How Modi (or Jaya or Mamata) can put out the fires lit by UPA and revive growth

The markets are setting great store by a Modi-led BJP government at the centre after 16 May 2014. But as several economists have pointed out, the UPA has pushed the economy into a downward spiral, and additionally booby-trapped the pathways to revival. So Modi (or Jaya, or Mamata, or Mulayam, or anybody, for that matter) will need a miracle to deliver on market expectations.

The legacy UPA leaves behind is the following: an economy decelerating to under 5 percent growth, an inflation untamed, an exchequer lacking resources for growth, an unmitigated fiscal deficit despite cooked account books, banks in dire straits, jobs in retreat, several industries in a tailspin (aviation, oil, gas, autos, durables, telecom) and, worse, a set of laws that will queer the pitch further for growth (the land and food security legislation). The impending defeat of the UPA is the only bright spot on the horizon, for it seems to be ready to inflict more wounds on an unhealed fisc (a Right to Healthcare Bill is part of the Congress manifesto).

All this calls for dramatic reforms on a scale bigger than 1991, in a more hostile global environment, and a more fragile domestic political climate.

While Arvind Panagariya of Columbia University, who is said to be advising the BJP, has said the party will need at least 220 seats and a viable coalition to push for real reforms, Shankar Acharya, former Chief Economic Advisor to the government of India, notes gloomily that “whichever government comes to power after the elections, it will face daunting challenges to revive and sustain economic growth and significantly improve the opportunities for gainful employment.”

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Acharya’s reasoning, explained last month in another article in Business Standard, is that the UPA leaves behind a severely damaged economy as it “failed to undertake economic, social and administrative reforms to strengthen India’s long-term development potential, despite the golden opportunity offered by the years of high growth and investment. It is hard to resist the conclusion that the overall economic legacy is bad, if not ugly.”

How does one fix this? This article is about suggesting some ways out, taking into account our political economy, and the pet foibles of our politicians.

First, the macroeconomy.

The big things that need fixing are the fiscal deficit and subsidies, speeding up project implementation, bringing down inflation, and reviving job creation.

The fiscal deficit (4.6 percent) indicated by P Chidambaram on 17 February in his interim budget is a piece of fiction, invented by cooking the books (rolling over subsidies to the next year, bringing forward next year’s revenues, cutting productive capital expenditure, and overestimating revenues). The real figure is probably more than 5 percent.

The new government can do two things to deal with this. The optics have to be dealt with first. It should seek a white paper (within two months, and before the budget in July 2014) that shows the real state of government finances, minus the legerdemain. Second, it should announce an immediate shift to accrual-based accounting with retrospective effect from 2013-14. This will throw back all the expenditures incurred by Chidambaram back to 2013-14, which will show the fiscal deficit for what it is. This will give the new government breathing room to chip away at the fiscal deficit more realistically from this year onwards.

So how will the fiscal deficit be fixed? Obviously, subsidies will have to be cut. Modi, of all people, cannot do that easily, since any substantial cut will be seen as anti-poor. The best way thus is to freeze the numerator (subsidies) and let the denominator (GDP) shrink the subsidies.

How? First, oil prices should be deregulated - but existing subsidies (say, upto Rs 50,000 crore in 2014-15) can be frozen. This will curtail any immediate increase in pump prices. Remember, people are already adjusting to monthly increases in diesel prices. These can continue till the subsidy is eliminated altogether in whatever timeframe possible.

Second, the same can be done with fertiliser subsidies - by deregulating. But any government with the Akalis in it will be loath to do this suddenly. A way around this would be to raise minimum support prices for food substantially to absorb the fertiliser price hike. If this is done in the initial honeymoon period of the new government, it may be easier to pull off. Food subsidies would bloat, but fertiliser would be off the hook.

Third, the food subsidy can be frozen and completely transferred to states. If, say, the food subsidy budgeted is Rs 1,75,000 crore after the fertiliser hike - the deal should be that this money will be entirely given to the states to organise their own subsidies. States should be eager for the cash, especially since they can then figure out whether they want to use the cash for food or something else. The subsidy figure would remain on the centre’s books, but it would be a shrinking ratio as the GDP rises. Of course, some states may not agree, since future increases in subsidies would be their problem - but it should be palatable to most in the short run. It would also force the states to keep demanding higher subsidies.

Next, finding the resources for growth.

Growth will come only if there is investment, and for this both government and private sector need to restart the investment cycle.

The problem of stuck projects has two components: slow clearances, especially environmental clearances. The other is the money. The first problem can come only from firm political leadership, where bureaucrats are assured that decisions taken in good faith will not be questioned.

As for money, the problem is banks are stuck with bad loans - and they can’t lend more to infrastructure. They need capital, and companies need cheaper money to invest.

Clearly, the resources can come only through privatisation - of banks, public sector undertakings, et al. Once again, if Modi does this, he will be seen as a dirty capitalist aiding cronies.

The way around it is to make privatisation look less like privatisation and by bribing of states.

The first thing to do is to legislate a golden share - a share with 51 percent voting power, but without economic rights (ie, no dividends). This means inserting a clause in all laws through which companies were initially nationalised (coal, banks, insurance, factories, etc) to allow government to reduce its holdings to less than 51 percent. The golden share will allow government to direct the company to take certain actions (reduce prices, or produce more at a loss, if needed) in specified national interest situations (war, a dramatic currency collapse, a quadrupling of oil prices, etc). This could mollify the non-Left unions and centrist political parties and allow the government to disinvest or dilute its holdings to raise capital.

The second idea is to give states some of the shares in companies operating in their territories - say 5 percent - at face value or a lower-than-market price.

The third thing is to allow private parties to bid for managing public sector companies. In the initial decades after independence, there was a system of managing agencies - which enabled big industrial houses to control large companies with minimal shareholdings. The idea should be revived to allow talented professionals to head public sector companies and deliver on predetermined financial and social goals. If they succeed, they get bonuses and shareholdings; if not, they exit. This would build value for future disinvestment.

As for the land bill, the best way to control its negative effects is to delete the provisions involving compulsory payment for rural and urban land at four and two times market prices, and allow states to decide these multiples separately. Each state can also be allowed to decide the minimum level of acceptance from landowners when land is compulsorily acquired for public projects.

It won’t be easy getting these changes through, but at least one can try to show this as state-friendly and pro-federalism, and push bits of them through.

There are surely more out-of-the-box ideas to embrace, but these could provide a starting point for the new government - whether run by Modi (or Jayalalithaa, or Mamata, or Mulayam Singh or Navin Patnaik). Whoever comes to power will have a short honeymoon period. They have to hit the ground running.