Brookings: Topics - India's Economy

The State of the Indian Economy: The Budget and Beyond

Mon, 04 Mar 2013 15:30:00 -0500

Event Information

March 4, 2013
3:30 PM - 5:00 PM EST

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

Over the last couple of years, India's economic growth rate has slowed. It remains one of the fastest-growing economies in the world, but the decline has caused concern within that country and outside of it. In the fall of 2012, the Indian government took measures to reverse the trend, but authorities acknowledge that much remains to be done. On February 28, P. Chidambaram, the Indian finance minister, will release the Union budget, which analysts will watch closely to determine the direction the government intends to take, especially with regard to economic reforms.

On March 4, the India Project at Brookings hosted a discussion of the state of the Indian economy, the highlights of the Indian budget, and prospects for further reforms and growth. Panelists also discussed the recently released International Monetary Fund annual staff report on India, which assesses Indian economic performance and lays out the risks and opportunities that lie ahead for the country. Panelists included Diane Farrell, executive vice president of the U.S.-India Business Council, Anne Krueger, professor of international economics at the School for Advanced International Studies, Johns Hopkins University, and Laura Papi, assistant director in the Asia and Pacific Department of the IMF. Brookings Senior Fellow Eswar Prasad, the New Century chair in International Trade and Economics, moderated the discussion.

Event Materials

China's Marathon is India's Triathlon

Tanvi Madan — Mon, 04 Feb 2013 11:00:00 -0500

Steve Rattner’s observation in The New York Times a couple of weeks ago that India had lost the race to China came on the heels of a year or more of global hand-wringing about India and its prospects. That had followed a few years of internal and external observers feting India as the next big thing. It brought to mind Heidi Klum’s weekly quip on Project Runway, “in fashion, one day you’re in, the next day you’re out.” If one wants to keep track of whether India is in or out, up or down, losing or winning “the race,” one only has to take a look at the latest Economist cover story or survey report headline on India. In 2004, “India’s Shining Hopes” were dazzling the world. A year later, India had been elevated to China levels with the newspaper declaring “The Tiger in Front.” By 2006, the newspaper was asking “Can India Fly?” with the answer a couple of years later being that unfortunately India was still “An Elephant, Not a Tiger.” Just a year later, however, there was “Good News from India” and a year after that the newspaper was laying out “How India’s Growth Will Outpace China’s.” Alas, by 2012, the newspaper, disappointed by developments in India, wistfully proclaimed that India needed to be “In Search of a Dream.”

These kind of report cards, rankings and ratings of India generate much interest, especially when the country’s progress is juxtaposed against that of China. Thus, predictably, Rattner’s piece laying out his view of the result of the economic race between China and India received some attention. Most of the responses tended to focus on whether or not India was losing or had lost the economic race. A different question, however, needs to be asked: Is that the only race India is in and the only race that those cheering for India want that country to win? Because it’s not that India doesn’t have the same “eye on the prize” as China does, as Rattner argues; it’s that the prize is different. Indeed, the race is different.

A few years ago, Indians and Indiawallahs might have “taken offense” – what Manu Joseph has called “India’s favorite spectator sport” – to a greater extent to Rattner’s declaration. Slowing economic growth and governance challenges, however, have reinforced the realization that victory parades are premature and the nation-building project that started six and a half decades ago continues. Many agree that India is indeed losing the race at the moment, at least the one that Rattner writes about: the economic one and, more narrowly, the infrastructure one. Some have even argued that he is late to this discovery and India lost the economic race a while back. Others have pointed out that the race isn’t over yet or that India started from behind and will catch up. Some have criticized Rattner for emphasizing growth at the expense of democracy. Yet others have responded with “what race?” either asserting that China and India haven’t been in the same league for the last three decades, or that comparisons should not be made because it’s like comparing apples and oranges.

It is perhaps futile to demand that people cease and desist from comparing the two Asian giants. Some have tried. Indian Finance Minister P. Chidambaram recently dismissed comparisons between the Chinese and Indian economic situations as irrelevant, saying that the countries faced different problems. Yet, his own prime minister has compared India’s banking system (favorably) and its scientific research achievements (unfavorably) with those of China. On the other side of the aisle, Gujarat Chief Minister Narendra Modi has compared his state’s progress with that of China, as have Indian corporate leaders. At the recently concluded Jaipur Literary Festival, a panel (“The Elephant Paradigm, the Dragon Paradox.”) was devoted to comparing the two, with panelist Gurcharan Das saying that India was a soup and China a salad, and Nandan Nilekani noting that a good diet required both.

Neither the idea of a “race” between China and India is new nor is the hope on the part of many in the West that India win that race. It is a concept and comparison that predates Rattner, Francis Fukuyama, Niall Ferguson, Pankaj Mishra, Raghav Bahl and Tarun Khanna and Yasheng Huang. 60 years before Rattner’s piece, in The New York Times Magazine, Barbara Ward, then of The Economist, laid out “The Fateful Race between China and India,” pitting an authoritarian and a democratic country against each other in a development race that the whole world was watching. American policymakers interested in aiding India used the idea to lobby for assistance arguing, as historian Nick Cullather noted, that while there was an arms race and space race, the development race was the third and “deciding heat in a Cold War triple crown” and the U.S. needed to help India win. The idea did not get mainstream support till the second half of the 1950s. As Washington watched the battle unfold beyond Europe for hearts, minds and stomachs, the idea stuck that if Soviet-backed China succeeded while democratic India failed economically, it would be a victory for communism. If, on the other hand, the U.S. could help India win the development race versus China, it could demonstrate to the “uncommitted” world that democracy and development could co-exist and thrive.

By 1957, the “competition between Communist China and India” was enshrined in official U.S. documents and linked to American national security. NSC 5701 explicitly stated that it was in the U.S. national interest to strengthen India because, “A strong India would be a successful example of an alternative to Communism in an Asian context and would permit the gradual development of the means to enforce its external security interests against Communist Chinese expansion into South and Southeast Asia.” This argument laid the basis for years and billions of dollars of aid to India over the next few administrations. It enjoyed bipartisan support, with then Senator John F. Kennedy and Vice President Richard Nixon both advocating for aid for India on these grounds. The latter, emphasizing the significance of the competition, even asserted, “what happens in India…could be as important or could be even more important in the long run, than what happens in the negotiations with regard to Berlin.” Initially, this aid was designed to help India win the race; over time, as Indian performance lagged, it was designed not just to prevent India from losing the race, but from falling off the racetrack. Eventually, frustration about this performance led to "India fatigue" and the cheerleading squad – and, with it, aid – dwindled.

