before the new leadership was formally appointed.  The latest (five point) statement from President and Party Chief Xi Jingping on Sino-Indian relations, suggests that the message has been received and understood.  To what extent it will be acted on is still not clear.

       The degree to which this happens depends on two factors.  One is the extent to which the new leadership feels confident about maintaining its control over Tibet.  The earlier ministry and organs of Internal security appeared to follow a very hardline and aggressive policy on, what to an outside observer appear to be, minor agitations that have no hope on earth or heaven/hell, of posing any threat to Chinese communist party rule in Tibet.  The down grading of the Internal security apparatus in the party hierarchy, following the Bo Xi Lai affair, may have had the salutary effect of downgrading the alarmist and perhaps self serving view of the Public Security ministry and party organs.  This in turn may have allowed the party to take a more realistic view of the self immolation in Tibet and to feel more confident about being able to handle any current or future agitations.  If true this would also have the collateral benefit of moderating its unnecessary suspicions about India.

The second factor is the global economic situation and its serious negative impact on the Chinese economy.  In a series of papers since the middle of the last decade I have predicted that the Chinese economy will slow down around the middle of the current decade and assuming that Indian economy maintains its growth trend would start growing at a slower rate than the Indian Economy [See projections in Virmani(2005), Virmani(2006), Virmani(2009)].  The global financial crisis greatly increased the probability that this prediction would come true, even though fiscal and credit expansion measures have eased the slowdown and staved of a sharp reduction in the growth rate. The new leadership, with a long term horizon of a decade, can no longer continue to think only about the short term.  Therefore, if they are to take difficult decisions on the domestic economic front they have to carefully modulate external relations.  With the heating of China's international relations with virtually all its maritime neighbours along the eastern seaboard, it may be considered wise to improve relations with a country that offers a potentially large market for its manufacturing industry and export juggernaut.

It therefore seems that the Indian strategy of carefully cultivating the new Chinese leadership, may actually pay off in terms of positive movement on the issues of terrorism, Afghanistan and perhaps over the medium term, even on the border issue. However, it always pays to resist the temptation to get carried away at the first positive signs, and to keep ones eyes open (particularly with respect to proliferation actions that undermine Indian security).

Higher Judiciary and Rule of Law

The supreme court and high courts in India are increasingly involved in issues of social welfare (nursery admissions) and public policy (coal allocation, telecom policy). Numerous studies have pointed to the huge backlog of cases in courts, the low number of judges to population and the limited funds available to the courts. Given the extreme limitations on resources and judges time would it not be better for the country if they focused on establishing the "Rule of Law" in India. This encompass critical issues like "Equality before law" and "Right to life."  As "rule of law" and "equality before law," applies equally to government servants (bureaucracy), judicial servants and public servants (politicians and ministers), this is also a vital and legitimate focus of the judiciary. Perhaps it is even more important, as respect for law must be demonstrated by those charged with making, implementing and upholding the law. So upholding "rule of law" requires higher judiciary to try to ensure that all these categories obey law and punish them if they do not.

The issue one is raising is one of priorities and focus.  Not that there are not many other worthy causes and issues that any public minded citizen, including a legal luminary, can take up.

 I would plead with all current and former judges of the high court and supreme court, to get together and form a society for establishing "The Rule of Law," "Equality Before Law," "Justice" (including for under-trails languishing in jail without trial) and "Public Safety and Security" in this country. It is a great service they would do for the country.

Realism and Reform: Re-Balancing Optimism and Pessimism

Introduction

When I read what politicians are saying and reportedly thinking, I am afraid that, as in 2009-10 they will once more become too complacent and ignore the need for continuing reforms over the next three years (not just this year), and permanently loose the opportunity of restoring growth  to its medium-long term potential of 8% to 8.5%.  When I talk to people from the World of Business and Private Equity (the long term investors) I often find a deep despair about a host of government actions and inactions that have stymied growth of output and investment in the recent past.  I fear that their pessimism will slow the pace of recovery even if the political system produces genuine reforms of the “permit-inspector raj”.  Both the over-optimism among politicians and the excessive-pessimism among business and industry can be bad for economic recovery.  We need a realistic balance between the two, if we are to get both a reasonably quick and a sustained recovery.

