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Are recent reforms enough to trigger growth?

Oct 08 2012, 18:00   |   By CNBC-TV18

After being blamed for policy paralysis for the first three years of its tenure, UPA-II is now trying to pack all that work into four weeks.

To tame the fiscal deficit, the price of diesel has been hiked by Rs 5 per litre. Also subsidised LPG cylinders have been capped to six per family per year. Fuel subsidy in every coming year is estimated to be down by 28 percent on account of this alone. For this year though, the diesel price hike and the LPG cap is likely to cut the subsidy bill by only Rs 10,000 crore.

To continue with the process of marketisation and globalisation, the government has allowed 51 percent foreign direct investment in multi-brand retail. It also hopes to raise the FDI in insurance from 26 to 49 percent, subject to parliament, which may be a big ask.

To rescue the ailing aviation sector, the government has given the green signal for 49 percent FDI. To tackle the declining savings rate and harness long-term savings into investment, the cabinet has given it okay to the pension fund regulation regulatory and development authority bill. That needs parliament's okay.

The much-awaited Companies Bill also got the cabinet nod, but again it needs parliament's approval. The good news is the BJP has decided to back the Companies Bill.

The government has also kicked off the divestment process. Five public sector companies have been lined up for stake sale; these include Hindustan Copper, Nalco, Oil India, MMTC and Neyveli Lignite Corporation. Stake sale in these five companies will raise Rs 15,000 crore against a target of Rs 30,000 crore.

Finally, it is slowly trying to disentangle the power mess. Fuel supplies are getting arranged through Coal India for the buyers of power. The electricity distribution companies may soon get some liquidity, when the state government takes over their loans.

But can it breathe more oxygen into the slowing economy? Are these measures good enough to give a U-turn to growth? Can you really expect growth, unless you tackle the fiscal deficit?

In an interview to CNBC-TV18's Latha Venkatesh, Pronab Sen, principal advisor at the Planning Commission, Sudipto Mundle, director general at the National Statistical Commission and member of the Technical Advisory Committee to the Reserve Bank of India, Samiran Chakraborty, head of research and chief economist at Standard Chartered Bank and Seshagiri Rao, joint managing director and group CFO of JSW Group discuss recent reforms and give their outlook going forward.

Also read: IMF cuts India growth forecast to 6% for 2013

Below is the edited transcript of the interview.

Q: A lot has been done in your space in terms of fuel supplies, State Electricity Boards (SEBs) getting cash, allowing foreign direct investment (FDI) in several areas, which in-turn has made the dollar cheap. Has the situation changed in anyway for you? Is money cheaper, foreign or domestic loans? Is industry just a little better than what it was three or six months back?

Rao: Steps, which we have seen from the last few weeks, are welcome from the industry point of view. We are seeing positive sentiment coming back into the market and also in the mindset. So, this is what is happening right now.

Is it all translating into demand pick up or investment at the ground level or foreign investment coming into India? I don't think so. But there is a clear sign of positive vibrations across. These are all very good steps, in my view, from reforms point of view. They would give a fillip to the industry.

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Q: When you expect things to genuinely get de-stressed and become easier for you to do business, when you will have the courage to go ahead and invest? Do you see the de-stressing happening in three months, in six months?

Rao: In order to bring back the demands and stimulate investments in India, there is a dire need to reduce the interest rates by the banks and also the policy rates by the Reserve Bank of India (RBI).

I am not seeing any hint from the RBI to cut the policy rates further, other than 0.5 percent, which they have done. So, the interest rates, in my view, have to be reduced. I think it will happen in the near future, if not in this month. I think it is very much essential today to revive the industry.

Q: We may have all this much needed and well intentioned reforms, but the key macroeconomic problem, I would think and Dr. Kelkar says, is really fiscal deficit. Unless that is brought down, do you see inflation coming down? Unless inflation comes down in a sustainable way, do you think growth will pick up? Is not that the key problem to be tackled?