The race was not just a Western concept. In 1951, it was the editor of a leading Indian newspaper who laid out in Life magazine the idea that China and India were “two testing grounds” and that the results had Cold War implications. Over the next decade and a half, Indian government officials, private sector leaders and public intellectuals used this idea of a China-India competition to attract aid. They also worried about the implications of the race at home. While Indian policymakers often denied there was a race underway, Prime Minister Jawaharlal Nehru accepted that comparisons between India and China were inevitable. In the 1950s, he acknowledged the “great test:” if his government did not “deliver the goods…democracy will then be in peril…Then people may think of totalitarian methods…” He wasn’t the only one making the comparison to the country next door, with many in India complaining about its progress lagging behind that of China. Nehru’s responses would be familiar today: he highlighted the progress that India was making, noted that democracy made development more difficult, emphasized China’s problems, noting that its statistics were exaggerated, and asserted that China’s failures were not as evident because of the lack of openness, but that “the lid” would come off and “terrible criticism” would emerge later. Overall, he stated that development might take longer, but it would be more sustainable in a democracy, which was “the sounder way of doing things.”

More recently, Indian leaders have cited the hare-tortoise or the sprint-marathon analogies to argue that it’s only a question of time or distance, but India will eventually win. But the issue that Nehru brought up decades ago and Bihar Chief Minister Nitish Kumar has brought up more recently – democracy – leads to the question of whether China and India are in the same race at all. If one must put it in sporting terms, the question is whether China is running a marathon while India is participating in a triathlon—one where it is not running, swimming and riding sequentially, but simultaneously, competing in an economic development race, a democratic one, as well as a social one.

India’s progress should be assessed on each of those fronts, even though final results might take a while to come in. Perhaps it is harder to track democratic and social progress. Perhaps statistics are easier to pick and choose from and quote than “the rhythm and sensibility” of countries are to measure. Perhaps the fact that there is nothing monochromatic about India makes it frustrating to assess. And perhaps developments in India lend themselves to different interpretations. Rattner’s piece makes this evident. For example, you can see the government’s response to the protests after a horrific gang-rape as a sign of concern or you can see peoples’ response as one of hope. You can see Mukesh Ambani’s billion-dollar home as a symbol of wealth disparity and limited economic mobility or, as Dhruva Jaishankar of the German Marshall Fund noted, given Ambani’s father’s modest beginnings, you can see it as a sign of the economic mobility that is possible. Or you can see both. Regardless of the difficulty of tracking the triathlon, it is important to look at more than just the economic race India is running. Investors looking for short-term returns might be focused on just that race, but neither Indians nor those who want it to really win should. After all, those who want India to win – and, as Rattner notes, there are many in the West who “fervently” hope that it does – are rooting for that country because it is a multi-ethnic and multi-religious democracy and not despite it. Democracy should not be used as excuse for not developing. But development without democracy is not a prize India should want to win.

Authors

Tanvi Madan

Image Source: © Vivek Prakash / Reuters

The India Investment

Tanvi Madan — Thu, 17 Jan 2013 00:00:00 -0500

The U.S.-India relationship is broader and deeper than it has ever been. On a bipartisan basis, U.S. policymakers believe that, overall, it benefits American interests. But the danger is that it will suffer from Indian and American inattention. Tanvi Madan drafted this memorandum to President Obama as part of Big Bets and Black Swans: A Presidential Briefing Book.

What actions can the U.S. take to continue engagement with India’s policymakers?
How will issues like the Comprehensive Test Ban Treaty and others affect the U.S.-India relationship?
What is “India fatigue” and what can the U.S. and India do to fight it?

Download Memorandum (pdf) | Download the Presidential Briefing Book (pdf)

TO: President Obama

FROM: Tanvi Madan

Your administration has made the correct judgment that the rise of India and its increasing role and influence in the international system benefit U.S. interests. This assessment has been articulated repeatedly and enjoys bipartisan support. While Indian policymakers have not been as vocal, their actions have indicated that they too recognize the importance of the bilateral relationship. U.S. relations with India are broader and deeper today than they have ever been. The danger to the relationship is that it will suffer from inattention – on the Indian side, because of the lack of bureaucratic and political capacity, and policymakers’ domestic preoccupations; on the U.S. side, because of the lack of a crisis or a single high-profile initiative focusing bureaucratic and political attention, and other more-pressing domestic and international concerns. Furthermore, the return on the U.S. investment in India will likely only manifest itself in a major way in the medium to long term. That, combined with political and economic circumstances in India, might lead to “India fatigue” in the United States.

Recommendation:

You have already made a bet on India. In your second term, as you try to shape the emerging global order in a liberal direction, India’s role will become ever more important because of its size, geostrategic location, economic potential and democratic institutions. Accordingly, you need to ensure that your administration stays invested in that bet and perhaps even ups the ante. In many instances, it is India that needs to put more chips on the table. However, there are steps that the United States can take to help increase the momentum, as well as shape the context in which Indian decisions are made. These include working with Indian counterparts to implement existing agreements, conclude current negotiations, and explore new areas of collaboration, in particular in the energy and education sectors. Your administration should also signal sustained commitment to the relationship through continued consultations, high-level visits and timely personnel appointments. Active efforts are also needed to encourage movement on the Indian side, increase public outreach and facilitate the consolidation and creation of constituencies for the relationship beyond government.

Background:

The relationship with India has been one of the little-heralded foreign policy successes of your first term. The momentum, however, will not sustain itself. Along with the danger of drift, there is likelihood that bilateral differences rather than achievements will take center stage. Past irritants are likely to re-emerge. Your administration and the Indian government successfully navigated the tricky Iran sanctions-Indian oil imports issue last year. However, if the situation with Iran worsens and conflict breaks out, Delhi and Washington might find themselves on opposite sides. The U.S. relationship with Pakistan, in the context of the withdrawal from Afghanistan, might create another area of potential difference. The United States has recently encouraged Indian involvement in Afghanistan and a U.S.-India-Afghanistan trilateral is in place. There are already concerns in India, however, that the U.S. desire to assuage Pakistan to facilitate the Afghanistan withdrawal might lead to a reversal of that position. There are also concerns that the United States will be less likely to pressure Pakistan on counter-terrorism issues related to India. Any renewed drive for the Comprehensive Test Ban Treaty (CTBT) might spark bilateral strain as well. U.S.-India relations have changed since the debate over the CTBT in the 1990s. But the CTBT issue could once again lead to contention between the two countries, which will not be restricted to the private sphere. Finally, as you carefully calibrate the relationship with the new leadership in Beijing, dormant Indian concerns about a G-2 or Sino-U.S. condominium will also likely arise again.

Avoiding drift and the dominance of differences will necessitate getting more deliverables from the numerous U.S.-Indian official dialogues. This means implementing agreements that have already been reached. In some cases, the major obstacles to implementation lie on the Indian side — the civil nuclear agreement is one such example — but there are others where the United States needs to act, including in the defense and technology areas. The expeditious completion of negotiations on other agreements would also help, including those related to bilateral investment, as well as defense technology and trade. These agreements have the potential to create opportunities for the U.S. private sector to invest in India and generate jobs here at home. It can also create new constituencies for the relationship, including at the state level, in both countries and demonstrate that the United States is interested in strengthening

India’s economy and security, as well as those of the United States. New assessments will be needed of other areas in which there can be substantive cooperation: space, maritime, and cyber-security offer opportunities. The United States and India should try to move from consultation in these areas to joint initiatives. An updated feasibility study on a free trade agreement with India could also clarify the desirability of moving on that front.

