Why the Indian Economy is in a Mess?

Dr M N Buch, 

Dean, Centre for Governance and Political Studies, VIF

Up to the election of 2004, it was ‘India Shining’ all the way. Glasnost and Perestroika had removed the Soviet Union as a serious player on the world stage and the new Russia had not yet taken root. Rajiv Gandhi had come to power riding a wave of sympathy when Indira Gandhi was assassinated and India embarked on what was to become an era of economic liberalisation. Nevertheless, it was actually Narasimha Rao, as Prime Minister, who really brought about the partial liberalisation of the Indian economy. Manmohan Singh was the Finance Minister and is said to be the author of the new economic regime, but the fact is that he was the hack who carried out Narasimha Rao’s directives and implemented his policies. My own view is that Manmohan Singh is neither creative nor inventive in his economic thought and has, in turn, adopted that theory which was contemporaneously fashionable. He has been a Nehruvian socialist, a South-South protagonist in the North-South dialogue, a centrist-liberal, a market oriented capitalist, a neo-liberal, a disinvestment back-tracker under Left Front pressure and a populist do gooder because Sonia Gandhi’s National Advisory Council dictates it. Is it any wonder that we have no economic policy at all, only populist adventurism and economic ad hocism?

Today we are in a mess. The rupee has been fluctuating violently at historically low levels almost day by day, inflation is out of control, industrial growth has fallen and industrialists are in despair, the markets are in a free dive and investment is declining, global confidence is shaken and our foreign exchange reserves are under pressure as foreign funds are flowing out of India and all that government and ruling party spokespersons can say is, “The fundamentals of our economy are sound.” Well, surprise of surprises, the fundamentals of our economy are not sound, in fact, they are ailing seriously, if not terminally. Our failure to recognise this makes an ostrich with its head buried in the sand almost an avid seeker of knowledge when we compare this with our refusal to see the reality. There is something very flawed about our economy. It is this blindness which is preventing us from taking those painful measures, those hard decisions, which can set us back on the road to recovery.

At a later stage in this paper, I shall attempt, perhaps somewhat ignorantly, to look at the theoretical underpinnings or lack thereof of the economy and our policies. At this stage, let us look at the so called fundamentals of our economy. The primary sector, mainly agriculture, but also mining for essential raw materials, has been our mainstay and it is this sector, which is most labour intensive, which has provided the bulk of employment. Being rural based, this sector has contributed to the basic equilibrium in our settlement pattern, from village to metropolitan city. This is our strength, because neither do we have one or more primate city which dominates the whole country, nor is the rural to urban migration alarming. Some improvement has been initiated over the years in the agricultural sector and as against the earlier Green Revolution states such as unified Punjab, which included Haryana, now one finds significant agricultural growth in states such as Gujarat and Madhya Pradesh, but overall the picture is very patchy indeed. The first three Five Year Plans did put emphasis on agriculture and irrigation, but the effort has not been sustained and we are unable to break free of our almost total dependence on the monsoon. There is, therefore, a major flaw even in the fundamentals of agriculture, the largest sector in terms of employment, though not in the share of GDP.

Our approach to agriculture has not been either holistic or consistent. Agriculture has major components --- the farmer, the land and its tenure, soil productivity, the cropping pattern, water availability, amplitude of quality power supply, agriculture research aimed at applying technology, technique, seed, fertilisers and sound agricultural practices in order to maximise productivity, the support services of roads, developed markets, financial support through easy credit, value addition through processing and government backing to ensure that the farmer to consumer relationship is healthy and mutually beneficial. We also need to promote land related activities such as animal husbandry, fishing, poultry keeping, horticulture, fodder development and silviculture which meets the village requirements of fodder, fuel and secondary timber. But before we do any of these, we need a national land use policy which identifies and allocates land according to the use to which it is best suited, of which agriculture would be the most predominant. From this would flow land management at meso, mili and micro level, an art at which the Japanese seem to excel. Unfortunately, India has no national land use policy at all. So much for our fundamentals!

