Saturday, February 28, 2015

Goodbye big bang reforms, hello economic growth

One of the most striking points of this year's Economic Survey relates to 'big bang reforms'. For years, commentators have been bemoaning the lack of political will to push through such reforms. IN the run-up to the budget, they have been warning the government that it will be judged on how well it does on this account. The Survey pours cold water on such hopes and explains why:

Given the expectations surrounding the upcoming budget, one question needs to be addressed head-on: Does India need Big Bang reforms?Much of the cross-country evidence of the post-war years suggests that Big Bang reforms occur during or in the aftermath of major crises. Moreover, Big Bang reforms in robust democracies with multiple actors and institutions with the power to do, undo, and block, are the exception rather than the rule.India today is not in crisis, and decision-making authority is vibrantly and frustratingly diffuse.

This is refreshingly candid stuff- and one hopes it will put an end to the 'big bang reform' cottage industry. It's not just that such reforms are not politically feasible. One could argue that the past pace of reform is perfectly consistent with rapid economic growth in India. Over ten years of the UPA regime, few major reforms occurred- and we saw among a period of the highest growth ever.  In the slow growth period of the last three years when the world was still feeling the impact of the financial crisis, India grew at 6.7%. The Indian economy is now set to grow at over 8% in 2015-16. We should not be surprised. Reform or no reform, we can expect an investment rate of 32% or more. This should translate into growth of around 8%.

The Survey should have spelt out the implications for fiscal policy of  the imminent return to the high growth path. Whenever the economy is growing at over 7% and 8%, the fiscal deficit problem tends to disappear- the fiscal deficit to gdp begins to decline and fall within an acceptable range. The debt to gdp ratio also declines. If we are looking at double digit growth in the medium term, we can tolerate a fiscal deficit to gdp ratio of over 3%. The finance minister need not have been apologetic at all about deferring the year for meeting this target by one year, as he has in the budget. He might have been bolder on the spending front and given a greater boost to public investment than he has.

More on the growth and India's fiscal problem in my article here.

Wednesday, February 25, 2015

Raghuram Rajan on free markets and political freedom

Rajan's most recent speech on democracy, inclusion and prosperity has drawn attention for quite the wrong reason: the reference to Hitler and the perils of strong government. Since Modi was being likened by the Congress to Hitler in the run-up to the last elections, the reference is liable to be misconstrued and, indeed, the highlighting of this particular point in sections of the media appears mischevous.

It's the larger point in the speech that deserves highlighting, namely, that liberal democracies rest not just on three pillars- rule of long, strong government and political accountability- as Francis Fukuyama has said but also on a fourth one, free markets.

Rajan sees competition in the market place as the counterpart of competition in politics. The two tend to support each other. However, he points out, there is a difference. In politics, every citizen has one vote. In the marketplace, the richer guy has more votes than the poorer guy. He then poses the question: why would voters not use the power of their votes to disenfranchise the rich? Because they see the owners of property or resources as spreading prosperity and benefiting the voters. Also, they don't mind richness as they long as they see a certain fairness about the acquisition of wealth. As long as these two conditions are met, voters will tolerate free markets and a measure of

Well, well, the conclusions appear rather sweeping. It's not as if voters can disenfranchise the rich if they wanted to. The people who get voted in do support with the money power of the rich behind them. They are beholden as much to the rich as to the voters. And their natural affinity is towards the rich rather than the voters.

As for the fairness of the process, we do know that upward mobility has fallen in the US. And, we have one book (The son also rises) that claims that mobility has changed very little in the west over hundreds of years. In India, upward mobility has been made possible more by the political process rather than the markets. By grabbing political power, the backward classes and the scheduled castes have been able to advance. They have also advanced through government jobs. Markets and enterprise haven't contributed as much.

There isn't much fairness or legitimacy to the system we have. Political accountability has largely meant substituting one set of crooks supported by businessmen with another set of crooks supported by businessmen. The victory of Aap in the Delhi polls shows that people are still looking for a fix to the crooked political and economic system we have. A Nandan Nilekani emerging on the landscape doesn't mean much of a change in the Indian system. Inequality is more of an issue, perhaps, in Indian than in the US where it has emerged as an important issue.