While diplomatic, defense and economic engagement get the most attention, cooperation elsewhere could bear fruit, particularly in the energy and education sectors. Your administration’s efforts should include urging Indian reform of its higher education sector to allow the participation of American universities. Meanwhile, research collaboration, academic exchanges, and university linkages should be facilitated, and you should encourage India to review visa procedures to facilitate more American citizens studying and working there. U.S. immigration reform that includes addressing the question of the mobility of high-skilled workers could strengthen the U.S. hand in encouraging these changes. On the energy front, the administration should work to allow the export of natural gas to India, while explaining that this is not the major solution that many in India seem to think it is. Furthermore, there should be additional progress on cooperative clean energy initiatives and the opening up of the energy infrastructure sector in India to greater U.S. investment.

Progress in these areas will require difficult domestic decisions for the Indian government. Yet recent statements and actions from Delhi have shown that it recognizes the magnitude of the problems and the need for foreign investment and cooperation. Progress on these issues would also encourage engagement from state governments, corporations, civil society and individuals on both sides. Finally, while offering opportunities for the American people and corporations, these initiatives would also help build physical and human capacity in India, and demonstrate U.S. investment in India’s future.

The quality of bilateral interaction will also need to improve further. As personnel change on the U.S. end and, potentially, on the Indian side, there is a need to ensure that the level of trust and workinglevel cooperation that has been established is not lost. The relationship requires White House attention and coordination, which would be facilitated if an official responsible for India policy is appointed. Furthermore, India-related positions across government need to be filled speedily and not left vacant as they were in some high-profile instances in the first term. This is especially important since post-Afghanistan withdrawal and with the possible consolidation of South Asia bureaucracies, there is a danger that India will revert to being seen in the government as just another South Asian country. India’s involvement in the rest of the world is only going to increase. If the United States does not continue to engage with it on regional and functional issues outside South Asia, it will miss an opportunity to cooperate and increase the possibility that India will hinder U.S. interests.

There is a continuing need for attention and commitment at senior levels. You could make evident your personal interest by visiting India during your second term, making you the first U.S. president to visit India twice. A reciprocal visit from the Indian prime minister should also be encouraged. Such visits would be especially important if there is a change in leadership at the top in India.

An overarching challenge is how to facilitate movement with India without stepping on Indian sensitivities and becoming an issue in Indian domestic politics. First, your administration should continue to share with the Indian government your concern that “India fatigue” will make further progress on our end harder. India will need to help cultivate constituencies in the United States that support the relationship. In certain instances, pressure will be called for; ideally, it should be applied privately. Second, through a more vigorous and consistent public outreach effort in India, your administration needs to explain the content and objectives of its policies and agreements, as well as how India benefits. If the United States does not fill the vacuum, others will do so with misinformation or disinformation. Such an effort should also engage critics and, while keeping the sitting government informed, opposition leaders.

Conclusion:

You will need to manage the differences that the United States will continue to have with India and not underestimate the difficulties India’s rise might create for some U.S. interests, for example at the U.N. or in global trade talks. However, your judgment that the United States and India are natural partners and that the benefits of India’s rise outweigh any costs remains sound. But the relationship needs continued nurturing. It also requires sustained buy-in from legislators, corporations and individuals who have been key in driving the relationship; more recently their support has been flagging. Importantly, India needs to do its part too. It is likely that it will. India is concerned about an economic slowdown and the security situation in its neighborhood, especially involving China and Pakistan.

It also continues to aspire to a greater role on the world stage. And Indians realize that the United States can play a critical role in helping India achieve its security and economic goals to an extent that perhaps no other country can.

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Authors

Tanvi Madan

Image Source: © Stringer India / Reuters

India’s Protests as a Social "Stress Test"

Raj M. Desai and Shareen Joshi — Fri, 28 Dec 2012 13:00:00 -0500

2012 has been a rough year for India’s government. It began with a series of protests led by an anti-corruption activist, who went on hunger strikes to protest foot-dragging by the government in passing a new anti-corruption law. Then, as a reminder of one of the worst scandals in recent memory, the Indian Supreme Court revoked all broadband licenses granted through what turned out to be illegal spectrum auctions. On the economic front, India has maintained stubbornly high inflation and the Indian government lowered the economy's growth forecast for the current financial year to 5.7 percent, the lowest in a decade.

As if these events were not bad enough, just in time to ring out the old year, major protests have broken out across the major cities in India over the brutal rape of a 23-year-old medical student in New Delhi. In Delhi’s famous Raisina Hill area where the parliament, presidential palace and several ministries are located, thousands of demonstrators clashed with riot police for several days before the area was barricaded. Those who have witnessed the protests—including the authors of this article—have noticed that the protesters’ anger is directed against the country’s police and politicians as much as it is against the rapists. The crowds also bear more than a passing resemblance to those participating in the Arab Spring protests in early 2011, being composed predominantly of urban youth, mobilized through social media, whose collective anger is being vented at various targets all at once.

In fact, one can think of the protests as motivated by a confluence of three major stresses facing contemporary India: crime, government ineffectiveness and gender inequity.

To begin with, India’s police remain unable to provide basic policing services, even after reforms put in place following the terrorist attacks in Mumbai in 2008. Delhi, for example, is home to one of the largest metropolitan police forces in the world with some 84,000 officers. But only one-third are involved in any kind of actual “policing” at any given time, while the rest provide protection services to various politicians, senior bureaucrats, diplomats and other elites. According to the Times of India there is one officer for every 200 citizens and about 20 officers for every VIP. Many of those who do perform police duties can be found shaking down motorists, participating in protection rackets and simply looking the other way as crimes take place. The victim herself was allegedly being assaulted on a bus traveling along a major thoroughfare that crossed police checkpoints. Many police departments around the country lack basic crime-fighting resources such as forensic facilities or specialized crime units. Police are provided with little training on securing crime scenes, gathering evidence, or conducting criminal investigations. There are no nationwide standards for training, competence or accountability.

And then there is the perception of a corrupt, paternalistic governing class that seems to have been left behind as rapid changes have swept other parts of Indian society. As India’s economy has acquired a global reputation as an IT services hub, government offices are still buried under piles of handwritten records. Even as India’s businesspeople—from its CEOs to its small shopkeepers to its millions of rural and urban micro-entrepreneurs—have innovated and discovered new markets, their government still operates as it has for decades. And when young protesters ask for improvements in policing or changes in government behavior, politicians warn of chaos and disorder, or simply keep silent. It took the prime minister one week to comment on the recent demonstrations. The home minister likened the protesters to the Maoist insurgents that the government is currently fighting. And the Delhi police commissioner, when asked what is being done about improving ties with the public, responded by mentioning “vocational work” for the poor. “Young India, old politicians,” is how author Gurcharan Das once described this gulf between the aspirations of its citizens and the incapacity of its politicians to deliver.