Sen: We tend to conflate the terms here. Dr. Kelkar talked about the fiscal deficit, but really the deficit we need to worry about is the revenue deficit. It's basically the savings of the government which have taken a beating. That is then getting reflected in excess demand, which is inflationary on one side and high current account deficit on the other.

I have no real problems with having a fiscal deficit somewhere even in the 6 percent range. But I do have a problem when government savings goes into negative territory, which it has. That is what we really should be focusing on. In a sense, I think what the finance minister said is that we are focusing on reducing the savings of government, but we will still have a higher fiscal deficit. So, he is on the right track. I wouldn't focus that much on fiscal deficit. I would focus much more on the revenue side.

Q: Don't you think that we just have to do more in terms of raising revenues or cutting expense or both, otherwise there is that aggregate demand that is getting created and that's pumping up inflation and basically becoming a macro economic malaise?

Mundle: Let me just take a step back on the question of revenue and fiscal deficit. I think fair to Dr. Kelkar and his colleagues who are all drawn from the previous 13 Finance Commission, you have to read their present recommendations along with the 13 Finance Commission recommendations. In that, they had said that while brining down the fiscal deficit, they actually wanted to increase as a percent of GDP the expenditure on capital. That requires that by the end of their reference period, the revenue deficit would be reduced to zero.

It was exactly inline with what Sen said that to compress the revenue deficit, but actually increase the public investment and capital expenditure so that you would get the spin-off effects then multiplier effects and crowding in of private investments and therefore growth and all that. So, this is exactly their logic. Now this has been a year down the road from the recommendations, we have had a budget in between, we have had changes in inflation rate, so they have calibrated their recommendations in terms of numbers and so on. But the essential logic is very similar to what Sen was saying. If you discuss it with Vijay Kelkar, he will say exactly that that we do need to increase public investment, while reducing the deficit.

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Q: Seshagiri Rao does not see the wheels of the economy moving, until he sees interest rates falling.

Mundle: I am coming to that. Now as far as investment is concerned, while I share and respect Rao's view, the fact is that interest rates in real terms in India are not that high. If you allow for the practical inflation rate calculation, actually real interest rate or the policy rate is still negative in real terms.

What has really been behind decline in investment and therefore growth is, the interest rate matters very little in terms of cost of overall investment production, sentiment. Fund managers were saying that we think there is a policy paralysis and this government would not deliver. It is that negative expectation which has broken. You can already see the results in the stock market, portfolio investment has started coming in. I think this is already going to start perking up.

Once that starts happening, you are going to see investments slowly picking up. I know it would not happen overnight. But in the course of the next year, I do expect the investment rate to climb back up, it had declined and therefore growth to start recovering.

Q: Will you be that confident? As a classical economics student, I would think that we have to get inflation under control and only then interest rates climb down and then that makes for a sustainable growth rate. As long as inflation rate is higher than growth rate and that is for the third year running, we wouldn't solve the problem of the economy. Would you stick with that classical economics approach or do you think that we can cajole investors, we can cajole industry into investing before that?

Chakraborty: We are kind of in a situation where we have quite a few conundrums in our way of how the economy is behaving. Clearly while growth has slowed down substantially, inflation has not come off. Why is it so?

The other is that while interest rates in real terms are negative or very low, why is it that investment has not picked up? And third is that there has been an extremely short decline in productivity and investment rate as a whole, how do we get out of that? I think all these questions essentially boil down to the fact that we haven't done any supply side reforms for a very long period of time. This supply side reforms would possibly be on the input markets of land, labour, minerals etc and on the institutional side of bureaucracy, judiciary, political systems etc.

You have to have reforms from both these sides to tackle the productivity issue. Once you tackle that then you will be on a relatively higher growth path then you will possibly have investments coming in also. Right now, what we have seen on the reform side, clearly it changes the perception of the investors about a comatose government here. It changes the perception of about how foreign investment will be treated in this country. It changes the perception about an imminent threat of a rating downgrade. Because of these three things, the asset markets will react very positively.

I will not be surprised if corporate capex as Rao was mentioning is more delayed in coming. So, I am atleast walking with a six months lag, in my mind, if the political spectrum agrees to these reforms over the next three-six months and we do not see any disruption from this path of reforms then we are more hopeful of FY14 growth rates being much higher. Before that, I will be cautious on my FY13 growth rate.

