Stanford was charming, but my thoughts turned often to my home country, and to the reforms that I could not carry through. Vajpayee's government had proved more open to reforms, and I had hopes of it. So, early in 2000, I wrote this series in Business Standard.
Whither reforms?
The state of the Indian
economy appears to be embarrassingly sound. It is now two years after the
nuclear ceremony, which brought universal condemnation and sanctions upon
India; just the month before last President Clinton christened our subcontinent
the most dangerous spot in the world, thereby telling American business not to
invest in India. Despite this confrontation with the capitalist world, India’s
balance of payments remains surprisingly strong; through hail and high water,
the reserves keep rising.
And that is not because of
foreign investment. Foreign direct investment is distinctly down after the
coming of the BJP governments. Portfolio investment is not, but it is a fickle
bird of fancy. It has been down and up. It is here today and may be gone
tomorrow. In any case, capital inflows are not responsible for the rising
reserves. One cannot avoid the conclusion that the external fundamentals are
strong.
And more surprisingly, inflation
is down. The level of inflation showed a distinct fall from 1996 onwards; in
the past year it has come down to levels that have not been seen since the days
before socialism and the grand follies. Something has changed; we are no longer
in the boom-and-bust mode of the 1960s, 1970s or 1980s.
What has changed? Five
things in particular. First, industry is no longer in a position to pass on
cost increases. Domestic competition has increased, and now there is some
competition from abroad as well. This accounts for much of the fall in
inflation. For this, the credit must go to the Fund and the Bank, which forced
us to abolish industrial licensing in 1991, and to Narasimha Rao who had the
sense to yield to force. If the Fund and the Bank had any strategic sense, they
would be advertising their success in India instead of drawing comfort from
Côte d’Ivoire and El Salvador.
Second, the illegal balance
of payments has collapsed. The havala premium has disappeared, and billions of
dollars that used to be siphoned off into illegal foreign exchange
transactions have come into the legal channels. For this, credit again goes to the Fund and the Bank – they
forced us to devalue in 1991, begin to dismantle import licensing in 1992, and
start reducing tariffs in 1993 - and to Manmohan Singh at the Finance Ministry
and P Chidambaram at the Commerce Ministry who carried out these changes. But I
would now give greater credit to Chidambaram. For when Manmohan Singh
liberalized gold imports through NRIs without releasing foreign exchange for
them, he in effect legalized smuggling; most of the gold came to be brought in
by couriers of big Dubai smugglers. When Chidambaram allowed a few banks to
import and sell gold in 1996, he dug the grave of gold smuggling. We see the
effects of this single measure today in the death-throes of havala. The rise in
the reserves is due to the fall in the demand for gold and smuggled goods, and
in foreign exchange balances illegally held abroad.
The third change is
something Manmohan Singh did in a moment of righteousness. He felt it was
unfair that the government should take away people’s savings without a
by-your-leave through the loans it compulsorily sold to the banks. So he
resolved in 1992, without anyone asking him, that the central government and
its institutions would no longer resort to the Statutory Liquidity Ratio. On
the face of it, it changed nothing; even now the Reserve Bank sells thousands
of crores of central securities to the banks. But the absorption is no longer
automatic; the Reserve Bank has to cajole, threaten, twist arms, and even then
it sometimes cannot sell the loans. It has had to raise interest rates; the
cost to the government has gone up. IDBI and ICICI have had to raise money from
retail investors at high interest rates. The change is working its way through
the system. When Yashwant Sinha inveighs against the fiscal deficit, he is not
being a reformer; he is just reflecting the consequences of Manmohan Singh’s
decision.
The fourth change is in
taxation. Manmohan Singh brought down the income tax rates. If I write that
revenue has increased as a result, Mr S S Bagai will immediately write back
showing that it has not as a proportion of non-agricultural income. But I would
still claim that that in a country where tax evasion is so rife, all taxation
is unfair to honest taxpayers; the reduction in taxes has evened the scales
slightly in their favour. It is not just the tax reduction; there are two
further fiscal changes. One is that the rate of corporate tax and the peak
personal rate of tax are about the same, so the gains from declaring personal
expenses as corporate expenses have declined, and so have the advantages of
controlling companies for that purpose. And Yashwant Sinha abolished the tax on
dividends in the hands of shareholders, and thereby reduced the double taxation
of dividends (as against the single taxation of undistributed profits). This
too reduced the advantage of controlling companies. With these two changes, a
promoter no longer has to control a company to be able to live off its profits;
he can hand it over to competent managers and live comfortably as a
shareholder. A handful of promoters have done so already; many more have hired
more competent CEOs than themselves.