It is not as if we are unaware of the above issues. We are and from time to time we have even addressed some or all of them. But never wholly, holistically, harmoniously, or consistently and with persistence. Apparently we either tire very quickly or else are soon bored by consistency and want to move on to something new. Let me give two or three examples. We launched land reforms to give land to the tiller. Madhya Pradesh embraced this enthusiastically and enacted the Abolition of Proprietary Rights Act, 1950. We abolished Malguzari which was not quite zamindari and the Malguzar had only limited authority. He, however, was charged with the responsibility to manage the village commons, including the village forests. This function ceased in 1951 and from that year till 1961, when we brought the old “chhote jhad ke jungle” and “bade jhad ke jungle” within the ambit of protected forest under the Indian Forest Act, Madhya Pradesh lost four million hectares of village forests to indiscriminate felling, of which 2.8 million hectares were encroached upon. That is when village nistar rights were gravely affected, biotic pressure on reserve forests increased and villagers and forest officials entered into conflict. Yet another sound fundamental, Mr. Politician?

In the early fifties of the twentieth century. we launched S.K. Dey’s Community Development Programme. The whole country was divided into Community Development (CD) Blocks, each headed by a Tehsildar rank Block Development Officer, but forming with his team a separate cadre of development officers. We thus separated the Revenue, or regulatory and the development administration, from which eventually flowed Panchayat Raj. In a C.D. Block, all planning and implementation was participative and whereas the villagers prescribed their priorities, work was undertaken on the basis of fifty per cent contribution by the people in cash, materials or voluntary labour. Because the people had a stake in the work, they saw to it that it was done honestly and the roads, wells, minor irrigation works, schools and panchayat bhawans built sixty years ago are still intact. The Block was a complete unit, with a Primary Health Centre and extension officers in education, social welfare, agriculture, animal husbandry, cooperation, etc. In 1963, however, we abolished the C.D.B., gave up participative development and replaced it by hundred per cent government grants works. The fundamentals still OK?

A third example is of the watershed development and management programme. The whole country is divided into mili (about 5000 hectares covering about ten villages) and micro (about 500 hectares covering a village) watersheds. For each mili or micro watershed, a Project Implementation Agency was identified, whose job was to prepare a detailed management plan, do a participative rural appraisal with the villagers, form a watershed development committee and then oversee the work. With ridge to valley vegetation treatment of hill features, undertaking soil conservation works and suitably treating all waterways and creating water bodies, the programme has succeeded in converting sizeable tracts of drought prone areas into productive areas, reduced seasonal distress migration and substantially raised the water table and improved the availability of fuel and fodder. Employment is locally generated, first as wage labour on the works proper and then in the improved agriculture of the village. Because everyone benefits, there was very little corruption in the programme.

But can our “The fundamentals are sound” brigade leave well alone? Along comes the National Advisory Council (NAC), headed by Sonia Gandhi and with woolly headed do gooders, long on intention but very short indeed on practical commonsense, as members. They persuaded government to launch the National Rural Employment Guarantee Programme, supported by the MNREG Act, the purpose of which is to give a hundred days’ employment per capita per year. This is an employment programme, muster based, whose prime objective is not asset creation. NAC may think it was pioneering something, but all such programmes can trace their origin to the scarcity relief programme of British days. In his famine relief programme, Maharaja Sardul Singh of Bikaner at least built the Lal Bagh Palace. All we are building through NREGS is a massive web of corruption which has engulfed the entire Panchayat Raj system. The vast sums of money spent on a programme which, because it is muster based, has corruption built into its genes, have completely skewed our economy without creating any worthwhile assets which will give us long term returns. How can such a programme be part of our sound fundamentals?