Finally, it is no secret that India remains a difficult country for women despite major advances by women in professional life. Basic indicators—female literacy, female labor force participation, female life expectancy and maternal mortality—are low relative to South Asian neighbors (Bangladesh and Sri Lanka) and even when compared to poorer countries such as Laos, Yemen and many countries in sub-Saharan Africa. The male-female ratio, a statistic that says much about the status of women in a society, remains one of the lowest in the world with only 940 women per thousand men. These “missing women” are largely victims of sex-selective abortion, poor investments in health and education for girls, and their general neglect. Delhi and neighboring Haryana state have sex-ratios below the national average: 866 women and 830 women for every thousand men, respectively. The surplus of single men, the prevalence of widespread youth unemployment and the persistence of traditional marriage practices have combined to produce serious social consequences, including violence against women.

As for the incident that sparked the current protests, the official statistics are even grimmer: almost 25,000 rapes were reported to police in India in 2011, a 25 percent increase over the previous year. According to local reporters, this is a fraction of the over half-million rapes that are actually committed each year—almost one every minute. With less than 7 percent of the police officers being women, the police are widely accused of gender insensitivity and apathy to crimes against women. In 2010, as many as 414 rape cases were reported in Delhi, the highest among 35 major cities in the country. According to the National Crime Records Bureau, the conviction rate in these rape cases was less than 35 percent. An investigative report by NDTV and Tehelka Magazine exposed how male police blame women for violence and harassment against them; remarked a station commander of a Delhi precinct: “if girls don't stay within their boundaries, if they don't wear appropriate clothes, [this] attraction makes men aggressive.” A senior police officer from the same precinct later revealed the identity of a minor who was gang-raped in a moving car, criticizing her “moral character” at a press conference.

The public debate in India continues. Senior members of the Delhi and national governments have broken their silence to acknowledge the magnitude of public discontent. Some short-term measures have been proposed: a new helpline for women, a promise to prosecute rape cases quickly, a strengthening of punishment against rape and other crimes against women, etc. A special session of parliament has been convened to address short- and long-term solutions to these issues. It remains clear however, is that solutions to the protesters’ concerns are neither quick nor simple. An overhaul of law enforcement systems is required, with investments in recruitment, organization, training, and new systems of accountability and oversight. Laws against sexual crimes must be strengthened. And most importantly, greater dialogue about India’s patriarchal norms must continue.

As for the other societal strains that moved the protesters, organized collective action will be needed long after the street demonstrations have died down, as will the sustained mobilization of women and young people. Women in India have been slow to organize around crosscutting issues. In the years since independence, the Indian women’s movement has been largely eclipsed by other divisions along the lines of class, caste, tribe, language, religion and political affiliation. And an irony that has not been lost on some commentators is that the crowds protesting in the cities—young, middle- or upper-middle class—are not generally dependable voters in Indian elections.

Perhaps the recent protests are a turning point, a sign of growing awareness that the problems of policing, bad governance and crimes against women have been neglected by the normal political process, and that they have implications for managing social tensions as well as for economic development. Given that two-thirds of India is today below the age of 35, the potential for the voice of the youth to shape national policy is powerful, if still unfulfilled. As the New Year approaches, Indian politicians would be well-advised to remind themselves of the lessons of the Arab Spring: young people may not matter in politics… until they do.

Authors

Raj M. Desai
Shareen Joshi

Image Source: © Adnan Abidi / Reuters

The Gold Effect on Inflation

Urjit R. Patel — Thu, 22 Nov 2012 13:53:00 -0500

The data flow in recent months suggests that despite considerable tightening of monetary policy by the Reserve Bank of India (RBI) over the course of 2010 and 2011, inflation, whilst having declined, has exhibited disquieting stubbornness. India has also been an outlier in relation to most of its comparators in the context of price stability. Evolution of Indian inflation has brought forth several explanations, most with some merit. Among these both monetarist theories and structural explanations have been advanced, as well as internal and external factors. In the former category, a delay or insufficient tightening early in the cycle resulted in generalised inflationary expectations to percolate widely through the economy; in other words, policy makers initially underestimated the risk. In the second category, domestic food price developments catalysed by changes in minimum support prices are drivers. In addition, it has been argued that wage push on account of government funded entitlement schemes in rural areas continues to put upward pressure on prices. Among the external causes, high oil prices since 2008 has been important in policy discourse. Another external variable that has, intermittently, lent itself as a contributor to price pressure at home is high global prices of diverse food cereals.

At its simplest, interest rate changes for controlling inflation works by tempering current investment and consumption by making it more expensive to borrow; in part, growth in aggregate demand is moderated through inducing a change in expected future market interest rates. Usually, the private sector responds to the change in incentives more than the government. Cumulatively, over the cycle, the RBI’s policy rate changes have been prima facie striking, even as the impact on inflation has been gradual and less effective than what policy makers had probably hoped for. The Repo rate was increased in thirteen steps between March 2010 and October 2011 from 4.75 percent to 8.5 percent. Inflation measured by the Wholesale Price Index has remained above the RBI’s comfort zone of 5-5.5 percent for three years now, and persists in the 7-8 percent range. The Consumer Price Index, which analysts claim is important for assessing the trend in inflation expectations has stayed in the range of 9-10 percent since April 2012; that is why the RBI has refrained from further cuts since the fifty basis point reduction in April.

There can be several plausible reasons for the relatively slow price response to an activist monetary policy including, inter alia, a deep fiscal malaise requiring persistent increases in seignorage which is feeding expectations of continuing inflation, “misbehaviour” of monetary policy transmission channels vis-a-vis the real economy, etc. It is noteworthy that seignorage as a ratio to GDP has seen an uptick in India post-2007 compared to immediately prior years in that decade.

There might be an additional explanation. Indians in recent years have benefited from a huge positive boost to their private wealth (and private net worth); this wealth effect originates in the 75 percent increase in global gold prices between October 2009 (roughly US$ 1,000/ounce) and October 2012 (about US$ 1,750/ounce); in Rupee terms the increase is more. Even while keeping aside the rise in volume (that is, inflow) of gold imports in recent years, India’s widely held private stock of gold is disproportionately large; a quick data scan reveals estimates of the stock ranging from a low of 13,000 tonnes to as high as 40,000 tonnes (the latter is probably an exaggeration). As an example, assume that the private stock of gold in India was 17,000 tonnes in 2009; the value of this in October 2012 would work out to about US$ 960 billion (over 50 percent of gross domestic product) compared to around US$ 550 billion three years earlier. The time frame is illustrative, and some other snapshot can be used.