The last change is not very
clear to me: something has happened in the foodgrain market. In the 1970s, the
green revolution created a flood of wheat; to save Punjabi farmers from
distress, the central government turned the rationing scheme into a scheme to
subsidize foodgrains and increase their consumption. But there are always many
claimants for a subsidy: farmers, who would like higher prices, consumers, who
would like lower prices, and the officials of Food Corporation, who would like
fat margins to blow up on themselves. The farmers have politically been the
most powerful, and have won an annual support price increase of 10-15 per cent
year after year. That is what raised the rate of inflation from an average 7
per cent in the 1950s and 1960s to 11 per cent in the 1980s, even though the
growth rate of foodgrain output rose. In the 1990s, somehow, the political
advantage of pushing up support prices petered out. The first sign came in the
eight state elections of 1994-95, of which the Congress lost six. Manmohan
Singh connected this to Balram Jakhar’s pushing up of support prices by 60 per
cent in three years. He applied all brakes and brought down inflation to an
incredible 4 per cent by the general election of 1996; but the Congress still
lost. The present government is, if anything, even more beholden to Punjabi
farmers; but it has been more circumspect in raising support prices. The urban
supporters of the BJP have at last found a voice. So inflation has come down,
and I think the fall may last.
These five changes have
buttressed the economy and opened up great opportunities. In the next article I
shall suggest how the momentum imparted by these reforms can be maintained.
II The five best reforms
Some months ago I wrote a
series on the pending reforms. That series was more for reform aficionados; it
was meant to outline what in my views would be real reforms and not
pseudo-reforms. They were not what is going to happen; our political system is
creaky and cranky that it would take centuries to put through such a programme
of reforms even if we had statesmanlike leaders and reasonable followers. Given
the limited capacity of the system for change, it is worth making a short list
of the things that are most worth doing. In my view, they are five.
1. Abolition of customs duties: This sounds radical, but is not. We have reduced
the maximum rate of duty from 350 per cent in 1991 to 38.5 per cent today and
the average rate from 48 per cent to 29 per cent; now it is only a matter of
reducing it to zero. It would pose no threat to industry; all we have to do is
to make the appropriate devaluation to keep industries afloat. It cannot exceed
38.5 per cent; it will probably be more like 15 per cent. Nor would it mean the
end of all import taxation; imports should still bear the single-rated value added tax (see
2 below). Amongst the advantages, it would become impossible for politicians to
favour one industry against another and for firms to use customs duties in
their competitive wars; and zero duty would make duty drawbacks for export
industries unnecessary, and thereby abolish the huge empire of corruption and
export discouragement that the customs department and the DGFT have built up.
Caution: if customs duties are abolished, the exchange rate would be the only
instrument for holding the balance between domestic industry and imports, and
would have to be managed for that purpose. That means some controls on capital flows;
full convertibility is out.
2. Integration of business and commodity taxation: There should be a single
rate of value added tax, which would replace the present excise duties, state
sales taxes, and corporate income tax. It would be a tax on value added generated
in all businesses. It would be calculated just like the corporate income tax,
except that the base would be value added, and not profits. The base would be
much larger, and hence the rate would be much lower. A single tax collection
agency can replace the Central Board of Excise and Customs, the corporate tax
arm of the Central Board of Direct Taxes, and the revenue departments of state
governments; the fewer the collectors, the less the harassment and corruption.
The base rate of VAT would act as a base rate of personal income tax on all
employees and businessmen. There can be one or two higher brackets of personal
income tax. Caution: Although the tax
would be based on annual accounts and become due once a year on their
finalization, its collection may be spread out over the year just as with the
present corporate income tax.
