Many businessmen believe that their troubles will be over once the UPA is gone and the next government is ushered in by May 2014. This is one reason why the markets have been buoyant despite weak economic news.
In the run-up to 2014, the markets are reasonably buoyant – mostly for the wrong reasons. On Monday (18 November), the Sensex zoomed on good news from abroad. But was it really good news? The fact that the US Fed is going to keep printing money and China is going to speed up reforms is hardly good news. In the case of the former, it means real adjustments in the US economy will be postponed. The bubble will continue, waiting to explode later. And in the case of Chinese reforms, it is real bad news for India. If China is reforming faster than India, why should foreign money prefer us over them?
Many businessmen believe that their troubles will be over once the UPA is gone and the next government is ushered in by May 2014. This is one reason why the markets have been buoyant despite weak economic news (stagnant industrial output, rising price indices, et al). They also believe that if Narendra Modi’s BJP wins next year’s general elections, the economy will revive quickly.
The truth is, Modi cannot make a scorched-earth green in one year.
Businessmen should be cautious and, in fact, should be prepared to face tougher times for much longer. The fact is no government, even if it is headed by pro-business politicians, will be able to reverse the economic damage inflicted over the last few years of misgovernance and policy paralysis in double-quick time. Worse, the legislation passed in the last few months of the UPA’s tenure – the Food Security Bill, and the Land Acquisition Bill, in particular – will not be easily reversed or reduced in terms of negative impact.
The problem is that many of the changes made by the UPA have created long-term structural rigidities in the economy that will not be easily overcome. The problems the economy faces now have their roots in the UPA’s welfarist and interventionist policies, and they will not be ameliorated just by installing a new government.
The labour market, for example, has grown more rigid under UPA. Not only has the labour law not been eased, but the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA), where wages are indexed to inflation, has created a permanent wage cost escalator for everybody. MNREGA wages now put a floor under rural wages, and the indexation makes this base a moving target every year. As higher wages chase higher wage-goods, rural inflation (and also the linked urban one) will be on a permanent escalator. For industry, this means faster shifts away from labour usage – which can’t be good for employment growth.
The land market – never very market-friendly, and often manipulated by vested interests – has also become more pricey and rigid. The Land Acquisition Bill makes purchases of land for infrastructure and housing four times more expensive in rural areas (and two times in urban areas), and also more time-consuming. The government itself reckons that it could take upto four years to buy large parcels of land based on the consent of 70 percent of landowners. The process has also been made more bureaucratic, with more clearances now required to buy land.
The Food Security Bill will distort the markets for food even further. Since the basic idea is to provide 800 million Indians with rice, wheat and coarse cereals at Rs 3, Rs 2 and Re 1 a kg after buying it from farmers at much higher prices, the bill involves siphoning of large quantities of foodgrain currently coming to the market and funnelling it through an opaque and corrupt public distribution system. This could mean shrinking the formal market for food, even while bloating the illegal market for it as the poor buy grain at Rs 2-3 a kg and sell it in the market to raise money. For companies in the food processing industry, the Food Bill could have a significant impact. As far as inflation goes, higher food prices will impact every other industry and keep interest rates higher than needed despite the growth slowdown.
Farm products movement and agricultural pricing are government-controlled on multiple sides – inputs (fertiliser), output (minimum support prices), restrictions on inter-state movement, and export and import curbs. These will remain serious constraints to agricultural growth, not to speak of labour costs, due to MNREGA. Freeing agriculture will take some doing, and will not come without costs, even if all politicians summon up the courage to do so. But they won’t.
The markets for protein-based foods are also going to be naturally constrained. The consumption of pulses, fruits and vegetables, and eggs and meat will go up as poverty reduces and people get basic cereals cheaply under the Food Bill. Protein foods inflation will go through the roof as there is not enough land available for extending the area under pulses, and increases in milk production need an increase in bovine herd strengths. Milk prices have just gone up by Rs 2 a litre this month, and there could be more to come on eggs and meat.
The energy market – one of the most distorted during UPA-1 and UPA-2 – will also take a lot of effort to straighten out. During the last 9 years, the government has offered over Rs ,650,000 crore in direct and indirect oil subsidies – and another Rs 1,10,000 crore could be added before the UPA is turfed out – and as these are eliminated over the next two years, energy prices will rise despite a slowdown. Gas prices also have to go up, and possibly coal too. It is difficult to see how industry is going to weather this cost-push effect over the medium term. As an aside I may point out that we started diesel price reforms in January this year. Some 10 months later, diesel losses are exactly the same – Rs 9-10 a litre, almost the same as in January. The reform is too slow to work. But if it is hastened up, growth will be seriously impacted.
The broader point one is getting at is simple: all important factor markets – land and labour – and several sectors (agriculture, energy, aviation, telecom, infrastrcuture) have been distorted so much over the last 10 years by government interference that inflation and market rigidities have become more structural in nature. This means, inflation is not going to be easily tamed, and untamed inflation is the biggest roadblock to growth.
Consider investment in infrastructure – which has been lagging seriously in the last few years. Conventional wisdom says it was due to delayed environmental clearances, but that is not the whole story. The more important reason is inflation. When inflation is rising close to double-digits for years, almost no infrastructure project, with long-gestations and low rates of return, can be viable.
Inflation has been out of control for more than three years now. Actually, it has never been under control since 2008, but thanks to the global financial crisis it seemed to magically disappear in 2009 (the price index turned negative in mid-2009) till it reappeared with renewed vigour in 2010-11.
The net result is we now have inflation and inflationary expectations on steroids. I doubt it will get cured with a marginal tweaking of policies here and there, whether monetary or fiscal. Curing inflation may require a whole range of actions on several fronts simultaneously. It is not merely about raising interest rates or releasing more rice and wheat from bloated stocks. Whatever we do, any serious effort to reduce inflation will have lower short-term growth as an important consequence – just as was the case in 1991-92 (when GDP growth crashed to1.4 percent after reforms). But if the bitter medicine is swallowed by treating 2014 as 1991, the economy should rebound sharply (as it did in 1992-93 at 5.4 percent) in 2015-16. But it needs guts and gumption on the part of government.
For businesses, thus, the right attitude to take is caution. You cannot expect a quick rebound in economic growth since a lot of the damage done over the last 10 years still has to be reversed – and will be tough to do politically. Money may be dear for a longer period of time, inflation will take time to fall, projects will be slow to take off, and land will be tougher to acquire.
So Modi or no Modi, 2014 will be a year of false dawn. And, if the worst happens, and the UPA is back, the future could look worse.
(Parts of this article were originally published in the November issue of Entrepreneur India)
The writer is editor-in-chief, digital and publishing, Network18 Group