There is little doubt that India is sui generis when it comes to the importance of gold in its citizens’ portfolio of savings instruments and stock of wealth. While gold is not the only global commodity whose price has increased appreciably, gold has characteristics that are distinctive. Households rarely hoard other commodities to pass them from one generation to the next; the exception would be oil owned by Saudi princes. Long after the “Gold Standard” become history, gold held by central banks, national treasuries and multilateral institutions is still counted as a foreign asset in official balance sheets. Physical gold as store of value and as a “guarantee to redeem promises” puts it in a class of its own among physical assets.

While the real value of most financial assets held by Indians has declined (in line with developments elsewhere), house prices have somewhat moderated and business investment has stalled against the background of poor governance, the boost in the value of the stock of gold may have engendered wealth effects that propped up household consumption (at least to some extent) even as policy has increased interest rates across the board. It is not unreasonable that enhanced feeling of well being due to higher wealth can induce a consumer to spend a higher amount from her recurring “normal” income. Of course, it is not that policy induced interest rate hikes have been ineffective for price and real economy developments; the argument is that a coincidental, essentially external, dynamic may have helped to partially offset the effects of monetary tightening. Asset prices have been known to unravel – especially instances when the run up is of the “bubble” variety rather than fundamentals driven, which may be more enduring. Therefore, households’ perception of the permanence or temporariness of the gold price increase (and their increase in wealth) is critical for determining the extent to which their consumption has been impacted on account of this channel.

In conclusion, if gold prices stay elevated or increase going forward, and wealth effects emanating from this externally generated feature are quantitatively important, than monetary policy has that much more work to do to tame inflation.

Authors

Urjit R. Patel

Publication: Business Standard

Image Source: © Ajay Verma / Reuters

Why the End of British Aid to India Won’t Matter

Raj M. Desai and Natasha Ledlie — Wed, 21 Nov 2012 11:10:00 -0500

The British international development secretary, Justine Greening, recently announced that all assistance from the UK to India will end by 2015. The withdrawal of foreign assistance from India’s largest donor affords an opportunity to reflect on the role British aid (indeed, all foreign assistance) has played in Indian economic development, and on how Indian anti-poverty programs will evolve in the absence of foreign aid.

The Indian beneficiaries of UK aid programs will inevitably feel the loss of the experimentation and risk-taking that characterized UK aid. On the other hand, India has also been moving away from more fragmented anti-poverty programs traditionally supported by donors towards more centralized, universal schemes. But these reforms require increasingly sophisticated management and accountability mechanisms — something donors have had limited success in supporting. While the absence of British aid may leave a small hole, it will not affect India’s anti-poverty efforts.

To put the aid stoppage in context, consider that UK assistance comprises about 15 per cent of all foreign aid received by India. The UK gives slightly less than 10 per cent of its foreign aid to India. This makes India the largest beneficiary of UK aid and the UK the largest donor to India. Given the current state of the British economy, it is only natural the UK would be forced to reconsider its assistance to fast-growing countries such as India. Indeed, other donors may soon follow suit, forced by fiscal constraints. In the U.S. foreign aid may be cut due to “budget sequestration”, under which all government programs will be subject to across-the-board cuts.

More than half of official aid from Britain to India went to programs focused on education, health, nutritional programs, and water and sanitation access. In relative terms, these are not large amounts (the $450 mission in total annual British aid was about 0.04 per cent of India’s GDP). Despite some prevailing views that the Department for International Development was merely a source of British “soft power” or that British aid simply supported British strategic and commercial interests, the evidence suggests that Britain has been one of the better-behaved donors. According to a joint assessment of the Washington-based Brookings Institution and the Centre for Global Development, DFID performs quite well when ranked against other donor agencies on measures of efficiency, institution-building in recipient countries, keeping administrative burdens to a minimum and ensuring transparency.

British aid was also an invaluable source of piloting, access to knowledge and risk-taking. The Business Innovation Facility funded by DFID is a decent example of this—a programme that supported companies as they developed and implemented “inclusive” businesses that expanded opportunities for the poor. This was an example of foreign aid at its best: a gateway to current information, a clearinghouse for insights on good practice, a resource for businesses, and of course, targeted financial support.

On the other hand, British aid—and most foreign aid—has achieved only modest success in helping countries such as India make the transition from a multiplicity of narrowly targeted interventions, transfers and subsidies to a comprehensive welfare system. Both bilateral and multilateral aid to India may be rightly criticized for placing too much faith in these narrower instruments.

Many observers have long pushed for more comprehensive social policies based on universal provision of essential services in India, and for less reliance on narrower social programs. The latter have not served India well. In the past two decades, for example, India has grown much richer than Bangladesh and Nepal. But during the same period, both countries have overtaken India in terms of life expectancy, infant mortality, fertility rates, immunization rates, and female literacy. India’s expansion has been characterized by Jean Dreze and Amartya Sen as “growth without development”. In recent years, the Indian government has moved to consolidate social policy through nationwide multi-sector programs such as NREGA. But the local bodies largely responsible for administering them continue to suffer from capacity weaknesses. It is in governance and institutional capacity-building at the local level that foreign aid has had less impact.

While few in India may shed tears over the end of British official aid in India, the occasion should also provide an opportunity to double efforts to reform the public institutions that govern social policy and poverty alleviation.

Authors

Raj M. Desai
Natasha Ledlie

Publication: The Indian Express

Image Source: © Reuters Photographer / Reuters

Prospects for Indian Internationalism

Thu, 25 Oct 2012 14:00:00 -0400

Event Information

October 25, 2012
2:00 PM - 3:30 PM EDT

The Brookings Institution
1775 Massachusetts Ave., NW
Washington, DC

On October 25, the India Project held an event with C. Raja Mohan, distinguished fellow at the Observer Research Foundation, moderated by Teresita Schaffer, nonresident senior fellow with the 21st Century Defense Initiative, on prospects for Indian internationalism. His remarks and a summary of the following question and answer session can be found below.

1. Expansive Internationalism:

India’s heritage of internationalism contributed to the Indian independence movement. The Bengali literary giant Rabindranath Tagore expressed a vision broader than nationalism, with a spiritual emphasis that, far from being anti-Western, included Western spiritual movements and found echoes there. Socialism and Communism were at their height as international movements during this time. Wendell Willkie’s One World, which built on the shattering disillusion after World War I, had influence in India.

When India became independent, one of the first big events was an Asian unity conference. This showed both the dimensions of Nehru’s international vision and its limitations. Nehru called for observance of universal human rights, and expounded an interventionist approach to the United Nations declaration on human rights. India’s opposition to racism and specifically to apartheid was one of the leading features of the internationalism of this period. India broke diplomatic relations with South Africa as early as 1948.