3. Government borrowing only for fixed investment: Curbs on government
borrowing are in the air. What is wrong is not that the governments are
borrowing, but they are borrowing without lenders’ consent and spending the
money on unproductive expenditure. The statutory liquidity ratio should be
abolished; banks should no longer be forced to lend to the governments. A law
should be made that governments may raise debt only in the market, and can
finance only productive fixed investment with it. They would thus be forced to
consider their servicing capacity before borrowing, and to use borrowings for
investments that would lead to a rise in revenue.
4. Separation of cash holding and investment: At present banks provide
two services in a package: they hold cash for depositors, and invest it in
loans, government bonds etc. The two businesses should be separated. All banks
should be made to offer a pure cash holding service to depositors, on which
they would pay no interest and may levy charges. The cash holdings would be
simply entries in a central computer owned by the Reserve Bank; they would be
completely secure, and transferable at will. In addition, banks may offer their
depositors the option of investing the money in packages, which may consist of
loans to borrowers of a particular credit rating, bills of exchange, bonds,
shares or mutual funds. They should have to disclose to the investors the full
risks of investment in a particular channel. The investors should bear all the
risks of non-payment of interest or principal, or of bankruptcy. That would end
pre-emption of savings by banks, as well as accumulation of bad debts by them. Caution: Government banks would have to
be privatized; otherwise they would continue to lend by preference to the
government and be subject to politicians’ whims. Although cash holding would
become a very simple business and anyone should be allowed freely into it, only
banks that can offer their depositors a certain minimum range of choice should
be allowed into the business of investing depositors’ savings. That means
continued licensing of such banks. Reserve Bank should organize and run local
markets for bonds and bills, and thereby securitize as much of bank debt as
possible. Packaging of loans of similar credit rating would permit banks to pay
rates of interest reflecting the risk; depositors would thus be able to choose
different risk-return combinations. Interest spreads and investor choices would
determine the volume of credit available to businesses of different sizes and
risk levels; the present tendency of banks to fund large, low-risk borrowers
would disappear.
5. Dereservation of small industry: Small industry reservation should be abolished. It
was never needed. The evidence is that small firms pay lower wages and can
compete perfectly well with big ones, and have vanquished large firms in many
industries. Most of the 800-odd reserved products are not important to small
firms; and few small firms depend much on reserved products. The other
concessions – directed credit, tax concessions, industrial estates, government
purchases – favour a small number of small firms. What these privileges have
achieved is to punish those small firms that grow beyond the small industry
thresholds; they have thus thwarted the growth of precisely those firms that
could make India internationally competitive. Instead of small firms, new
start-ups should be favoured by means of a five-year tax holiday from the
single-rated value added tax proposed above. Caution: Such a tax holiday could lead to tax evasion: firms might
be wound up after five years and restarted under another name. Profits on
liquidation should therefore be taxed.
I think that these five reforms would do more than
anything to make India more competitive, to limit licence-permit raj, and to
unleash the forces of growth. But they are not the kind of things that appeal
to politicians, least of all to BJP politicians. So in the next article I shall
take up the types of initiatives that appeal to them, and describe how they can
be made more rational and effective.
III Reforms BJP-style
Although the five reforms I suggested in the last article
would do most to dynamize the economy, they are not the kind that would appeal
to politicians. Politicians are players in a political game, and they want
winning strategies that would win them the loyalty of the electorate and the
contributions of rich friends for decades to come. They long for the kind of
dream run the Congress had for forty years. Some of them also have ideals.
They are looking for winning
formulae, and have pursued a number of agendas with that aim. Let me take up
those agendas and show how best they are pursued.
1. Employment: We slick townsmen cannot imagine how the problem of employment haunts
politicians. Members of Parliament and MLAs are pursued by job-seekers. Once
they get into power, their survival depends on their giving jobs to their
supporters. Hence the popularity of Lallu Yadav, a shameless rewarder of
supporters; hence the hold of reservations on our political system; hence the
longing of every politician from Bihar and Bengal for the railway ministry, one
of the last ministries which can still be loaded with useless supporters. On
employment, a liberal’s view is that employment should be productive, and that
it should be created in the private sector by macro-measures which do not
favour one constituent against another. Hence in the liberal view, faster
growth of production is the key to faster employment growth. A liberal favours
openness because he believes that international trade will enable each country
to employ more of its abundant resources – for instance, labour in India.
