The long-delayed economic reforms that India passed recently to revive investor sentiment and growth momentum can and must be made to work, says the man who will help steer them as the government’s new chief economic adviser.
Raghuram Rajan, the former chief economist at the International Monetary Fund, took charge at the federal finance ministry on Aug 1, when Palaniappan Chidambaram returned as the finance minister after his predecessor became the country’s president.
“We have our problems, I am not denying that. Gross domestic product (GDP) growth has slowed from 8.5% in recent years to 5.5%. We certainly should be going back to 8.5% or 9% growth. To do that, there are a bunch of things we need to do,” says Mr Rajan with a sense of urgency following a spate of downgrades by international ratings agencies and global investment banks of the economy’s growth outlook.
“In the absence of a conducive external growth environment, it becomes more critical to cut subsidies, resolve regulatory and infrastructure bottlenecks, and build a sense of optimism to drive growth back to pre-crisis levels. We need to attract foreign investment, and keep fiscal and current account deficits in check.”
Every economist and industry leader agrees that subsidies are a major contributor to the worryingly high fiscal deficit, which may exceed the government’s target of 5.1% of gross domestic product in the current financial year through March.
Projects worth US$35 billion are stuck due to delays in various approvals. Foreign direct investment (FDI) in the country declined to $6.18 billion in the period from April to July 2012 compared with $14.6 billion in the same period last year.
On Sept 14, India announced the first of its long-delayed reform initiatives. They included allowing 51% foreign direct investment in multi-brand retail and 49% investment by foreign airlines in the aviation sector, selling equity in four government-owned companies, hiking diesel prices by more than 5 rupees a litre, and liberalising FDI rules for the broadcasting sector.
More reforms came on Oct 4 and included a rise in the limit on foreign ownership of local insurance companies to 49% from 26%. As well, overseas investors would be allowed to own up to a 26% stake in domestic pension fund managers. These latest proposals on insurance and pension funds, however, need to be approved by Parliament, unlike the previous ones that required just cabinet clearance.
But with the second wave of reforms, the Indian currency has appreciated 6.8% since the team of Mr Chidambaram and Mr Rajan returned to the finance ministry to push fiscal consolidation, making the currency the best performer in the region.
At the same time, the broad equity index, the S&P CNX Nifty, is up 25% this year, making it the top performer among major equity markets. Global investors bought shares and bonds worth US$4.3 billion in September.
“Besides the global downturn, India has domestic problems such as supply-side bottlenecks that have quickened inflation and weighed on the economy,” said Mr Rajan. “These problems aren’t beyond fixing. I think getting a few things right can stabilise the growth and move it on the way up.”
People who think that democracies go in a straight line and the paralysis of stagnation is permanent ignore the fact that ultimately, politicians have to respond to the people, he said. “And thus, sometimes space is created. I think there is no secret that Mr Chidambaram is the finance minister who certainly made some changes and also pushed hard. But there are other factors also at play.”
Mr Rajan, who has been an outspoken critic of Indian corruption and bureaucracy, served as the economic counsellor and director of research at the IMF besides teaching at the Graduate School of Business at the University of Chicago.
He was born at Bhopal in central India. He acquired international fame for correctly predicting the global financial crisis of 2008, a prediction for which he was initially derided. On Nov 3, 2008, India appointed him as an honorary economic adviser to the prime minister. He also chaired the high-level committee on financial sector reforms in 2007.
“One of the concerns over the past few years has been food inflation (averaging more than 7.5%) which has been not so much within the government control,” he says.
“This is because our population has become richer — a good thing — and therefore has been demanding more high-end food products like milk, eggs and meat rather than cereals. To rebalance or reduce food inflation, we have to produce more of such products. So productivity is going to be a part of fighting inflation.”
Cynics, however, caution that the recent big-bang reforms are not without risks for Prime Minister Manmohan Singh’s government and for investors who theoretically stand to benefit.
The flurry of measures to control public finances and liberalise the economy has destabilised the Congress-led coalition, thereby increasing the chances of an early election in the world’s largest democracy. And maybe, even raising the possibility of a less business-friendly government in the future.