But even in this early period, Nehru’s expansive vision was tempered. The Kashmir crisis made clear the need to defend Indian sovereignty. India’s policy toward intervention was inevitably inconsistent. India opposed the UK/French/Israeli Suez operation but not the Russian invasion of Hungary. India itself used force in Goa, despite Nehru’s peace policy and rhetoric.

2. Dysfunctional multilateralism (the post-Nehru period, into the 1980s):

During this phase, India’s internationalism became less idealistic and more ideological. The Non-Aligned Movement became more radical, and this influenced India’s positions. This was the period of the United Nations resolution equating Zionism with racism, which India supported. This coincided with a period of populism at home, with Indira Gandhi’s “abolish poverty” efforts.

India’s engagement with the world diminished during this period. Its economy became less international; its economic engagement with its neighbors also dropped. The memories of the 1970s still live on in some of the sensibilities on the Indian scene and, importantly, in the image of India’s policies held by non-Indians.

3. Defensive internationalism and regionalism (late 1980s through 1990s):

During the initial post-Cold War decade, India’s policies on international engagement were largely negative. India resisted international urgings to use “preventive diplomacy” to resolve Kashmir. Its response to assertive nonproliferation was hostile. It was largely negative toward the new United Nations agenda. All these initiatives were seen as threats to India’s sovereignty.

At the same time, the groundwork was being laid for a new and more dynamic phase of international engagement. India became more deeply involved in regionalism during this time. Its relaunch of closer relations with East and Southeast Asia was especially significant, along with its having joined some of the ASEAN-linked groups.

4. Responsible multilateralism (since 2000):

Between 1980 and 2011, India’s two-way goods trade grew from $22 billion to $750 billion. The growth would be even more striking if one included services. Imports and exports grew to about 45 percent of India’s GDP.

This increased economic engagement with the world paralleled increased political engagement. Relations with the United States were transformed; this decreased Indian fears that the United States would try to “roll back” its nuclear assets, and India in turn softened its opposition to international nonproliferation, seeking to join the nonproliferation-related export control groups. The United States also muted its “activism” on Kashmir.

At the regional level, India’s outreach in East Asia strengthened. India also deepened its involvement in selective international groupings, such as BRICS and IBSA. It continues to participate actively in the Non-Aligned Movement, but Dr. Mohan regarded this as an inconsequential ritual.

Globally, India somewhat softened its position on climate change. It continued to seek a permanent seat on the United Nations Security Council, this time with United States support. India’s term in a non-permanent seat, however, had turned out to be a big disappointment for the United States, largely because of problems the Council faced in the Middle East.

India is changing from a rule-defier or rule-taker on the international scene to a rule-maker. As it does so, it is insisting on some level of accommodation.

5. The problem of the Middle East:

The Middle East poses a particular problem for Indian foreign policy, one which constrains India’s engagement with the international community. The large Indian Muslim population has been a matter of great sensitivity for India’s rulers even during the time of the Raj. Post-Independence, Pakistan has further constrained India’s policy. India’s goals are to protect India’s secularism and to ensure that Pakistan is not accepted as the spokesman for Muslims in opposition to India.

On the international scene, on issues that are framed between the West and Islam, India will tilt toward Islam or remain on the sidelines. Issues that are framed between Sunni and Shia-majority Muslim countries give India more space, hence India’s ability to support the Arab League mission in Syria.

Discussion:

During the discussion period, the following key points came up:

• India has massive economic interests in the Middle East, including dependence on that region for 70 percent of its energy imports and the presence of some 6 million Indians in the Gulf and elsewhere. It also has an active relationship with Israel. Saudi Arabia has become a more important economic partner than Iran.

• Why was India’s position on Libya at the UN so anti-Western? This was a case of delayed Indian adaptation to changed circumstances.

• India’s interest in permanent membership of the United Nations Security Council reflects its longstanding view that India should “be a member of any club that exists.” It may not happen soon; if India gains in strength, that will transform the situation.

• India has had difficulty finding the right style for engaging in Asean. Economic engagement in East Asia is important. India has free trade areas with Japan, Korea and Asean, but Indian politics are not yet ready to handle the Trans Pacific Partnership.

• India wants the United States to remain engaged in East Asia, and has supported the U.S. agenda on freedom of navigation.

• India and the U.S. have come a long way in their security relationship. The 2005 Defense Cooperation Agreement is an important milestone, as are service-to-service cooperation, defense industrial cooperation, and now shared missions. Trilateral and regional security cooperation in Asia are expanding. India has urged the IORARC to admit the United States and included the U.S. as observer in the Indian Ocean Naval Summit. This is still a subject of internal disagreement in India. India under the Raj was a “security provider”; it may move back to that position.

• India may be starting to move away from its classic insistence of a UNSC mandate for military operations. (“do you want to get Chinese permission every time you use Indian forces?”)

• India is skeptical of international disarmament negotiations. The international community needs to take on new issues: use of space, and how to create new rules of the road.

• India is a trading power and now emphasized keeping sea lanes of communications open. China has not yet shifted to giving priority to this issue in the South China Sea.

• Institutions and interests shape India’s policy more than personalities. There are few Indian internationalists on the right side of the political spectrum. We need to build up the realist discourse on foreign policy.

• Nonalignment 2.0 does not constrain government policy. If India doesn’t have “a US game,” it can’t have a “China game.” It can’t hang back indefinitely.

India and China Should Go Their Own Ways

Eswar Prasad — Mon, 21 May 2012 11:25:00 -0400

In the aftermath of the financial crisis, emerging market economies, led by China and India, kept world growth from collapsing. As Europe again teeters on the brink of disaster and the tepid US recovery lurches along, the growth slowdowns in China and India augur rough times ahead for the world economy.

To keep these two engines of world growth on track, fiscal policy intervention must be a priority. What is needed in each country is a mirror image of the other. China needs more, well-targeted fiscal stimulus while India needs fiscal discipline. While these actions are diametrically opposed due to different circumstances in each country, they will have similar, positive effects. Fiscal policy, if executed well, could help stimulate private demand, boost business and consumer confidence and improve the effectiveness of monetary policy.

With both domestic and external demand slowing, the Chinese government faces a choice of policies to hit this year’s growth target. As in 2009-10, looser monetary policy and a rapid burst of credit expansion by state-owned banks could do the trick of boosting investment and output. But this would come at a heavy cost – a retreat from the goal of a consumption-driven economy, more wasteful investment spending and additional bad loans in the banking system.

By contrast, a healthy dose of fiscal stimulus would not only bolster short-term growth but also make long-term growth more sustainable and equitable. Well-targeted increases in social expenditures, including on health and education and a better social safety net, would reduce incentives for precautionary savings and encourage consumption.

China has adequate room on the fiscal policy front. The level of public debt, estimated by the IMF to be about 25 per cent of gross domestic product, is low by international standards and the government budget was close to balance in 2011. No doubt local government debts and contingent liabilities in the banking system – loans that could turn sour if growth slows – might mean a higher implicit public debt burden. But many of those contingent liabilities will not turn into real liabilities unless growth slows sharply.