Although being a democrat he will not say so loudly, a liberal distrusts trade
unions, which he thinks raise wages and reduce the demand for labour. This is
all correct; but it is not going to satisfy politicians who depend on local
electorates thirsty for jobs. My own thinking is that industry could absorb
much labour 150 years ago; since then so much labour-saving technology has been
developed that industry cannot be efficient and give many jobs. Agriculture, on
the other hand, is hugely inefficient and will shed jobs if given a chance.
Jobs can be created only in services. They are being created there and will
continue to be. But services require interaction with buyers, and have to be
produced wherever they are sold. Hence mobility of labour is all-important to
service jobs. It will be helped if transport services are good and cheap, there
is housing everywhere for the poor, and they are educated to be versatile
and to communicate well. Transport, housing and education are also top
priorities of the BJP; to these I go on.
2. Transport: The Prime Minister’s cross of roads has attracted much criticism,
including from me. But the spirit behind it is laudable: the idea is to employ
people and cheapen transport. Except that a north-south road and an east-west
road are poor ways of doing it. Good roads these days are highly material- and
capital-intensive: they are made of reinforced steel and concrete, and making
them with big machinery saves time and hence money. Nor are new roads the
cheapest way of increasing road capacity; it is cheaper to widen the roads that
are there, to remove bottlenecks, and to improve road surface. Of the three
ways, the last is the most labour-intensive. To create employment, the
governments should give out long-term contracts to improve the surface of and
to maintain particular stretches of roads; the payment for the contracts should
depend on the minimization of potholes and other defects. Transport costs are
raised and delays caused by states’ and local authorities’ checkposts. Their
removal will increase road capacity and actually lower total costs.
3. Housing: The BJP as well as the NDA manifestos placed great stress on housing.
Ram Jethmalani got the Urban Land Ceiling Act repealed – with little effect,
since most states continue to impose the same restrictions. Yashwant Sinha has
allocated money each year for housing schemes. But these are not the means to
improve housing cheaply and quickly. What India needs is housing for the poor.
The cheapest housing the poor can get is what they themselves build.
Unfortunately, it is low-rise and hence wasteful of land; and since they cannot
buy land, they squat, mainly on public land. The solution that is popular with
politicians is to remove the poor from their squats, give them land on city
outskirts and help them build little houses. Sanjay did it, so did Thackeray,
with little effect. Apart from disrupting lives, it only shifts the current
poor; they are soon replaced by new squatters. The solution is to release land
– public land, or land purchased from private owners – for standardized
high-rise housing made up of small flats in which none but the poor would want
to live; if the costs are so high to take the flats beyond the poor’s reach,
their building should be subsidized. Lower interest rates would help; but not
the poor, for they would also raise land prices.
4. Education: Murli Manohar Joshi has been very active. But his agenda is only
ideological and political: he would like to introduce Bharatiya Samskriti into
education and find jobs for BJP supporters. This is a very narrow agenda. What
matters is taking education to the poor, and giving them education that would
enable them to diversify their skills and improve their communication ability.
For this, what they really need to learn is languages – not just their mother
tongue, but languages of states where employment is available, and English –
and arithmetic. The way to make such education widely accessible is to impart
it on television; today, DTH television, which can send 200 channels at a time,
offers an ideal medium for education. Government schools are no answer; they are
just havens for teachers who teach little. The answer is to give children
vouchers to attend any school they want.
5. Technology: Starting from the Prime Minister, BJP politicians are enthused by the
software success and would like to replicate it on a large scale. The
instruments are there in the universities and government laboratories. They all
need to be privatized and liberated from government rules on appointments,
promotions, pay etc; they must also finance themselves, which they will do by
selling research. Subsidies should go, not to institutions and their staff, but
to students and to equipment. Recruitment in the institutions should be opened
up, not only to all Indians, but to the best from anywhere in the world. Just
as America drains away our best brains, let us drain Pakistan, Bangladesh,
Egypt, Kenya and other neighbours of their brains.
Thus, the aims chosen by the
BJP are worth pursuing; but the instruments they choose are unlikely to
succeed. If they want to achieve anything in the directions of their choice,
they will have to look for economic solutions – and those solutions will not be
such as to suit their predilections.
