Growing pains

Indian Express, 16th November 2012

Clarify policy and ease bottlenecks to spur investment

Preventing India's growth slowdown is a difficult but not impossible task. The government needs to follow a two-pronged strategy to put India back on a high-growth path. On the one hand, it must focus on putting stalled projects back on track. On the other hand, it must put in place policy frameworks for the allocation of land and natural resources, as well as for environmental standards and the rule of law.

Episodes like the 2G spectrum sale and the coal block allocation issue demonstrate that the lack of a clear framework can seriously disrupt investment and growth. Though there are no easy answers to these questions, arriving at policy frameworks through research, public consultation and discussions among stakeholders, and implementing the rule of law, should make them more tractable than they are today.

One somewhat simple way to address growth slowdown in the short run may be through fiscal and monetary policies. But in India, macroeconomic policy choices, even in the short run, are going to be very difficult. The latest data on output and prices confirm the stagflation that has been on its way. We now see growth slipping below 5 per cent, even as consumer price inflation reaches 9.75 per cent. This is almost the reverse combination of what India witnessed a few years ago at the peak of the business cycle.

As output growth slipped in September 2012, with the IIP data showing an actual contraction in economic activity, consumer price inflation continued to rise, hitting almost double digits. The trade data released also showed a higher trade deficit. Stagflation is a much more difficult problem than overheating, which happens when prices and output are both rising, and which we saw in 2006 and 2007. That is when fiscal and monetary policy both need to be contractionary. Tackling stagflation is also more difficult than facing a recession, when fiscal and monetary policies both need to be expansionary. When faced with stagflation, no standard recipes work. Contractionary fiscal policy would mean raising tax rates, something that would hurt investment further. Easing monetary policy would mean cutting interest rates, something that would make inflation worse. The experience of other countries like the US, which has seen stagflation in the past, suggests that simple solutions can only worsen economic conditions.

Standard macroeconomic stabilisation policies are not the answer to India's economic problems today. One clear area of failure, which needs government action, is governance issues. These are responsible for having created an environment that has put on hold various projects and discouraged further investment. The stalling of a large number of investment projects since governance problems began, especially after 2010, have reduced investment and worsened supply constraints, particularly in infrastructure. Various bottlenecks, especially bureaucratic and judicial, are now holding back the economy as never before. The tools of macroeconomic policy are meant to address an economy operating around its full capacity output. That framework assumes that problems such as India's do not exist. India is not at its long-run, steady-state growth rate. The output gap is not caused by investment inventory cycles, which can be addressed by macro policies.

To address immediate governance issues, the government has proposed a National Investment Board (NIB) to speed up stalled projects. This could help push up output as well as bring down prices. But the environment minister, Jayanthi Natarajan, has opposed routing environmental clearances through the NIB. This brings us to the question of how the NIB will work. Can the bulk of issues on which investment is stalled be resolved without transparent policy frameworks in place?

There is no doubt that the reforms proposed by Finance Minister P. Chidambaram created optimism among investors, both foreign and domestic. But while it is true that the gloom and doom went away, it was replaced only by a very cautious optimism. Investors need to see the government take concrete steps before making investment decisions. If large projects and large sums of money continue to be stuck in governmental processes, and investment decisions keep getting postponed, it will not encourage them to invest. Not only are resources limited, an increasing number of bad assets reduces the banks' ability to lend. It is not just that companies are constrained by their capacity to incur further risk, there is a trust and governance deficit. Equally important are the worsening finances of the banking sector. The government needs to act quickly.

But if the laws that create a policy framework are not in place, there are fears that the very clearances that such a board gives could be challenged in court the very next day. Therefore, the second element of the strategy is to understand why projects were stalled and to correct the existing policy frameworks.

There will be no simple answers. In the process of economic growth, there are trade-offs between protecting the environment, forests and land rights on the one hand, and creating infrastructure, generating power, making dams, encouraging mining and other economic activity on the other. Any solution that swings to one extreme will not work. It will be very easy to stall projects if citizens who are losers in the process, or those that support them, go to court or use political pressure to stop economic activity. Any attempt to push through projects in a non-transparent or arbitrary way will not be acceptable either. There is no doubt that India will have to industrialise, but in such a way that the environment and forests are protected. It is essential to put in place the rule of law and processes to ensure that such issues do not hijack politics and economics.

Most countries face similar problems when they grow fast. As the Indian economy has grown, the stakes involved have become very high. With that, corruption in high places has become more attractive. What must be a priority is the creation of policy frameworks, for example, strategies for the sale of natural resources or public sector enterprises, through auction or otherwise, should be formulated in a transparent, consultative process, with independent research and discussions with stakeholders, where the public understands the debate and buys into the solutions.