In India’s case, high public debt, nearly 70 per cent of GDP, and a persistently high fiscal deficit have hamstrung monetary policy and kept the current account deficit large. This makes the economy vulnerable to external shocks such as oil price increases and capital flow reversals.

The government’s inability to push through fiscal and other reforms has further spooked domestic and foreign investors. The Indian rupee yesterday fell to a record low against the US dollar and growth in industrial production has stalled. The central bank has been forced to lower interest rates to support growth, even as inflation has surged to dangerously high levels.

An ambitious medium-term deficit reduction plan, along with short-term measures such as replacing inefficient fuel subsidies with direct cash transfers, would rebuild confidence in India’s long-term growth prospects.

Monetary policy is typically the first line of defence against macroeconomic shocks. But in both China and India, its effectiveness has been compromised by inadequate support from fiscal policy. These countries need to straighten out their policy mix so monetary policy does not fight a lonely battle on multiple fronts to restore growth, keep inflation under control and compensate for the failings of fiscal policy. In both countries, fiscal policy intervention is one way to resolve potential tensions between short-term and long-term objectives. In China, well-designed fiscal measures would provide a short-term boost to growth and help to rebalance it. In India, a reorientation of government expenditures and a more credible plan for medium-term fiscal discipline would boost consumer and investor confidence.

The growth versus-austerity-debate has been derided by some as presenting a false choice. But some advanced economies are caught in a bind where they are unable to make progress on either objective.

If China and India play their cards right, they can have it both ways, lock in short-term growth and improve long-term prospects and, once again, carry the world economy on their shoulders.

Authors

Eswar Prasad

Publication: Financial Times

Image Source: © B Mathur / Reuters

India's Rupee in Free Fall

Eswar Prasad — Mon, 21 May 2012 10:56:00 -0400

The falling Indian rupee, which Monday closed at an all-time low relative to the dollar, is a perfect metaphor for the free fall India's economy seems to be in. Growth has slowed to below 7%, and industrial growth has virtually ground to a halt. High oil prices widened the current account deficit, and now finicky global investors are pulling capital out.

Prime Minister Manmohan Singh and his government face a stark choice that they can no longer avoid. They can batten down the hatches and try to get the central bank to intervene in foreign exchange markets to ride out the storm. Or they can heed the real message of the rupee's fall: India's policy making has lost its way. How the government responds will determine whether India's economy gets its shine back or slides into old "Hindu" rates of growth or worse after just a few years of stellar performance.

One problem is New Delhi's undisciplined fiscal policy, which has hurt confidence in both India's ability to weather adverse shocks and its long-term prospects. A high level of public debt—nearly 70% of GDP—and a persistently high budget deficit have pumped up overall demand in the economy. This hamstrings monetary policy, which has to keep tightening, and also contributes to the large current account gap. This leaves the economy vulnerable to shocks such as oil price increases and capital flow reversals.

Populism seems to be an overriding consideration in designing fiscal policy. This year's budget, released in February, lacks any ambition to bring down spending on subsidies and other welfare projects. Markets are concerned that, with national elections due by 2014, next year's budget will be no better. The temptation to lard it with populist measures may be too much to resist.

Finance Minister Pranab Mukherjee is now talking about "austerity," though he's suggested only meager measures. Yet even if he proposes something more drastic—like tax increases in the short term—that's not what India needs.

New Delhi instead should clearly articulate an ambitious and detailed medium-term deficit reduction plan. This can be supplemented with short-term measures that would at least reorient government expenditures in a better direction. For instance, New Delhi could remove inefficient fuel subsidies, which mostly end up benefiting the middle class, and replace them with direct cash transfers to the poor. Such measures would rebuild some confidence by signaling that the reform momentum is not dead.

A similarly urgent priority is to resuscitate broader reforms, especially those that make India a more attractive destination for foreign investment. Industry-specific regulation and caps for foreign investors are big deterrents. Rather than undoing these, however, New Delhi proposed policies in its March budget that scared investors even more.

The most worrying is the government's move to retroactively tax mergers or takeovers that involve Indian assets. Many see this tax change as a repudiation of a recent Supreme Court ruling that denied tax authorities the power to extract a $2 billion capital gains tax from British telecom giant Vodafone. Moves like this, whatever their justification, have left international investors with the impression that the rules of the game can be changed whimsically to suit the government's search for revenue.

More generally, New Delhi seems to lack the spine to push through reforms that would have broad benefits. Mr. Singh has done too much backtracking, such as his overnight retreat last year on liberalizing foreign investment in retail.

Policies regarding foreign investors usually whip up jingoistic sentiments in India, but the government hasn't even made repairs to its own systems. Reforms to the public-sector food distribution system, which is characterized by spoilage, inefficiency and corruption, could directly benefit the poor. Unfortunately, the narrative has been seized by those opposed to greater competition in food markets, who argue that it would lead to job losses.

The political constituency for reform is usually hard to find, but Mr. Singh now has the chance to articulate a rationale: that reforms are a must to revive growth and deliver more benefits to the poor. The government has in the past year resorted to half-measures, such as setting up manufacturing zones rather than reforming labor laws and regulations that have hindered the manufacturing sector. But the time has come to put everything on the line.

Of course, to prolong his political life, Mr. Singh could switch to survival mode for the rest of his term, clinging to power while devoting his energy to fending off accusations of graft and mismanagement. This would be a sad legacy for a man who put the country on a high-growth trajectory through reforms he instituted 20 years ago.

Authors

Eswar Prasad

Publication: Wall Street Journal

Image Source: Mukesh Gupta / Reuters

Regaining Fiscal Credibility in India

Vijay L. Kelkar and Urjit R. Patel — Wed, 15 Feb 2012 10:37:00 -0500

Editor's Note: An abridged version of this commentary was published as an op-ed in Mint on February 13, 2012.

The challenge of reining in large fiscal deficits has re-emerged in diverse parts of the world. In India doubts over sustaining a high growth performance have morphed to reservations on broad stability issues. There are two macroeconomic drivers that have changed the state of affairs. First was a sharp depreciation of the Indian rupee towards the end of last year to the extent of it being the worst performing currency among emerging market peers, despite hikes in policy rates. Notwithstanding official foreign exchange reserves of $293 billion, India’s external position is no longer felt to be impregnable; for example, the ratio of short term debt on a residual maturity basis to reserves has more than doubled since 2006/07 to 40 percent in 2010/11. The second factor is that the stream of poor, mainly self inflicted, trends for the expected budget outturn in 2011/12 have turned into an avalanche for the government’s fiscal balance (after correctly accounting for off-budget items). Most components of the budget have gone awry, viz., lower than projected tax revenues, negligible privatization receipts, and subsidies reaching stratospheric levels, especially those related to energy. At present, India’s fiscal position, as measured by such common indicators as the general government budget deficit and the general government gross debt (as shares of GDP) puts it in the same camp as recognized fiscally stretched economies. India has had a run of four years of general government deficit of about 10 percent of GDP, of which the central government’s share is two-thirds. Against this background, it is difficult to reject claims that recent growth performance has been propped up by unsustainable aggregate demand policies.