In the long term, genuine democracy or political freedom does not seem compatible with deep inequality. How to get the political system to address such inequality will remain the fundamental challenge in the years to come.

Monday, February 16, 2015

Government mustn't get fixated on the fiscal deficit.

Should the government stick to its fiscal road-map- 4.% for fiscal deficit/GDP in the current year and a lower deficit the next year? Ruchir Sharma argues in today's TOI that it should. He gives instances, such as China, where an increase in government spending has been followed by lower growth rate.

I disagree. China is over-invested in infrastructure. We are under-invested. Without infrastructure investment, it's hard to see investment in general reviving. And the private sector is in no position to get into infrastructure now. So, the government should go ahead and spend on infrastructure- and it doesn't matter if it's about half a percentage point away from its fiscal deficit targets. Here's my case.

India's debt to GDP ratio of around 65% today is among the lowest in the world today. So, considerations of sustainability of debt need not deter us. The only case can be that higher spending will spur inflation which will undermine our currency. The inflation rate has declined sharply, our external account has improved considerably and quantitative easing in Europe and Japan can be expected to offset somewhat the effect of any rise in the interest rate in the US. So, concerns about the impact of the rupee are not a factor either.

Whichever you look at it, this is the right time for Jaitley to go out and spend boldly.

Wednesday, February 11, 2015

The many mistakes of Narendra Modi

Vox Populi is Vox Dei. The voice of the people is the voice of God. Whatever  your political leanings, it's hard not feel a sense of exhilaration over the outcome of the Delhi elections.The people have spoken- and how!

It's not just a vote for Kejriwal & Co. It's a vote against the NDA government. It's an expression of anger against the Modi and the BJP. That alone can explain the margin of victory of Aap.

How has this come about? Why are the voters of Delhi so angry? Let me list what I think are some of the mistakes Modi has made. Some of these points may have been made by others but I'd like to add my own little voice:

i. Choosing Kiran Bedi over the heads of long-serving leaders of the Delhi BJP: Harsh Vardhan, now a minister in Modi's cabinet, was a five-time MLA. He's known for his probity. He was discarded in favour of an outsider. Moreover, an outsider who had been baiting politicians, including Modi, until very recently. This angered not just BJP workers but the electorate. What was on display was the politics of opportunism.

ii. The Land Acquisition ordinance: This allows the government to grab people's land without their consent. The slum-dwellers of Delhi must  have reckoned that, if the government could grab land that poor people owned, they wouldn't think very hard about uprooting poor people who were sitting on land they didn't own (whatever the poll promises of the BJP).

iii. Proximity to industrial houses: We've had so many functions where the leaders of industrial houses, some of whom are close to the BJP, have showed up. It's not a good for politicians in India to advertise their proximity to industrial houses. The BJP came to perceived as the wrong AAP- Ambani and Adani Party.

iv. Making a huge spectacle of the Obama visit:Ok, you wanted to get the US president over. But was it necessary to make such a spectacle out of it? There's a difference between being comfortable with world leaders and grandstanding.

v. Flaunting the Rs 10 lakh suit: Especially on the social media, the impact of the monogrammed suit was hugely negative. People had voted in Modi because they identified with and admired his chaiwallah background. What they saw in the suit was somebody very different, a member of the Delhi elite.

Modi rode to power on the strength of the perception that he was an outsider who would bring to the capital a very different style of leadership, one that resonated with the aspirations of the aam admi. In his nine months in power, Modi began to look like any other member of the Delhi Durbar. This was disappointing. That disappointment has made its felt.

It's a setback but not the end of the road. Modi is a seasoned leader, somebody with the capacity to learn from mistakes. He must go back to being his original self, a leader with a natural empathy for the section of society from where he comes. And he has to make adaptations to the economic model he followed in Gujarat. He must not forget that, at least in the immediate future, the only economics that will work is one that is resolutely people-oriented- and seen to be so.