Reasons For Pessimism

Two numbers from the Economic survey, encapsulate the negative story for 2012-13:  One is the Current Account Deficit (CAD) of 4.6 per cent of GDP and the other is the growth rate of Gross Domestic Product at constant market prices (GDPMP) of 3.3 per cent.  These are both unprecedented and unsustainable numbers.  The growth projection of 5 per cent for GDPFC that shocked many observers, is 1.8 per cent point higher than the number for GDPMP.  We last had such a low growth rate for GDPMP during the BOP crises of 1991-2 when it plummeted to 1 per cent.  The CAD of 4.6 per cent has no historical precedent; the worst historical CAD was 3% of GDP in 1990-91 when the BOP crises started.  The high inflation rate, best captured by a five year average 9% rise in the implicit GDP deflator for private consumption, is another symptom of macro-economic imbalance. However, it is still lower than the nine year average of 9.9% from 1990-91 to 1998-99.

Parallels With BOP Crisis of 1991

Despite underlying imbalances that are arguably worse than in late 1980s, there has been no crisis this time.  The reason is the foreign exchange, trade and capital account reforms of the 1990s, which have allowed the economy to adjust without blowing up into a full-fledged crisis.  But the underlying problems still need to and must be addressed if they are not to act as drag on the economy or lead a BOP crisis a decade later.  Fortunately, because of the 1990s reforms, we now have more time to address them.  These reforms proved that a combination of “macro rebalancing” and “structural reform” could correct the macro imbalances and bring us on to a higher growth path than the 1980s. The former involved a classic (fiscal) expenditure reduction cum expenditure switching policy of real depreciation, which got us out of the 1990 BOP crises.  Intelligently adapted to current economic conditions, including a much more open economy, it can still bring results. In this context, policy actions to facilitate short term external financing of high CADs and increase nominal appreciation, are misdirected.

Reasons For Optimism

The Indian economy looks better from a medium term global perspective.  India is currently one of only seven countries (out of around 250) in the World with an average decadal per capita GDP growth rate of over 6% (2003-2012).  The ratio of India’s GDP growth to the growth of World GDP shows virtually no trend since 1994 (figure).  In other words India has maintained its growth performance relative to the World economy since 1994, even though in any given year it may have performed better or worse (as in 2012).  Similarly the ratio of the Indian Economy’s growth rate to that of China’s has been on a rising trend since 1994, as China’s growth slowed relative to the World economy.  This trend rise in India’s growth rate relative to China’s is very modest, from about 60% of China’s rate in 1994-1995 to about 80% in 2011-2012.  From this global medium term perspective, 2012 is a bad but not unprecedented setback, from which we can still recover if we take the necessary corrective steps over the next three years.

Policy, Regulations And Institutions

There is need for policy, regulatory and institutional reforms.  Part of the extreme business pessimism stems from the fact that one of our most cherished beliefs, since the 1991 reforms, has lost its credibility.  When reforms slowed after the initial burst in 1990s, we (in the MOF) used to tell foreign investors that the pace of reforms and the sector preference may vary with every government, but no government including the left front, had reversed any reform.  Gradually at first, then more rapidly, negative practices of the old “license-permit-inspector raj” have returned, in sectors/areas still under the control of the government.  Whether this happened inadvertently or deliberately, it has affected both domestic and foreign investors in the real economy and is a factor in the investment collapse.  It needs to be corrected through regulatory and institutional reforms.  Don’t be misled by the FIIs lack of concern on this score, as short term investors are quite happy to profit from the high interest rates relative to US, Europe and Japan and finance the high CAD for now.

Realism And Reform

In conclusion the Indian economy is not in as bad shape as investors in the real economy think nor is it as good as many politicians and political advisors think.  The government must not abandon (at the first sign of recovery), its efforts to correct the imbalances and bottlenecks that have arisen.  The real economy investors must shed their pessimism, as government makes genuine efforts to restore growth, and start investing. More realism on the part of both can return the economy to the long term growth trend more quickly.
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A version of this article appeared on the editorial page of, The Indian Express on Wednesday, 13^th March, 2013, under the banner, “Two Stories of The Economy,”  at,

  http://www.indianexpress.com/news/two-stories-of-the-economy/1087095/
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Figure:

 

Thinking with your Heart? Feeling with your Brain?

       In the old days before Facebook and twitter it used to be said that if you were not a communist in your youth you do not have a heart and if you are still a communist as an adult, you do not have a brain.  There was a kernel of truth in this expression. A modern/practical/operational version of the embedded truth would be as follows:  Use your artistic, humanitarian sensibility to identify social problems and issues needing public attention but use your analytical capabilities and scientific methodology to find solutions.  In other words, society should pay heed to artists, humanists, philosophers in identifying problems, but listen to analysts, scientists and subject experts to solve problems.  Ignoring this approach is a recipe for perpetuating problems not for solving them.

