License Raj is dead. Licensor is not

Rediff January 7, 2013

http://www.rediff.com/business/slide-show/slide-show-1-column-mrv-license-raj-is-dead-licensor-is-not/20130107.htm

 

The near decade of India under Dr Singh has convinced most that India is an Absentee State, where governance is grossly missing and rule of law virtually non-existent, writes M R Venkatesh.

The days of denial by our government are certainly over. Successive economic data shows up that something is structurally flawed within our economy. The government may be reluctant to admit it. But the fact remains we are now heading for another economic crisis. And the root cause? Government and lack of governance.

More to the point, India is no longer regarded as a soft state - a term invented by Gunnar Myrdal, the noted Swedish Nobel Laureate. Myrdal used this term in his classicAsian Drama to describe a general societal "indiscipline" prevalent in South Asia.

That was in a distant past, within a decade or two of India attaining her independence where the Indian government could well have been probably soft, but importantly did exist. Now consider the present.

The near decade of India under Dr. Singh has convinced most that it is no longer a case of a soft state. Rather, it is an Absentee State, where governance is grossly missing and rule of law virtually non-existent. And even in a case where law exists, order does not. That explains my conclusion that the Government of India is the cause, not solution, to most ills plaguing the Indian economy.

At the root of the present economic crisis is lack of governance to the point that it is impacting us at every level. Governance deficit - as it is popularly called - has come to a pass that it is no longer the cause of a lower economic growth; it is no longer the difference between an 9 per cent potential growth rate and an actual 6 per cent growth rate.

Governance deficit, let us not forget, adversely impacts production of ordinary goods (and even in some cases services). This lack of production is the fundamental cause of inflation in India as more money chases lesser goods. Now to control inflation, government is forced to import. This leads to higher trade deficit and consequential current account deficit.

As current account deficit increases, pressure mounts on India's perennially weak external sector. This in turn puts the rupee on a downward spiral. Basic economics tells us that a weak currency is a cause, not antidote, for inflation.

As inflation increases, the Reserve Bank of India (RBI) is forced to intervene with the instrumentality at its command viz., by increasing interest rates. Experiences of the past few years demonstrate that this (feeble) attempt by RBI to control inflation is akin to applying pain balm when chemotherapy is the need of the hour. Nevertheless, increased borrowing adversely impacts Indian economy.

Interestingly, elevated interest rates - the cumulative effect of UPA (United Progressive Alliance) rule is held to be the villain of the piece. Crucially, mal-administration - under an economist Prime Minister - the genuine villain of the piece is forgotten in the melee. And that is the crux of the issue.

The Financial Stability Report of the RBI

The sixth issue of the Financial Stability Report (FSR) of the RBI was issued on December 28th 2012. This report brought into sharp focus the structural weakness of our economy accentuated by certain unsound economic policies of the UPA government, heightened by its failure to uphold the majesty of law and of course compounded by corruption.

Chronic inflation, the net result of all this, over the past few years has taken its toll on our economy as it robbed people of their savings. As savings rate declined, domestic investment increasing became to depend on foreign capital flows. The intellectual dishonesty of our government began to be exposed as a necessity of such flows was converted into a virtue and passed as reforms!

That is not all. Lending rates were sufficiently raised to deter growth but borrowing rates were not raised in tandem to improve savings, notably financial savings. As inflation outpaced interest rates, savings got channeled into gold, which as we all know is substantially imported into India. This widened trade deficits and put additional pressure on the Rupee.

A depreciating rupee automatically makes gold attractive - a fact lost on most in our establishment. In contrast, an appreciating rupee could possibly make gold unattractive. But that is easier said than done for reasons explained above. That explains the country's fixation to gold.

Yet, the FSR innocently states that external sector imbalances remained a worry. It adds that rising gold imports have worsened the current account deficit, little realising that gold imports are not the cause, but effects of a larger malaise within the economy. No wonder, a lower proportion of household savings is now channeled towards financial products.

Further, lower economic growth has significantly stressed out some of our leading corporate to service their debt. Some industrial groups with greater exposure to key infrastructure sectors like power have witnessed higher leverage in recent years.

Naturally, asset quality of the banking system has come under unprecedented stress making loan portfolios of banks risky. This has made our financial sector vulnerable. Simultaneously, lower growth has the calculated effect of dynamiting the finances of the government on account of lower revenues. Surely, we run a risk of potential downgrade by international rating agencies. And should that happen, a financial Tsunami is bound to hit us.

There is yet another dimension to the debate - the subsidy conundrum. Government borrowals to fund deficits leaves very little of savings within the domestic economy. This crowding out by the government is yet another cause of our economic under-performance. The issue once again is not subsidy per se but the manner in which we (inefficiently) administer our food, petroleum or fertiliser subsidies.

Under this paradigm, as the government contemplates controlling subsidies, vested interest within the system ensure that subsidies are neither controlled nor are they administered efficiently. Surely an unenviable position for Indians!

Mal-Governance - the rot within Gurucharan Das in his recent work titled "Grows at Night - A liberal Case for a Strong State" points out that a power plant in a "liberalised" India and with an economist as a head of its government required 118 - yes 118 - approvals. This is where India needs to reform - reforming Babudom.

Press reports point out that over two dozen projects of the government in key areas of infrastructure had been struck after permission had been given by the government. Obviously, the Government buckled to some groups - possibly a handful of people, potential competitors or other extraneous pressure. A buckling state (or is it a conspiring state?) inspires no confidence from any investors, foreign or domestic.

Similarly, the Economic Survey presented to the Parliament in February 2012 tracked the progress of 583 projects in different sectors. Of these, only 7 were reportedly ahead of schedule, 166 were on schedule, and 235 were delayed. Interestingly, 175 projects were sanctioned without specifying any commissioning schedule. So no question of any delays in such cases!

The delays also imply a cost overrun in excess of 15 percent. The maximum number of projects delayed belong to road transport and highways (90), followed by power (45), petroleum (29), railways (26), and coal (17) [Source Para 1.29 of Economic Survey 2012].

Apparently, the rot is fairly deep. Primary deficits, revenue deficits, fiscal deficits, current account deficits, trade deficits, inflation, interest rates and other negative macro-economic parameters are all symptoms of a larger malaise. The real issue is governance deficit - the mother of all deficits. What is lost in the debate is the impact of an Absentee State on our economy.