Friday, January 30, 2015

Management: awaiting the new paradigm

We have heard a great deal about the shift from the top-down model to a more decentralised one, the dismantling of hierarchy and the importance of self-driven teams. But very little of this is happening on the ground, as a report in the FT highlights. The astonishing thing is that the old, centralised model persists in the corporate world despite evidence that it's not producing results:

Returns are diminishing, while the number of listed companies has shrunk by more than half in 15 years. In that sense the fears seem justified: despite bulging coffers, quoted companies are investing too little and distributing too much in dividends and share buybacks to survive in the long term, let alone create the new products, markets and jobs economies require for sustainable growth.

What could be the reason? One is, of course, inertia and the power of the unknown. The other is that companies apparently don't know how to put in place the measures needed to make the team-driven model happen. The second is rubbish.There are plenty of models available on the new paradigm. It simply doesn't suit top management to make the shift. People at the top are concerned only about how to make their pile in the five or six years they are at the helm.They lack the motivation to worry about the long-term future of their companies.

What make bring about change? Not investor pressure because most investors too are focused only on the short-term. Real change can come about only from the NextGen crowd. Younger people don't want to be ordered around, they want challenge and fulfilment in their jobs and they need a sense of purpose. They will gravitate towards companies that provide these. Some of it is already happening. When more of the older model companies find they are losing their ability to perform, we can expect to see the present model of management being dismantled.

Thursday, January 15, 2015

India set to overtake China?

Optimism about the Indian economy is alive despite 2014-15 being largely washed out. We have commentators again talking of India overtaking China in the second half of the decade. They were saying so at the beginning of the decade as well. At that time, however, China was growing at over 8 per cent. What commentators meant then was that India would inch towards 9 or 10 per cent and thus overtake China.

Today, the overtaking, if it happens, will be at a different level. And it will happen later than commentators had predicted. Chinese growth is poised to fall below 7 per cent. The World Bank sees the Indian economy growing at 7 per cent - in 2017, a good two years later than forecast at the beginning of the decade.

Still, becoming the fastest growing economy in the world is no mean prize. Is the prize within reach? Most commentators would say - yes, if the government could push through "big ticket reforms". An article in today's FT makes this point:
Reforms aimed at boosting manufacturing or encouraging capital investment may prove tougher to implement at national level than they did when he was running Gujarat. Besides, some reforms, such as relaxing the rules on foreign ownership of insurance companies, may not prove to be the magic bullets that industry lobbyists claim. Second, and perhaps more fundamental, democratic India is still caught in an ideological battle over where to strike the balance between pursuit of growth and protection of the environment and land rights.  

This is the sort of thing we have been hearing for two decades now. Reforms didn't happen in UPA-I and growth soared to 9 per cent for at least a three year period, thanks to the global boom. I don't believe India's growth is contingent on the familiar set of "reforms". I think the Indian economy can hit 7 per cent if two things happen. First, banks need to be recapitalised. This, as readers of this blog would know by now, doesn't mean "big ticket" reforms in banking. It means a few simple things like reducing the government's stake to say, 52%, getting the right people into top management, strengthening boards and improving risk management.

Secondly, the world economy needs to get better. Will it be by 2017? All bets are off at the moment. But if the improvement did happen in the world economy, we have a good chance of being the fastest growing economy in the world in 2017.

Friday, January 09, 2015

Kotak- Ing Bank Vysya merger

Shareholders have reportedly approved the Ing Bank Vysya merger. Ing Vysya Bank unions are still seeking assurance that no jobs will be lost.

There are important lessons to be drawn from the merger. One, new private banks, not foreign banks, are the big winners in the post-reform period. Public sector bank share will continue to decline but the loss will be to new private banks, not so much to foreign banks. Two, branches are crucial to cost competitiveness and growth in Indian banking- no new private bank would like less than a 1000 branches. Thirdly, for public sector banks, the branch network needs to be larger as they must rely mainly in interest income to grow profit- their ability to generate fee income is not as good as that of private banks.

It follows that PSBs with less than, say, 2000 branches are vulnerable. We are better off selling of such PSBs instead of merging them with other PSBs- mergers in today's context will weaken stronger banks. More in my EPW article, Merger they wrote.