Twenty years after India’s historic economic reforms, it’s time for another big effort

ON JULY 24th 1991 Manmohan Singh, then India’s finance minister, presented a budget to India’s parliament that would change his country and the world. It was an unlikely triumph wrested from a moment of national humiliation. Thanks to political turmoil, high oil prices and fiscal profligacy, India was left with barely enough foreign exchange to last a fortnight. Like an indigent household pawning the family jewels, its central bank was forced to airlift 47 tonnes of gold to the Bank of England as collateral for a loan, while it waited for more help from the IMF.

In that fraught summer, Mr Singh devalued the rupee, abolished most of the quotas and licences that dictated who could produce what, and opened some industries to foreign capital. His reforms ripped pages out of the Red Book of regulations with which customs inspectors tormented Indian businessmen. He commended his budget proposals to parliament by paraphrasing Victor Hugo: “No power on Earth can stop an idea whose time has come.”
That idea, Mr Singh suggested, was India’s emergence as a “major economic power in the world”. The years since have amply vindicated his confidence. India’s economy has almost quadrupled in size, growing by about 7% a year on average over the past two decades and by over 9% from 2005 to 2007. Given India’s sheer scale, its economic rise is bigger than any that came before, bar China’s, and far bigger than anything that will come after. And its demography, unlike China’s (see leader), will underpin future growth.

Some economists argue that the role of Mr Singh’s reforms has been overstated, pointing out that India grew almost as fast in the decade before the crisis as it did for ten years after it. Earlier, smaller, changes did create some passing momentum; but Mr Singh’s liberalisation was of more lasting significance. July 1991 therefore deserves its spot in the annals of economic history alongside December 1978, when China’s Communist Party approved the opening up of its economy, or even May 1846, when Britain voted to repeal the Corn Laws.

You forgot our anniversary
India is not, however, in a mood to celebrate. Although its economy sailed through the global financial crisis, inflation is rising and growth slowing. Price pressures have persisted long enough to cast doubt on the assumption that it can resume growth of 9% or more without overheating. Foreign investment has been patchy of late and even India’s indefatigable entrepreneurs seem disheartened.

When he became prime minister in 2004, serving at the pleasure of the Congress party’s head, Sonia Gandhi, Mr Singh took charge of an economy reaping the benefits of liberalisation. He thus found himself in the unusual position of inheriting his own economic legacy. But like the heirs to many family fortunes, he has turned cautious and conservative. Besieged by scandal, his government has squandered precious time staving off inquiries and defending indefensible ministers, two of whom have now resigned in disgrace. His presence at the helm provides some assurance that economic policy will not regress, but no guarantee of progress.

The government seems to think that a stout defence of past reforms is enough. It sometimes acts as if growth is a given: an expanding workforce and an impressive savings rate guarantee extra labour and capital. India’s ingenuity and entrepreneurialism will take care of the rest.
Such confidence is misplaced. The animal spirits even of Indian entrepreneurs can flag. And demographic momentum should inspire urgency not complacency. Every year over 25m Indians enter the world and the labour force swells by 10m or more. Each year that passes without progress on malnutrition, schooling and hiring thus consigns millions of youngsters to marginal jobs, with little chance of realising their potential.

The mahout’s last ride

Many of the reformers of 1991 have, like Mr Singh, resurfaced in this government. But the tasks they face this time round are quite different, in two big ways. In the 1990s they freed the market for outputs, allowing companies to produce what they liked, how they liked. But successive governments have failed to repair the markets for inputs like labour, land and power. Of its many delayed infrastructure projects, 70% are stalled because of problems acquiring land, a process still governed by an 1894 law Mr Singh’s government has been trying to amend for over three years. The government urgently needs to fix this problem, and to reform both the labour laws, which make it too hard to fire people, and the power market, which is haemorrhaging cash and unable to deliver enough electricity.

The 1991 reforms were enacted by an elite corps of committed reformers in the capital. But to improve education, health and nutrition requires motivating and monitoring the legionnaires out in the rural schools, clinics and outposts of officialdom, where the central government has little sway. Central government has, for example, increased spending on schooling and passed a law giving everyone the right to an education. Now it is up to state and local authorities to ensure that the money gets spent in the right places and teachers are held to account for showing up and teaching well.