An important component of the primary sector is mining for minerals which are the raw material for industry. This activity is extractive and impacts the environment, hence is the target of activists, some environmental, some social, some just plain cussed and, therefore, antiestablishment. Such activism has seriously affected mining for coal, iron ore, bauxite aggregate and sand, to mention just a few items. Thermal power plants are denied coal, thus inhibiting new plants. Steel plants are denied iron ore. Sand mines are closed. Apart from adversely affecting industry, this has led to huge job losses, estimated at over 50,000 in Bellary and over 20,000 in Hoshangabad. No one advocates exploitative mining which destroys whole ecological systems, or the corrupt practices that have burdened these industries in recent years. But one has to evolve a balance between exploitation, curbing corruption, and using the resultant ore for job creation and generating wealth and minimising the adverse environmental impact and rehabilitating the mined areas.

The German State of Rheinland Westphalia worked out about 70 years ago a policy whereby before mining began, the company had to submit a detailed plan of the mining operations, site for dumping overburden, restoring the site through backfill and layering with fresh soil, carrying out a vegetation plan and generally ensuring a return of the site to its old biodiversity. The policy has paid rich dividends, especially because it is vigorously enforced. That is the direction in which we must move, that is, extract, but responsibly and restore the land to its former state thereafter. We have a huge potential for employment and wealth generation in this segment of the primary sector and we must use this wisely.

The backbone of a modern industrial state is the secondary or manufacturing, sector. At the time of independence, this was still rudimentary, though the Second World War had given a fillip to manufacture because many of the industrial goods which were imported could not be brought in and the British war effort needed the contribution of Indian industry. However, the main push to industry was given after independence when India deliberately embarked on a voyage of developing capital goods industries and of infrastructural development. From the First Five Year Plan onwards, the State took the lead in capital investment in power, irrigation, metallurgy, defence industry and other sectors of the economy, which were generically clubbed together as the high ground of the economy. Various power projects, steel plants, aluminium, copper, etc., smelters all came up in the public sector. At that stage, only the State had the capacity to mobilise capital in sufficient quantity and at a scale necessary for investment in infrastructure and the capital goods industries. If this formed the core of Nehruvian socialism, which is now being condemned by modern economists and the neo-liberalists, it was nevertheless the only course open to India for rapid development at a time when India had few real industrialists and the average businessman would rather trade than manufacture. Japan went through a similar phase after the Meiji Restoration, but wisely that country kept open the doors of private enterprise and as the great Japanese business houses, the Ziabatsu, were able to undertake a larger role, the State stepped back from directly running the economy and allowed the private sector to take over. The State first led, then it worked in tandem and finally it allowed management to go into the hands of business houses whose primary objective was to maximise profit. The Japanese being a patriotic people, the State was able to retain a major role as facilitator and regulator and industry itself imposed self-discipline in which the interests of the nation were always kept paramount.

In sharp contrast, in India, as our planned economy increased the tentacles of the State, those in charge of governance began to taste economic power and not merely government power. Patronage soon skewed any sensible personnel policy in the public sector, nepotism led to unsuitable appointments to critical posts, the temptation of making money soon overcame the interests of the enterprise and the whole system began to fall apart because of inefficient management, overstaffing, delay in decision making and outright corruption. Huge amounts of money were frittered away in loss making activities and cumulatively this has certainly affected our economy adversely.

Rajiv Gandhi, followed by Narasimha Rao, did bring about a change of attitude in terms of opening up the economy to private enterprise. This did bring a large number of new start ups and sunrise industries and brought about rapid industrial growth in many sectors. Unfortunately, the government continued to vacillate because many of the sectors related to industry, mainly dealing with infrastructure, continued to be inefficiently run by government. Power has been one of biggest bottlenecks and this is one sector which government did not deregulate for a long time. Even today, private participation in power generation and distribution is hedged in by many constraints. These include a reluctance on the part of government to loosen its hold over what government considers a strategically important sector but which in fact is only a public utility. The constraints are in licensing of new power stations, environmental clearance on their location, making available land, reserving coal for the use of the power stations and evolving environmental norms which, while protecting the environment, do not completely negate the project itself. Much of the problem of the episode now popularly referred to as ‘Coalgate’ arose out of the fact that government has not holistically looked at the power sector. There is demand for power and it can be met by private investment, provided a reasonable return can be ensured. If on the one hand, government decides to allow private players to function whilst at the same time government insists on subsidising whole sections of users, which denies the generation company a fair return on its investment, how can we expect private participation?

