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March 15, 2012

Reforms Needed For India to Reach Potential of Double Digit GDP Growth

Baker Institute - Limits of the Jugaad Growth Model: No Workaround to Good Governance for India (12 pages)

Indian industry has gained fame in management circles for jugaad, or persevering despite limited resources. This skill has proven particularly important in overcoming inadequate public services. However, the economy appears to have reached the limit of using jugaad in the place of good government, suggesting a lower growth trajectory in the absence of a major improvement in political dynamics.
India’s economy performed exceedingly well in the past decade, averaging an impressive 7.8% growth across 10 years, even sustaining 5% growth during the peak of the financial crisis. A common refrain holds that growth occurred “despite the government,” requiring India’s celebrated expertise in jugaad, or creative workarounds to poor resources. The exceptional growth of India’s service industry exemplifies this success.

Infrastructure experts like Vinayak Chatterjee, president of Feedback Ventures, caution that the pipeline for infrastructure projects has thinned out significantly and does not reflect the average annual value of projects needed to meet India’s ambitious target of investing $1 trillion over the coming five years. Poor infrastructure, more than low investment in other areas, presents a serious obstacle to India once again exceeding 8% growth.

The report cites lagging government services like education (India's adult literacy rate is 64 percent), energy systems and transportation as major issues facing the Indian people and private sector. "The road systems in India have been expanding but at too slow of a pace, and the rail system used today is basically the same now as in British times




Power Shortages - Uncertain Coal Supplies

India already faces peak power shortages of nearly 10%, despite an impressive amount of new generation capacity coming online this year and next. Yet lack of coal supply risks slowing the addition of new power.

In 2009, Coal India—the domestic coal monopoly—decided to guarantee only 50% of supply needs for new private power producers (from 80% previously). Since imported coal costs nearly four times more than domestic coal, developers or their financiers have been balking at new coal-based projects for the past two years. Those that were funded have been slow-rolled awaiting more certainty of supply.


In the current fiscal year ending in March 2012, India’s economic energy has faded to levels seen during the worst of the financial crisis—though without a crisis to blame. So what is the reason? Observers in Delhi and Mumbai nearly uniformly point to weak government, which has sapped investor enthusiasm for new projects. Through the lens of headline policies in Delhi, weak government means lack of action on economic reforms or the fiscal deficit. Long-pending items include addressing low infrastructure, adverse labor markets, limits on foreign participation, tax reform, and many others.

Near-term reforms

• Fiscal: A politically and economically credible plan to introduce greater fiscal discipline could arrive with Finance Minister Mukherjee’s budget announcement in March 2012. Lowering subsidies and holding the line on new spending must take priority, as tax measures may not show revenue gains for several years.

• Taxes: The goods and services tax reform would greatly simplify taxes across states, unleashing a small wave of cross-state border and national network growth in the medium term. While it may have little immediate impact on the budget, even announcing political consensus to move forward could alter investment sentiment.

• Governance: Anti-corruption initiatives may have hijacked the conventional reform agenda in the government, but attention to this critical problem can pay off in the long run. Meaningful measures will be painful to implement, and will slow government functioning for a period. But if transparency becomes a more common practice, government will produce higher quality services more efficiently, yielding wide-ranging benefits.

• Agriculture: States need to cut out the middlemen mandated through the current agricultural marketing laws. They then need to remove barriers to interstate trade. Rajiv Kumar, head of a major business group, rightly says India needs a trade agreement with itself. These measures would make a bigger difference than multi-brand retail FDI in improving the plight of small farmers and reducing the pressure onfood prices that fuel inflation spikes. The central government should also reformulate the price floors it provides for certain staple products to allow greater market influence in agricultural output.
• Debt Collection: Much-needed bankruptcy procedures are outlined in the Companies Bill, introduced in the Parliament in December 2011. The bill is not perfect, but improves borrowers’ confidence in collecting debts, an essential component of developing a more robust corporate bond market. Accordingly, amendments to strengthen the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act to facilitate bank and other creditor collections would help improve the lending appetite of banks and other direct lenders.

Deeper reforms

• Judiciary: The need for additional court capacity to try more cases cannot be more obvious. Other aspects of the judiciary need adjustment, such as more specialized courts for technical matters like taxes or bankruptcy, but simply raising output would reassure investors—among many others—that enforcement of laws and contracts will occur within a reasonable time frame. This could revolutionize the perception of India’s business climate.

• Bureaucracy: Bureaucrats may move from a state-level urban planning job to a position leading national banking policy, and then to state-level livestock programs. Such a generalist approach may have worked in the 1920s when the British designed India’s civil service, but it demands modernization today. India benefits from amazing talent in top positions, but they are too few, paid too little, and allowed too little specialization.

An indicator of reform success would be regularly attracting mid-career private sector talent into the bureaucracy.

• Labor: A number of antiquated laws and regulations make hiring and firing workers in the formal sector difficult, especially in larger firms. This has the unfortunate impact of shifting employment to the informal sector, limiting firm size, and pushing large firms toward more capital-intensive production. This and inadequate human capital from a poor education are the two main reasons India cannot capitalize on its low-wage structure to expand its manufacturing base.

• Education: As in many countries, teachers are both the solution and the barrier to improving education. Teachers unions often resist reforms, and teachers’ critical role in India’s election machinery makes their opposition formidable. Yet without better instruction, getting more children into schools will not improve outcomes.

• Land: Land acquisition problems plague business, perhaps most critically by limiting the development of infrastructure. The Land Acquisition Bill that sets terms for compensating landholders is important, but the harder state-by-state job of cleaning up land records remains

Almost any other country would envy India’s current growth rate of about 7%, but India should aim higher. Achieving its potential for double-digit growth does not imply blind devotion to the altar of economic growth. Economic growth underpins India’s ability to alleviate poverty, and consistently hitting 9% versus 7% growth advances that achievement by many years. In a country with more poverty than the continent of Africa, meeting India’s economic potential means a great deal to a great many people.

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