If the tasks now facing India are different, so are its circumstances. In 1991 India reformed because it had to. Mr Singh made a virtue of this necessity, pushing through measures that were not strictly required to resolve the immediate crisis, although they did help ensure India never suffered a repeat.
Thanks to his efforts India is now a far more successful and resilient economy. It is not on the brink of another crisis. But its recent economic performance has been disappointing enough to provide an alibi for another bout of opportunistic reform, were Mr Singh bold enough to make the most of the opening.
“Let the whole world hear it loud and clear,” Mr Singh, a soft-spoken man, said 20 years ago, “India is now wide-awake.” In the last years of this government—and the final years of Mr Singh’s career—India’s politicians need to rouse themselves and give reform another powerful push.

What happened after US' ratings downgrade..........In INDIA

Sometimes the news flow is slow.But sometimes the news comes so fast he can barely keep up with it. "Europe sparks global sell-off," was the Financial Times' lead headline on Thursday.

Italy's debt was sinking in the bond market. The Italians need to borrow more than $200 billion a year to stay afloat. But yields (the cost of borrowing) were rising to the point where it would soon be impossible. And Europe's bailout fund doesn't have enough money to save the Italians. The European Central Bank announced that it was buying bonds on the open market. But nobody believed the ECB could or would be able to support the market on its own.

This was followed by Friday's FT headline:

"Stock markets plunge worldwide." All over the world, stocks fell on Thursday (reported on Friday). Some sellers sold because they were afraid of Europe. Some sold because they were afraid of Asia. Some sold because they were nervous about the US. And some sold just because everyone else was selling.
The move came even though the Treasury Department said that it had found a math error in the firm's calculations of deficit projections, according to a person familiar with the matter.
S&P decided to lower the AAA rating, held by the United States for 70 years, to AA+ after a bipartisan debt deal signed into law this week failed to assuage concerns about the nation's growing spending.

Analysts have said a downgrade could increase the cost of borrowing for the U.S. government and lead to tens of billions of dollars in more interest costs per year. That could translate into higher borrowing for consumers and businesses, too.
A downgrade would also have a cascading series of effects on states and localities that rely on federal funding, including in the Washington metro area, potentially raising the cost of borrowing for schools and parks.
But the exact impact of the downgrade won't be known at least until Sunday night, when Asian markets open, and perhaps not fully grasped for months. Analysts say the immediate term impact is likely to be modest because the markets have been expecting a downgrade by S&P for weeks.
"...several lawmakers have publicly questioned whether the ratings agencies have the competence to evaluate the country's finances, and whether it was appropriate for them to be so deeply involved in discussions of fiscal politics."

In short, they were indignant. They thought they had bought the rating agencies when they bought Wall Street. They must feel as though they have been cheated.

 What the US debt downgrade would spell for India in particular.

We are not exactly delinked from the US. It is a major client for nearly all of the exporters. Therefore any recession or slowdown in demand from US would impact the earnings of the export focused firms. To add to this, the domestic demand environment has slowed down as well. This was on account of the monetary tightening measures adopted by RBI to control inflation. Therefore, the domestic demand may not be able to offset the slowdown in demand from overseas. This spells trouble for Indian firms.

But is this problem new? US has been in a crisis since 2007 when Lehman Brothers collapsed. In reality, the crisis started when the banks decided to give loans to people who did not qualify for it.. But then that's history. Nonetheless, the fact is that US has been in crisis for a while now. The recent downgrade is just finally accepting the fact that US is in crisis. The Indian exporters have already learned to live and work around with clients who have tightened their purse strings. They have learnt how to negotiate with them. They have also learned how the crisis and changes in regulatory environment can be used to get better and more work from the clients.

Therefore, the recent selloff does not spell trouble for India. These risks could already be accounted for in the stocks. True there may be more crashes to come due to global volatility. But these should be treated as an opportunity. An opportunity to pick up fundamentally sound companies The market crash is giving us an opportunity to get these stocks at cheaper valuations.

