T N Ninan: UPA-II(a)?

Challenge before the govt is to administer the bitter medicine that is associated with structural adjustment while simultaneously boosting consumer as well as investor sentiment

Many of the reform measures that the government has announced in recent weeks have focused on allowing or increasing foreign investment — in aviation, broadcast services, retail trade, insurance, pension services… You would think that the lack of foreign direct investment (FDI) has been one of the problems plaguing the economy, except that that’s not what the figures say. FDI in 2011-12 increased to a record $46.8 billion, up a handsome 34 per cent from the year before. In fact, FDI inflow in each of the last four years has been more than it was in the last boom year before the domestic slowdown (2007-08: $34.8 billion). If there has been a problem with international investor interest in India, it has concerned portfolio investment, which dropped sharply to $16.8 billion last year, from $29.4 billion the year before. But if you look at the combined FDI-FII inflow during the three confidence-lacking years of UPA-II (2009-12), it has been constant at about $65 billion each year. That happens to be a sharp improvement on the previous three-year period (2006-09) when the average annual inflow was just $36 billion. The short point is that the economy’s problems have not been caused by the lack of investment from abroad.

This is not to criticise the opening up of the economy to more foreign investment, which in general should help improve efficiency and quality standards. Portfolio inflows have also sent up stock market valuations, which had been languishing (and pushing savings into unproductive gold). So the FDI decisions are to be welcomed, but let us not mistake them for the substantive reforms that must address domestic issues.

Nor is it that there has been no domestic action. Indeed, the range and speed of decisions in the last few weeks have been breathtaking. Notable among the measures is how the way has been cleared for sorting out the messy finances of the crisis-ridden power sector. But how much closer are we to solutions to the four macroeconomic problems that confront us: persistent high inflation, a stubbornly high fiscal deficit, a yawning trade deficit and stalled infrastructure projects? You could add two more to that list: flagging consumer confidence and the choking of the financial sector with problematic credit.

If an investment board is set up, reporting directly to the prime minister, and this clears the hurdles in the way of stalled projects, that would give the booster shot to the economy. The action on diesel and cooking gas addresses the fiscal problem but only to a small degree, and the rupee’s ascent up the charts gives relief by making oil products cheaper in rupees (thus reducing the subsidy and the fiscal deficit). However, the rupee is now well above what its inflation-adjusted value might be, and this affects exporters’ ability to sell abroad at a profit; that could make the trade deficit get worse rather than better. In any sensible accounting, the rupee’s continued ascent is therefore a negative macroeconomic development and needs to be partially corrected. The strategy of tackling imported inflation, and its impact on the subsidy bill, by driving up the rupee with the use of portfolio inflows, is flawed because it will worsen the current account deficit.

The fact also is that inflation control needs to be done even as several prices need to be jacked up further — electricity tariffs, railway fares, virtually the full range of petroleum products, fertiliser prices… The challenge before the government is to administer the bitter medicine that is associated with structural adjustment while simultaneously boosting consumer as well as investor sentiment, and the “animal spirits” of businessmen. It was done in 1991 but not by boosting the rupee, indeed by doing the opposite.