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Friday, June 8, 2012

Nearsighted politicians play spoiler to India's economy


Special to The Japan Times

HONG KONG — News that India's growth rate in the last financial year dropped to a nine-year low of 6.5 percent and that growth in the first quarter of this calendar year fell further to 5.3 percent had learned pundits muttering that India, too, was a victim of the global economic slowdown.

What hooey! India is a victim largely of its own political paralysis and incompetence. Apart from suffering from higher prices for imported oil, India is less exposed to international economic winds than other major economies.

The situation has become so grim that some Indian economic commentators are hoping that old-time politician Pranab Mukherjee will contest the presidency of India in elections next month. Then he would have to give up the job of finance minister, then someone with fresh energy would take the finance job, and then India might find a minister committed to reforms that would smash many bottlenecks and release the energies of the people to make India potentially a great economic power.

India's economy is a tragedy, held back by political deadlock, the inability of the political leaders to understand the country as it really is, and deep social, physical and structural faults in the organization of the economy and society.

As India's growth rate has been slipping, its budget and current account deficits have been widening, the rupee has fallen to new lows of 56 against the U.S. dollar, and Standard & Poor's rating agency in April put India on negative watch for a credit downgrade from its present BBB- (minus), the lowest investment grade. It is a mark of the failure of the Indian politicians that they were expecting an upgrade.

The 76-year-old finance minister promised that India wants to attract foreign investment to help its faltering economic growth. But in his March budget, Mukherjee introduced controversial tax proposals that spooked foreign investors. Foreign investors are upset by continuing government demands for a more than $2-billion capital gains tax against Vodafone for its 2007 purchase of Hutchison Whampoa's Indian mobile telephone assets for $11.2 billion.

Vodafone argued that it had no duty to deduct withholding tax from its payment since it was a transaction between two foreign entities. India's supreme court agreed this year, but Mukherjee remains in hot pursuit. In his budget, he introduced proposals for anti-tax avoidance rules that would allow the government to amend laws retrospectively to claw back tax revenue.

The move brought howls of protest from foreign business organizations in India. Eventually, Mukherjee postponed the measures for a year but vigorously defended his claims to the tax. "There cannot be a situation where somebody makes money on an asset located in India and not pay tax," Mukherjee said this month.

Many economists — importantly including S&P — thought he was unrealistic in his hopes of getting on top of the budget and external deficits. India's fiscal deficit rose to 5.9 percent of GDP in the year ended March 31, far above the government target. The ambition to cut it to 3.9 percent seems out of reach.

S&P said the high fiscal deficit and a heavy debt burden "remain the most significant constraints on sovereign ratings." It expects India to make only "modest progress" in fiscal and public sector reforms, given "the political gridlock."

The devious politics of the Indian presidency gives clues to India's political and economic mess. The president is chosen by members of the two houses of India's parliament and state legislatures, which gives the government an edge in the choice. Mukherjee's candidature is supported by some parties in the 10-party United Progressive Alliance government. But Congress, the dominant party, which alone has 206 seats in the lower house against 61 by other members of the government, and to which both Prime Minister Manmohan Singh and Mukherjee belong, is ambivalent. Party leader Sonia Gandhi is said to be afraid that Mukherjee might manipulate the powers of the largely ceremonial office of president. The official party line is that Mukherjee is too valuable a minister to spare.

Mamata Banerjee, chief minister of West Bengal, Mukherjee's home state, whose small party, Trinamool Congress, has a seat in the Cabinet, opposes Mukherjee. She plays a small but important spoiler role, illustrating the mess that the government is in. In this year's railway budget, minister Dinish Trivedi, from Banerjee's party, raised fares for the first time in nine years to take the vast railway system off life support. (A second-class fare for the 1,390 kilometers from Delhi to Mumbai would have risen to 260 rupees or $4.60.) His move angered Banerjee, who previously was in charge of the railways and likes to present herself as the friend of India's common man. She demanded that Singh sack Trivedi; he did and a new minister installed from Banerjee's party promptly rolled back the fare hikes. A more clever prime minister might have removed Trivedi but kept the fare increases, giving Banerjee's party a different Cabinet portfolio.

Such is the prime minister's declining influence that India's chattering classes joke that at meetings people are instructed to turn their mobile telephones to "Manmohan Singh mode," where they won't be heard. Singh was the author of India's economic reform program, but has increasingly failed to use his prime ministerial powers to keep reforms on track.

India continues to make some progress in reforms. The government recently removed some gasoline subsidies, but not on the more important diesel fuel. Nomura estimates that prices for diesel, liquid petroleum gas and kerosene would have to be raised respectively by 38 percent, 120 percent and 220 percent to erase the losses to oil marketing companies.

Removal of subsidies would be a giant step forward toward reducing the massive budget deficit. The Organization for Economic Cooperation and Development estimates that 9 percent of India's GDP is spent on subsidies for fertilizer, food and fuel. The next step would be to institute a general sales tax. But the government lacks the guts to tackle measures that would have a short-term political penalty.

India's tragedy is that the country does not have to be so poor. Consultants McKinsey recently produced a report that saw India's manufacturing sector coming out of the shadow of the booming services sector and growing sixfold by 2025 into a $1 trillion business adding 90 million new jobs.

With the rise in incomes at least among the growingly prosperous middle class, India should be able to support a prosperous manufacturing industry that would earn its keep through exports.

McKinsey underplays the failure of government support, notably wretched infrastructure — which foreigners have not supported as India hoped — the still considerable red tape, poverty of education, labor restrictions and barriers to competition through cozy alliances between industry and government.

I remember being told back in the 1970s by one of India's richest industrialists about his "important investment" in labor leaders and leading politicians — read "bribe." "Small investment makes sure I get peace in my factories, permission whenever I need, and keeps out rivals," he said with a smile.

Kevin Rafferty was executive editor of the Indian Express newspaper group.


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