Q: It is not just supply side issues that have dwelled growth, we have seen those supply side issues rise largely because of civil society because of courts, Lokayukta, NGOs and the CAG to some extent. Questions in the way decisions have been taken. Because of that decisions taken have been revoked by the government; spectrum licence revoked, coal allocations revoked, land given revoked. Do you think that investors' psychology, India Inc's investment will be able to put all this behind and go with the tide of reforms and go ahead and invest or do you think they will be shy of investing because of this fear that decisions will be cancelled retrospectively?

Rao: No. I think there are two issues. First, India has a very good problem, very good problem in the sense that we have a very good demand relative to supply. We have higher demand than the supply. So, creating capacities, bringing in more investments into India is not a big issue for us, provided the policy supports that. But the issue today, which the industry is facing, is the competitive strength that India has in terms of resources, the policies are not helping the industry to leverage that strength.

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Q: Would that be a big impediment? It is a very good development that the rule of law as well as civil society is questioning bad decisions. Do you believe that investor psychology will get over this and we will probably have clearer governance and investment very soon?

Sen: Yes. What you are seeing is really a paradigm shift. Paradigm shifts are disruptive, but in the medium run, we will be much better off for it. The credibility of the country would be a lot higher. I feel very uncomfortable if India is looked at as a place where robber barons come in to do business. That is not the kind of country anyone of us would like to live in.

What is happening is good. It is disruptive, but mind you most of corporate India is probably fairly comfortable with things as they are. So, this may actually have an impact on people looking in from outside. But within the country, people pretty much know what is going on. So, in terms of the longer-term growth prospects, in any case, you are not going to see a whole lot of FDI coming in, until domestic investors confidence is back, domestic investments are booming then FDI will come on its own. We do have a certain amount of time. We do have a sufficiently wide and deep catchment area of domestic entrepreneurs who will be able to handle this kind of issue reasonably well.

Q: When do you think investment psyche might turn, when do you think GDP might turn? Will FY14 be better off both in terms of savings, investment and growth you think?

Sen: Let me be very clear. I think what all of us have been saying is don't expect anything on the ground for another six months or so. The real question is that we have seen for the last year-and-a-half a steady reduction in pipeline investments. What they are now talking about is actually starting to rebuilt that pipeline, but remember rebuilding takes place at the starting point. So, the pipeline will remain empty for a while, when the new intents are being processed. So, I don't expect to see anything big on the ground, maybe the next four-six months.

Q: What would you estimate the current year's growth to be? When does the U-turn start, will FY14 be better?

Mundle: We are going to see a return to higher risk of growth only in the next fiscal, fiscal '13-14. For this year, growth is going to remain somewhat depressed. I can't give you can an exact number. I can give you a number, but that would be crystal ball grazing like anybody else, because six months of the year is already gone. The next six months, I doubt, if we are going to see a sharp increase in investment on the demand side now. If what is going-on on the exchange rate front happens then some of that advantage we are getting from the depreciated rupee is also not going to be there. So, as Pronab was saying we will end this year on a depressed note, but nobody's time horizon is six months.

Q: Do you believe that we are getting into a sustainable or even a higher growth path, unless we beard the fiscal lion in?

Chakraborty: Our estimate of fiscal deficit for this year is about 5.8% of GDP. That is not a good number. For that number to come down to 3.9% in two years time the way Kelkar Committee is suggesting is going to be a tall task given that in between we will have one election. I am uncomfortable with the high fiscal deficit number.

Having said that, the measures that have been taken are definitely welcome. We should not expect miracles on fiscal deficit, given that more than two third of fiscal expenditure is extremely sticky in nature. We have to think of ways to get revenue buoyancy up. For that, if we have to do some amount of one of exercises, I am all for it. To that extent, the Kelkar committee suggestions on revenue mobilisation also needs to be given enough importance not just the expenditure reduction side. But, overall, fiscal deficit to my mind still remains a concern.


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