    Real life in which real human beings are involved, is however, never as clear as the Aphorisms. Analysts and experts may not be trained in scientific method as they should be and go by personal experiences and emotionally determined memories to identify solutions.  Philosophers and humanists may be ruled by ideology and the sayings/writings of "long defunct" 'experts.'  Nevertheless, even though real life can be very confusing, it is useful to have some simple intutive truths to guide us in making judgements.

Setting The Stage for Macro-Pivot: The 2012-13 Budget

Introduction

Many different words have been used to describe this budget. ‘Reasonable’, ‘Responsible’, ‘Sound’, ‘did no harm.’  The words that have not been used are ‘reformist’ or ‘big bang’. Those who were dis-appointed fall largely in the latter camp.  I would call it a “conventional budget,” where, by conventional I mean what one had begun to expect once the reforms of the 1990s were over.  Its main distinguishing feature is the determination to hold to fiscal deficit fixed in the budget and outlined in the long term policy stance.  This was a welcome and necessary departure from the budgets since 2009-10. For the rest it was the usual socio-political document, with a number of expenditure allocations to different groups to reassure them of its inclusive nature and incremental measure to correct small anomalies in infrastructure sectors, presumed to be the central propeller of government planned development programs.

Popular Expectations

 Some expected growth oriented budget and others feared a populist budget.  Neither the expectations nor the fears came true. Though the Finance Minister opened with a statement on the importance of economic growth for generating jobs, inclusive growth and revenues which could be used to help the poor, there was no headline making reform that could enthuse the stock markets or the domestic industrial community.  Measures to incentivize investment, savings, infrastructure, bond markets were neither much better nor much worse than those seen in earlier budgets.  Similarly there were a number of expenditures and increases in the same, directed at the Welfare of various groups, at food security and malnutrition, education and skill development, agriculture, textile workers and small industry.

Benchmark: Macro-Pivot

  Personally, the budget achieved the professed objective of the Finance minister to contain the fiscal deficit to 5.3% of GDP in 2012-13 and to reduce it to 4.8% of GDP in 2013-14.  Though the growth assumption on which this was based were optimistic, my view is that this finance minister is very serious about this objective and will therefore ensure that it is achieved.  This is an important step in restoring the fiscal sustainability and macro-economic balance, some of the most disturbing symbols of which are the current account deficit of 4.2% of GDP during the last two years and the high rate of consumer price inflation.

Why is this so important?  In a paper in 2012 I showed how many growth stars became shooting stars because they were not able to deal with macro-economic shocks emanating inside and outside their country. Thus it is essential to deal with this issue if we want to restore growth to a reasonable level and sustain it for the next few decades. Further, my analysis of the macro-economic situation in India, suggests that the best way to remove the cyclical down turn in the Indian economy is a “Macro-pivot,” which rebalances the fiscal and monetary policy, by tightening the former and loosening the latter.  Again this is based on research which showed that economies showing similar symptoms of macro imbalance as us, such a pivot led to an increase in the average growth rate in one to three succeeding years.  Further the evidence very clear when the fiscal tightening was the result of expenditure reduction but mixed or non-existent when it was the outcome of a tax increase

Fiscal Tightening

The finance minister has accomplished this reduction in the fiscal deficit by correctly focusing on the reduction of subsidies, which were the cause of the unsustainable rise in the fiscal deficit.  Further he has achieved it without cutting capital expenditure (government investment).  In fact capital expenditures are budgeted to increase by 27% in 2013-14.  There is however, one trend that has not been reversed, which needs to be, to put the fiscal deficit on a sustainable trend.  Revenue expenditures net of subsidies, are projected to increase at an even faster rate that the increase in GDP.  Thus the ratio of these expenditures to GDP is likely to increase significantly.

Further Reforms

 The finance minister has also mentioned a number of pending bills, such as the DTA, GST, Pensions and Insurance, that will help improve the investment climate.  If his expectation-hope of these bills in the budget of subsequent session of Parliament fructify, then enough momentum will be generated to return to a growth rate of over 6% in 2012-13.  If these and other administrative and procedural reforms, such as the setting up of an effective ‘Road Regulatory Authority,”  that have been talked about do not come through, then growth is likely to be around 6% (+/- 0.5%). 

A version of this note appeared in the Op Ed page of The Hindu on March 1, 2013 under the banner, “The path to Fiscal Sustainability,” at  http://www.thehindu.com/opinion/op-ed/the-path-to-fiscal-sustainability/article4463052.ece?homepage=tru