Because all major minerals are a monopoly of the State and coal is a major mineral, unless government allocates coal to a power plant, how can it produce power? The Environment Ministry does not clear coal mining projects, in the allocation of coal blocks there are allegations of corruption and wrongdoing, the mining of coal never takes place and yet we expect the power plants to generate electricity. This scenario is so reminiscent of a lunatic asylum. If power is to be generated and a power plant is to be built, then it is the job of the ministries concerned to sit together, hammer out norms of environmental clearance and then ensure that the power plant gets all the necessary clearances automatically. The Coal Ministry and the Environment Ministry have to sit together and work out the areas from which coal will be mined and made available to the power plants. My own view is that even if coal is given free it would be worthwhile because that coal will be converted to electrical energy, the users of which would pay the State electricity duty and the use of that power for industrial production will create jobs and generate income. Instead of being apologetic, though one can understand that because in the allocation of coal mines government’s policy has been inconsistent, the Prime Minister should have stood up in Parliament and said that he has approved the allocation of coal, he stood by his decision and that anyone who did not like it could campaign for the defeat of the ruling party at the next election. Mere police agencies such as CBI or even the Supreme Court cannot sit in judgement over the executive decisions of the Prime Minister which he is constitutionally competent to take. It is the absolute lack of guts of government to stand by its decisions which is responsible for its woes.

Be that as it may, unlike China, India post liberalisation preferred the easy path of the tertiary sector for its own economy growth. In the tertiary sector, we emphasised IT and ICT as the core areas. The world was seeking the information highway and India provided it, which led to a massive upsurge in employment in the IT sector. Does information technology directly produce tangible goods? Obviously not because information technology is merely an enabler to access information, analyse data and suggest a course of action. By itself Information Technology produces nothing, though by using this technology manufacturing industry can extend its horizon and massively upgrade its own efficiency and profitability. China produces, we give ideas. India has the capacity for marrying both but our industrialists and businessmen prefer the easy path and our government enthusiastically falls in line. We are proud of our IT industry and we also claim to have the fastest growing mobile telephony sector in the world. But do we manufacture even one brand of mobile telephone? Do we produce any computers? We assemble some but that is only screw driver technology. All the hardware is designed and manufactured in the United States, Japan, Taiwan, Korea and China. Lenovo has become a big name both in IT and ICT and the market is flooded with Lenovo computers and Lenovo mobile telephones. Our over dependence on the tertiary sector for economic growth is also the source of our greatest weakness because this is a vulnerable sector which is very quickly affected by what happens elsewhere in the world and by itself generates neither manufacturing competence nor manufacturing capacity.

Yet government used growth in the sector to showcase its claim that India is amongst the fastest growing economies in the world, part of the global market and yet protected against global economic vicissitudes because of the fundamental strength of our economy. The hollowness of the claim has been suddenly exposed as inflation threatens to get out of hand, the rupee is devaluing from day-to-day and investor confidence in India is ebbing away. If our fundamentals are sound, why is this happening? Before we look at the unholy mess in which we find ourselves today, let us try and understand the theoretical underpinnings of our economy. Do we believe in the laissez faire of Adam Smith? Do we believe in capitalist free enterprise? Do we practise mercantilism which, in any case in the present day and age of open seas, does not lend itself to monopolising trade through a Navigation Act? Are we players in the monetarism advocated by Milton Friedman, who advocated that it is possible to control the economy by controlling money supply? Are we Keynesian in our belief that the State has a major role to kick start a flagging economy and to generate employment through public spending on works which create assets? Are we Marxian in outlook or Fabian socialist? Are we neo-liberals? What exactly are our economic moorings and to which brand of macroeconomics do we owe allegiance? Do we really believe that India is part of the global economy and is almost wholly controlled by global trends? Is that why a minor policy change by the Federal Reserve in the United States can make or break the Rupee? This last point is emphasised because the various apologists for government, ministers, economists and planners all claim helplessness because they say that it is global trends which are affecting the Indian economy and these forces are beyond our control. When Y.V. Reddy was Governor of the Reserve Bank and the entire banking system in the Western world and in South East Asia was collapsing, his conservative policies enabled our banks to be relatively immunised from the crisis. At that time, we claimed that we had the innate strength to resist the global trend. Today what has happened to that strength that a mere whiff of a rumour somewhere else causes the rupee to go into freefall?

