Towards climate change

Indian Express, 19th July 2012

A slow trickle of reforms won't do. Nor can government follow a policy of 'do no harm'

The change of guard at the finance ministry has brought in a cautious optimism among investors. In the first few days of the month, stock prices moved up and $1.3 billion of portfolio investment came into India, perhaps reflecting improved investor sentiment. The problems the country faces are, however, far from over, and the prime minister and his team have huge challenges ahead. Macroeconomic difficulties facing India may be exacerbated in the coming months, making it difficult to keep up the optimism.

One of the biggest difficulties facing the government is likely to be bad news on production. Since 2008, when the global crisis began, the investment climate has been poor and worsening. While existing projects were completed, new project plans, both public and private, slowed down. Even if the investment climate improves, and the government and the private sector start planning to invest again, it could easily be two to three years before these translate into higher investment. After projects are planned, it takes time to get various clearances and tie up the finances to execute them. These are not necessarily delays but part of project execution, even when all processes are moving smoothly. So even an improved investment climate will not translate immediately into higher investment spending.

Meanwhile, the slowdown in new investment plans in the last four years is likely to lead to lower investment in the pipeline. Lower investment is likely to translate into lower output and unemployment. The quiet decline in investment plans that has been happening over the last few years could translate into a shrill discussion on slipping industrial growth and poor corporate performance on every business channel. It will be a constant challenge for the government to offset the gloom and pressure caused by the bad news. There will need to be more than a slow trickle of reforms. It will not be enough to follow a policy of "do no harm".

At the same time, there is little sign that inflation will come down soon. Month-on-month seasonally adjusted inflation based on the consumer price index is showing that inflation for the next five months is likely to be high. Even after that there is no indication that price rise will slow down.

What might be the best way for the government to stabilise the economy? Considering the multiple problems facing the economy, there is clearly no single magic bullet. The government will have to adopt a multi-pronged approach. For example, there needs to be one set of strategies to address the question of investment plans and the implementation of existing projects that will work towards pushing growth. Interest rate policy should not be used to push growth. It should be used only to fight inflation.

In the next few days, the government must swing into action to free up blocked investment projects. It must work with the relevant ministries, and courts, to find out ways to move ahead faster. If norms have been violated and this implies that fines will need to be imposed, or other action is required, or if additional environmental standards need to be met, the government must get that process under way as soon as possible. Long delays lock up finances, get companies and banks into trouble, and slow down the economy.

In the longer term, improving the investment climate will require an array of reforms. Reducing uncertainty in investment and project implementation is an important element of economic policy. While on one hand, unearthing corruption is good for the country, on the other, it implies a change in the way people do business. The old ways of using political influence or money power and being helped by a politician or bureaucrat who would assist in removing the various hurdles in the way of a project are no longer going to be as easy under a more transparent system and a more cautious bureaucracy. Moving away from the present ad hoc system towards one where there are well-defined rules and standards for environment, land rights and forest rights is now needed.

For this purpose, the prime minister should set up task forces to review rules and laws proposed for land acquisition, environment, forest rights to ensure that while there is no violation of people's fundamental rights or undue destruction of our country's natural resources, we do not make it impossible for honest entrepreneurs and investors to do business.

In addition, there is the usual laundry list of economic reforms that have been much debated and can help ease the current economic difficulties. The problem of inflation is the other big issue that has been mishandled by the present regime. If bad news on the economy comes in, the pressure on the government to ease monetary policy could also increase. It will be a mistake to ease monetary policy at this stage, when inflationary expectations are high.

In order to avoid taking the blame for raising interest rates, the politicians of many countries have redefined the role of central banks as one where their primary objective is price stability. Tightening monetary policy is the hardest during stagflation as industry lobbying for easing increases. The best policy at this time would be to change the institutional arrangement for inflation control and to give the RBI a clear mandate to focus on price stability.

Not only is it important for the government to implement this strategy, it should communicate it adequately to the public. In the last few years, former finance minister Pranab Mukherjee often made statements that amounted to suggesting that the instrument to address economic growth was the interest rate, and that the RBI is not an independent central bank whose objective is price stability, implying that interest rate policy in India can be used to push growth at the cost of inflation. The government needs to change this perception.

The mismanagement of the economy is translating into lower job growth and higher prices that hit the voter. The government must act urgently.

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