Wednesday, 27 June 2012

THE HARD TIMES MUST GO - India needs drastic reforms, not cosmetic ones


- India needs drastic reforms, not cosmetic ones
Commentarao: S.L. Rao
The power to decide
In 1990, A.M. Khusro was editor of The Financial Express. The country’s economic situation was dire. A four-page article by an anonymous writer (later speculated to be Montek Singh Ahluwalia) laid out what must be done for economic revival and growth. The article listed policy changes (that were also in reports by L.K. Jha and recommendations made by the World Bank mostly by Indian economists). Policy changes or new ones introduced by P.V. Narasimha Rao as prime minister in 1991 with Manmohan Singh as his finance minister followed this blueprint.
India’s situation today is no less dire than it was in 1991. The prime minister says that unlike then we now have ample foreign exchange reserves. But they have come down by almost 10 per cent in the last two months. And the reserves cost high interest. Being volatile funds they can flee at short notice. As in 1991 we need drastic reforms, not cosmetic ones. Growth is declining, inflation rampant, investment down, and payments balance dangerously bad. Thankfully Pranab Mukherjee — the worst finance minister that the Congress has had — will move soon and the United Progressive Alliance can reverse his many mistaken polices. The best reform would be to replace the two-headed “leadership” of the UPA with one head with political power.
Contrary to the statements of Congress and government spokesmen, there is no magic wand. Opening foreign direct investment to retail, massive infrastructure expenditures, superficial cuts in government expenditures, are Mukherjee’s cosmetic sound bites, not reforms. The needed reforms are structural and systemic, prioritizing decentralized governance, and administrative reform.
Slashing the fiscal deficit — and immediately — demands genuine and drastic cutting of expenditures. Pious pleadings for reducing overseas travel by government servants or not holding meetings in five-star hotels will not do. Social service expenditures are the chief cause of Central and state government spending since 2009. The figures between 2006-07 and 2010-11 (in rupees crores) are: 2006: 11,09,174; 2007: 13,16,246; 2008: 15,95,110; 2009: 19,09,380; 2010-11: 20, 71,147.
Schemes and expenditures were rolled out with little prior testing, poorly targeting beneficiaries. Much of the claimed expenditures have been stolen. Obvious actions are to make an overall cut in each scheme, cut allocations to states which have been shown to spend funds on non-target beneficiaries, and in allocations to states that do not submit required periodic returns.
The capacity of panchayats and local authorities must be strengthened and then funds disbursed directly to them for different social schemes. They might steal, but can monitor closer to the beneficiaries. All schemes should first be pilot-tested and a monitoring and evaluation mechanism established, using lessons from the past as aids to minimize wastage and theft.
Foreign investment has already increased to the United States of America and Germany. Their strong currencies offer safety. The retrospective taxation introduced in the last budget has unsettled investors. It should be withdrawn immediately without waiting for judicial scrutiny. For foreign companies, acquiring valuable Indian capital assets by buying their holding companies abroad saved regulatory interference and taxes. Some examples over the years: Lever buying Brooke Bond; Glaxo buying SKF and Burroughs-Welcome; Kraft buying Cadbury, and many others. The government must impose a prospective tax on capital gains on overseas purchases of companies with sizeable Indian assets, and withdraw the retrospective tax.
When our composition of foreign exchange reserves improves, a calibrated programme to reduce our dependence on volatile foreign funds must be initiated. A tax must be imposed on foreign institutional investors who move funds out of India without holding them for at least a year. As FDI and exports increase, we must abolish the tax treaties with countries like Mauritius, and the scheme of participatory notes, which have become conduits for money laundering and illegal overseas accounts.
Foreign direct investment policies must become open. Allow FDI in all sectors — insurance, retail, pensions, aviation and anything else, with close regulatory oversight, and with a small negative list on security considerations. Rules and procedures must be simplified so that India does not remain at the bottom of the list of countries where a new business can be started speedily. The intention of the government and its policies must be to make investment welcome, not to show suspicion.
The government must abandon ‘disinvestment’ in State-owned enterprises where it sells minor percentages of its equity; instead, it must privatize them. The revenues that will be generated can be used for funding social service schemes and for infrastructure. The bonus for the economy will be that the fr eed public enterprises will function entrepreneurially, efficiently and add substantially to the economy.
‘Disinvestment’ of part of the equity allows government to retain full control. It is a revenue-raising exercise — not one to improve entrepreneurship and management autonomy. Minority shareholder interests are ignored. The freedom of the government as majority equity holder and policymaker to overrule interests of minority shareholders under the present disinvestment will no doubt be settled in court. Disinvestment does not correct the biggest hurdle to the efficient management of public enterprises — the interference of ministers and bureaucrats in all major decisions and the absence of managerial autonomy in key decisions on strategy, diversification, technology, collaboration, key appointments and so on.
Attempts to distance ministries from public enterprises — memoranda of understanding between the controlling ministry and the enterprise on who is to be responsible for what action — ended up as another budgeting exercise and paperwork for the enterprise without achieving distancing between the two. Another effort was to have holding companies like Indian Tourism Development Corporation, and thoughtless mergers like that of Indian Airlines and Air India. A recent fancy is that of conferring ‘navaratna’ and ‘mahanavaratna’ status, but that has not stopped bureaucratic control. Many times, even the top operating management is given to bureaucrats. Public enterprises that are not enterprising are still critical to the economy. But their culture is administrative — of procedures. All serving and retired bureaucrats in Central and state government-owned enterprises must be removed. This is especially so for state electricity boards that have accumulated losses of over Rs 1 trillion paid out of state budgets.
Decisions on goods and services tax, the direct tax code, oversight of credit rating agencies, introduction of the international financial reporting system for all accounts, codification of standard rules for transfer pricing, should be accelerated, not meander desultorily. Land acquisition, environment and forest clearance are major hindrances to industrial development. One suspects that the government prefers them to be so discretionary. This must be corrected and a fast approval/disapproval process introduced.
Natural resources like coal, iron ore, oil and gas, telecommunications spectrum, and others are national resources. A clear procedure for allocation, fees for sale or lease and so on is not difficult to evolve but obviously a discretionary procedure is more profitable to the government functionary. Ministerial and bureaucratic discretion must go in these matters, as on land and environment.
Independent regulation of information, competition, electricity, telecom and so on must also be treated as such. They must be made accountable to the higher judiciary. Appointments must not be restricted, as now, to retiring bureaucrats.
The fundamental reforms must be decentralization of decision-making and the individual accountability of the bureaucracy for decisions. Proposals for administrative reforms exist and must be implemented immediately. Administrative reforms must move the bureaucracy away from a pre-independence system of revenue gathering, law and order maintenance to a development and social service oriented one.
Financial decentralization is another priority reform. Elected representatives, especially in state legislatures, do not want to surrender their power to distribute largesse. They have resisted financial devolution to panchayatsPanchayats must have capacity-building and decision-making powers. Similarly in large urban municipalities, corporators must be accountable for their decisions. These are the urgent, doable and dramatic reforms. Will vested interests in all political parties accept and implement them?
The author is former director general, National Council for Applied Economic research