Much has been written on what is causing our woes, but some points need to be made again, because failure of government to recognise that our policies are flawed has resulted in exacerbating the situation. Let us begin with inflation. There are many factors behind inflation, but excessive money supply is certainly not one of them. If money supply were excessive, would government be prepared to spend anything between Rupees 1.25 lakh crores and 3.0 lakh crores in subsidising grain for the poor under the Food Security Programme? And yet government adopts monetarism as one of the means of checking inflation. Money supply is attempted to be restricted by a high bank rate, which pushes up the cost of money by way of credit. In a country where there is a very strong parallel economy and where in any case the Reserve Bank is totally clueless about how much money is actually circulating, pushing up the bank rate does not push down consumption. What it does is to make the cost of legitimate capital needed for investment in business and industry unaffordable and thus render the product of such industry costly and uncompetitive in the global market. The way to counter this is not to make the rupee worthless. The way forward is to make money affordable so that the input costs reduce and the product can be produced at a competitive price. The high interest rate has some effects. The cost of capital is increased. Even at a high interest rate, industry could invest, provided there is an optimistic climate in which the possibility of reasonable returns cannot be ruled out. However, when this is accompanied by a fast devaluing rupee, the economic climate is vitiated and industry is holding back investment. This causes growth to stagnate, new start ups to be postponed or even abandoned, investment in upgradation and modernisation kept pending and, generally speaking growth suffers. This is the direct result of the monetarist policy followed by our government. This is also inhibiting industry from investing self owned capital in expansion, new start ups or modernisation. All this in a situation in which the banks are flush with funds but are not going for aggressive lending because the state of the market does not encourage this.

Another area in which we are on the wrong track is in our capacity to take sound decisions. The world can live with a harsh tax regime, provided it is practicable and consistent. In India, however, the tax regime is totally inconsistent, as has been proved in the Vodafone case. Our tax policies are not economics driven but are completely political in character. Somebody suggests to tax the rich and so everyone runs in that direction. Then someone else says that we must give concessions to encourage industry and that becomes the flavour of the day. Someone makes some complaint about wrongdoing because a certain order has been issued in a tax matter and everyone runs around like a chicken with its head cut off. Why can we not have a long term tax policy aimed at sending a message to investors about what they can expect in this country in terms of taxation and the policy of government regarding fair repatriation of profit?

I had said in the beginning of this paper that we take a holistic view of almost nothing. Many smaller activities are involved in any activity and one component can cause all components to fail. Industry has certain requirements, the first one of which is land on which industry can locate. Some States are able to handle the matter better than others, Gujarat being one of them. Industry is welcome to locate in Kutch where land is plentiful and does not have a gainful alternative. Water is a problem here, which the government has solved by bringing in Narmada water. A number of industries, therefore, have located in Kutch. The Gujarat Government had made it clear that it will not use coercion to acquire fertile land for industry, though it has no objection to private purchase. There is no ambiguity and, therefore, the industry has no inhibition in locating in Gujarat. We should certainly keep the interests of cultivators in mind, but we cannot adopt a policy whereby land is simply not made available for undertaking public works or for location of economic activity which provides large scale gainful employment. Therefore, land promises to be a big obstacle in any future development project.