The downgrade of the US' credit ratings may make little or no difference to the fundamental prospects of India Inc. But for the fact that the cost of short term borrowings just got steeper. At a time when domestic credit is unviable, thanks to the RBI's strict monetary tightening, foreign money is the only recourse. The latter has been at least 5-7% cheaper than domestic debt and the hedging costs have also been low. But most of that changes with the downgrade of the US' credit rating. For the uninitiated, the yields for most international bonds are linked to US Treasuries. But with the US treasury papers themselves commanding a higher rate, the borrowing cost for corporate automatically gets dearer. While the same may get evened out in the long run, the short term pain itself could be very taxing for companies that are heavily dependent on leverage. What is good here is that the notion of 'cheap credit' is slowly getting phased out. That is expected to bring in more rational re-pricing of risk and allocation of funds.

With the risk of another recession in the developed world looming large, will the Indian Government play the economic stimulus card all over again? Not quite if a leading business daily is to be believed. For starters, the current economic situation in India is different than the period of 2008-09. Right now, the Government is in fiscal consolidation mode. In other words, its expenses exceed its income by quite a bit and any further stimulus would mean putting this number in even more danger.

Also, it is quite possible that the Indian central bank, easily one of the most hawkish in the world, stops its interest rate hiking exercise. This can happen if global commodity prices fall and consequently, inflation in India cools down. Hence, there is a chance here that even without the Government giving a stimulus shot, the economy could be boosted on account of the RBI's measures.

However, it would be wrong to completely rule out fiscal stimulus from the Government. It could well become a possibility if the developed world plunges into a recession worse than imagined. Here, the Indian Government may have to step in to pick up the slack on account of severe slowdown in net capital inflows and trade balance. For the time being though, it is a wait and watch approach by the Government.

 Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The authors do not claim it to be accurate nor accept any responsibility for the same.

Economic conditions are not as bad as they seem. The future, in fact, is looking brighter than before.Two things going for the economy at present are the peaking of interest rates and inflation. The Reserve Bank of India (RBI) can pause its rate hiking spree on the back of the topping out of inflation. Equity and debt markets can then give up their bearishness and look ahead into a period of stable inflation with interest rates coming off.
Inflation for June 2011 printed at 9.44 percent, against consensus estimates of 9.65 percent. Inflation was higher by 0.8 percent from the previous month, but the non-food manufacturing index rose by just 0.2 percent month-on-month (ie, June compared to May) and 7.23 percent year-on-year (June 2011 vs June 2010).
The weakness in the IIP (Index of Industrial Production) is seen as a precursor to non-food manufacturing inflation coming off down the line. The IIP growth numbers for May 2011 came in weaker than expected at 5.6 percent against consensus estimates of over 8 percent. The IIP contracted by 3.1 percent month-on-month. This is the second straight month-on-month contraction in IIP. In April, the IIP had contracted by 1.6 percent month-on-month.
Inflation for the month of July is also likely to print at over 9.5 percent levels as the fuel price hikes announced by the government in June will be reflected in the July numbers – especially the spread on effects of transporters and others raising prices. If commodity prices, especially crude oil, stay steady, inflation will start trending down from August onwards. In this scenario, the RBI can hold on to policy rates.

Commercial vehicle sales, seen as a barometer of economic growth, registered 17.7%growth for June 2011. Growing commercial vehicle sales in a period of high inflation and high interest rates is promising. Reuters

There are signs of interest rates coming off. Banking system liquidity has eased with bank borrowings from the RBI coming off by over Rs 50,000 crore. Government spending, bond maturities, rising deposit growth and drop in currency in circulation have all contributed to the rise in liquidity. The easing liquidity situation has brought down borrowing costs for banks and corporates with yields on one-year and five-year corporate debt paper falling by around 40 basis points (100 basis points make 1 percent) from peaks seen in May.
On the economy front, exports have shown good performance for June 2011. They have grown by 46.4 percent year-on-year for June 2011. Exports at $29.2 billion have grown by over 12 percent month-on-month. Export growth is promising despite signs of a weakening global economy.
Commercial vehicle sales, seen as a barometer of economic growth, registered 17.7 percent growth for June 2011. Growing commercial vehicle sales in a period of high inflation and high interest rates is promising.
Direct tax collections were higher by close to 24 percent year-on-year in the first quarter of 2011-12. The higher direct tax collection is an indication that corporate profitability is still not threatened. On the whole, the Indian economy, while showing signs of weakening, is looking resilient despite global economic issues of US unemployment, Chinese inflation and eurozone debt.