x Abu Dhabi, UAETuesday 25 July 2017

India needs a crisis to make the right choice

India's leaders tend to blame the outside world for the country's economic troubles.

After powering ahead, India's economy has come to a halt, partly because of faulty government spending priorities.
After powering ahead, India's economy has come to a halt, partly because of faulty government spending priorities.

MUMBAI // To listen to India's government, you would think the country's financial mess was entirely the result of outside forces, that the authorities had been ambushed first by last year's soaring oil prices and then by the global credit seizure. But the government is more to blame than it would like us to believe. Faced with a four-year cash bonanza, it decided to spend, and it spent badly. Tax receipts increased at an average of more than 20 per cent annually from 2004, the year the Congress-led coalition of Manmohan Singh, the prime minister, took office. This could have been an opportunity for Mr Singh and P Chidambaram, the finance minister, to finally achieve what both had failed to do in past stints as finance minister: end the deficit India has carried since independence.

And that is exactly what Mr Chidambaram promised, pledging to wipe out the debt by the end of March this year. Instead, it has increased to a record high of 11.4 per cent of GDP in real terms, according to Standard and Poor's, the ratings agency which last month fixed a negative outlook to India's sovereign credit rating. R Ravimohan, the head of S&P's for South Asia, said "the reason that sustainability has come back into the focus this year is because the deficit has ballooned to pretty high levels, the prognosis is not looking too good". More pessimistic Indian commentators are talking of a return to the balance-of-payments crisis of the early 1990s.

So where did Mr Chidambaram go wrong? After two years of relative austerity, the government opened the coffers in 2006, pumping money into a host of rural and social schemes. But this isn't the problem. In fact, the US$12.5 billion (Dh45.91bn) write-off of farmers' debt, $8.3bn in government pay rises and $8bn or so the government has put into its rural infrastructure schemes are arguably the types of stimuli required in these times. Mr Ravimohan estimates about 40 per cent of this spending feeds straight back into the economy.

The real problem is that the Congress Party failed to tackle India's subsidy-addicted government-run industry. Percy Mistry, who led the nation's committee on making Mumbai an international financial centre, said: "It's not only what it is spent on, but how it's spent. India is making a colossal mistake by trying to hang on to producer-led subsidies for fuel and fertiliser." Fuel and fertiliser subsidies alone accounted for 25 per cent of India's $80bn deficit this fiscal year. Add in subsidised power, milk and grain and the bill is higher still.

The Congress Party cannot claim to be a powerless bystander. The previous BJP-led government had already, at least in theory, dismantled controls over petrol and diesel prices two years before Congress came to power. Mr Chidambaram could have let prices at the pump rise with the international market, and left the blame at the opposition's door. Instead, he reached for price caps as soon as crude prices began their ascent in 2004, paying for it with the huge issuance of oil bonds which now drag on the government balance sheets.

Supporters will argue that the common man would have suffered if the government had allowed high oil prices, which peaked at more than $140 a barrel, to filter down to consumers. But the government's chosen course of action constitutes a wildly untargeted way of helping the poor. "The fertiliser subsidy works better for a [rich] farmer... than it does for a poor farmer," Mr Mistry said. "If you added up all the producer-price subsidies and gave them out in cash, every poor family in India would get 4000 to 5000 rupees a month."

And, in theory, building more of the roads, ports, airports, power stations, and water-supply systems that India desperately needs would set the stage for long-term sustainable growth. But Indranil Sen, an economist at Merrill Lynch, said that would in practice be hugely inefficient. "Half the money is taken by the bureaucracy and never gets spent. If you travel through India you will find foundation stone after foundation stone of government projects which never took off."

At any rate, the government is unlikely to do away with subsidies. Now that oil prices have fallen, it could revert to a freely floating price for petrol and diesel quite painlessly. But it has not, and India is now vulnerable to the next oil price spike. Mr Mistry said he thought government would never make the right choice unless absolutely forced. "India will reach a point where it either has to carry out a massive forced sale of assets, or it will hit a massive crisis which it will take a decade to get out of."

If the government sold down its stakes in listed public companies to 51 per cent, it could raise more than $80bn without even risking a politically difficult privatisation, said Mr Ravimohan. But a more severe crisis that led to dismantling of the remains of state-run industry might work better. "If you look at history, the only time India has reformed is in a crisis," said Mr Mistry. business@thenational.ae