There are many countries which have struck a balance between environmental considerations and development needs. There are very strong environmental regulations, but they stop short of bringing all economic activities to a halt. What these regulations do is to force industry to realise its key role in protecting the environment and to make it accept responsibility to discharge this role both in the setting up of the industry and in running it. There is regular environmental audit and violation of environmental laws invites and in fact gets severe punishment. However, industry is encouraged to establish new plants, but with responsibility. In India our approach is the reverse. There is a shortage of wood and, therefore, government has put a ban on use of wooden furniture in government offices. My approach would be to insist on the greater use of wood, with a specific mandate being given to the Forest Department to go in for aggressive afforestation and to create an environment in which the people and the private sector become partners in afforestation. Without sand, buildings cannot be constructed. Unless I find a sand substitute, I would not stop the use of sand but would regulate mining so that environmental damage is either avoided or minimised. In any case a ‘can do’ mindset would have to replace a ‘do not do’ mindset because ultimately Ludditism is not only an enemy of growth but is an ally of negative primitivism.

The obvious lack of policy direction is compounded by hair brained schemes to go on spending nonexistent money on so-called welfare programmes. Lord Keynes was a product of the Depression. He developed a theory that in times of depression or economic recession it is the duty of the State to kick-start the economy by judicious public spending on works which create permanent assets. If necessary the State would be justified, under controlled conditions, to print currency notes to fund such works, a process which goes by the name of deficit financing, which also covers revenue deficits in the budget. Franklin Delano Roosevelt, President of the United States, used the New Deal to fund public spending to overcome the effects of the Great Depression. The magnificent works in the Tennessee Valley, which harnessed the Tennessee River and its tributaries, generated hydel power and made available water for irrigation, is one of the finest monuments to well designed public spending to counter economic recession. In a way President Eisenhower’s post war programme of building 40,000 miles of interstate highways in the United States not only put money into the economy by way of public spending, but it created the infrastructure which today supports trade, commerce and industry in the whole of the United States. These are all Keynesian measures and are perfectly justified. This was the path we followed in our earlier plan period. There was a budget deficit on revenue account, but so what? It generated jobs, created assets and if there was a slight inflationary pressure, it was countered by greater productivity. That is still legitimate in India.

What is not legitimate is throwing money down the drain, which the National Rural Employment Guarantee Scheme as enshrined under the Mahatma Gandhi National Rural Employment Guarantee Act and the so-called Food Security Bill are doing and will do. The real addition to money supply in the parallel economy is from the corruption generally found in India and corruption in NREGS specifically. To this will be added the colossal amount to be spent on subsidising food grain, which can have only one result --- a virtual collapse of the economy. Money, which should go into infrastructure, agriculture, business, industrial growth, promotion of foreign trade, will be denied to all these sectors and will be thrown down the drain. The way to feed people is to generate jobs which give them the money to buy food. Giving subsidised foodgrain but denying money to the sectors which generate employment is the single most foolish decision that government has ever taken in India since independence. It is so perfect a method of ruining the economy that it should be archived as a permanent record of how foolish governments can be. In any case, India now needs economic administrators with a sound practical knowledge of Indian realities. What it does not need is foreign trained economic advisors, who are clueless about India and what it emphatically does not need is the National Advisory Council.

To sum up, we need to abandon every scheme which squanders money for possible electoral gain. We need very clear decisions on directions of growth, with ruthless planning on providing both the environment and the financial and natural resources thereof. We need gainful employment generation which creates long term assets, thus providing the equality of opportunity to all enshrined in the Preamble to the Constitution. We need massive State support for health, education, skill development and infrastructure building. We need policies which carefully balance environmental concerns and protection on the one hand and growth of employment on the other. We need a government which decides and stands by its decisions. We need a grievance redressal mechanism which refuses to allow irresponsible activism to trivialise the process and bring development to a halt. We need to promote equity, not through doles but by encouraging activities from the village level projects which create assets all the way up to major industries, which genuinely give people equality of opportunity. What is more, we need a government, not the present spavined, paralysed, dithering apology of a government that we have today. All this in a democratic set up because as has been proved over and over again, a self critical (not self destructive) democracy, in the long run, will always be better than totalitarianism. This is where we must say, “Yes, we can do, we shall do.”