For the most part, the disquiet over India’s fiscal stance stems not so much from impending external debt service problems as doubts over maneuverability. To start with, a virtual exhaustion of fiscal “insurance cover” to counter cyclically deal with prospective shocks emanating as backwash from serious crisis elsewhere like the euro zone, or, Iran, not to mention the task of recapitalizing government-owned banks as non-performing assets rise. The fiscal situation also severely circumscribes exchange rate management by the Reserve Bank of India as an instrument of strategic commercial policy. Even more worrisome, and a source of considerable uncertainty for the nation’s public finance, is the impending expansion of entitlements, both explicitly for food and implicitly for petroleum products. Furthermore, there has been an excessive reliance on monetary policy in the absence of the requisite fiscal retrenchment in the fight against inflation.

It is important to observe that the adverse evolution in the central government’s fiscal balances in recent times has not wholly been on account of the operation of automatic stabilizers during a cyclical slowdown. On the contrary, the central government’s revenues have been buoyant – the gross tax-GDP ratio increased from 9.7 percent in 2004/05 to 12.6 percent in 2007/08 – on the back of an almost 9 percent average annual real growth rate. The profligacy of the central government has its primary driver in populist spending policies initiated in early 2008 by the ruling coalition leading up to national elections in May 2009; three stimulus packages (including a reduction in indirect tax rates) starting in late 2008 to counter the global recessionary headwinds only accentuated matters.

The challenge of addressing the parlous fiscal situation was squarely faced by the 13th Finance Commission (TFC). Quantitative signposts for general government consolidation were recommended. The TFC called for general government deficits to shrink by 4 percentage points of GDP between 2009/10 and 2014/15 and for public debt to fall from 79 to 68 percent of GDP. The TFC also sought to impart integrity to the budgetary process of the central government by drawing attention to off-budget liabilities that had been accumulated since 2005/06.

It is natural at this juncture to examine the broad possibilities to obtain the quantum of consolidation envisaged by the TFC. On the revenue side, the decline in indirect taxes on account of excise duty reduction in 2008/09 presents a natural point for efforts to reverse the trend. In addition, removing exemptions on the direct tax side will add to the revenue kitty without upward tinkering of tax rates. Even more importantly, implementing a comprehensive Goods and Service Tax (GST), which encompasses the petroleum sector, should not be delayed. Rationalization of coal prices in tandem with its inclusion in GST is desirable, viz., mitigating distortion between hydrocarbon fuels and although coal has a share of one-half in commercial primary energy consumption its share in revenue is negligible at 0.1 percent of GDP.

The expenditure side, where the government’s credibility is at its lowest, presents the toughest challenge. India has painted itself in a corner in this regard. Analogous to old-age and health related commitments in mature economies, the implementation of schemes for the poor in India (inter alia comprising of sector subsidies) have been mangled into unconditional, uncapped and open-ended entitlements. In political economy terms, all non-merit subsidies are considered part of social spending, hence a holy cow. A widening of the food security net combined with the inability to adjust petroleum product prices has engendered a backdrop to India’s fiscal challenge that almost seems overwhelming, especially since the large number of stakeholders who benefit from the schemes are perceived, rightly or wrongly, to vote against political dispensations that seek to downsize outlays.

One form of expenditure growth mitigation could be a phased expansion in entitlement coverage so that the impact on the budget is spread over several years. Over time, Aadhar – under implementation by the Unique Identification Authority of India – through better targeting should help to plug leakages and assist expenditure control. However in the near term, on balance, given the constraints on the expenditure side, viz., interest payments, defense and education, disproportionate adjustment on the fiscal balance is likely to come from revenue enhancements.

The difficult path of consolidation is further challenged along other dimensions. Growth is faltering, and even as headline inflation finally shows sign of declining, an important caveat is in order. Energy prices, comprising petroleum and power, have not yet been adjusted to the requisite levels by some distance, with concomitant pass through implications. Core inflation is still above the comfort zone and, therefore, the down cycle in interest rate reduction could be delayed. There has been procrastination in reorienting growth drivers towards eliciting supply and productivity responses in key sectors, and away from government sponsored aggregate demand. Lastly, investing in macroeconomic management credibility means that the Indian government cannot postpone matters; easy options have been exhausted for some time.

Authors

Vijay L. Kelkar
Urjit R. Patel

Publication: Mint

Image Source: © Rupak De Chowdhuri / Reuters

Mumbai Elections: How India’s Regional Politics Affect the Country’s Future

William J. Antholis — Wed, 15 Feb 2012 17:45:00 -0500

This week, I will profile India’s three most important states. Maharashtra, Tamil Nadu and Gujarat are as different as New York, Texas or California. In fact, since each state has its own official language, the better comparisons may be with England, France and Germany. Their chief ministers are no more alike than Andrew Cuomo, Rick Perry and Jerry Brown—or Nicholas Sarkozy, David Cameron, and Angela Merkel.

Friends and "frienemies": Maharashtra is India’s richest and most important state. With over 100 million people and the highest GDP per capita of a major state, it spans the full range of India’s industrial, rural, and cultural diversity.

Moreover, its capital, Mumbai, is India’s largest, most cosmopolitan, and most complicated city—an all-in-one financial, manufacturing, and entertainment capital. Scores of Indian companies headquarter here. Mumbai is New York, Los Angeles, and Miami rolled into one. Only New Delhi comes close in importance.

Prithviraj Chavan, a Berkeley-trained engineer, is Maharashtra’s Chief Minister. He is the ultimate manager, appointed his post a year ago by Sonia Gandhi's Congress Party. In New Delhi, he successfully ran key national ministries such as atomic affairs, personnel, scientific affairs, and parliamentary affairs.

Now Chavan is back in Mumbai. He must wake up each morning wondering what he did to deserve this job. For all of his hometown’s riches and charms, it faces immense challenges: insufficient roads and sewers, and an insatiable thirst for water and power. Those deficits are compounded daily by a fast-growing population. Mumbai has about 12 million people in the city itself, and about 30 million in the metro region.

While Chavan is well-regarded by business leaders and academics, he inherited a nearly impossible job. In the capital city alone, he is a technocrat fighting a war against not one, but two political machines. That two front war will witness a critical battle tomorrow: the Mumbai Municipal elections.

The first front is with Mumbai’s Municipal Authority, currently run by the Shiv Sena party. Chavan's Maharashtra state headquarters are less than two miles from the Mumbai Municipal Authority, both a short walk to the iconic Gateway to India. But the two governments might as well be on different ends of the country. In fact, being farther apart might be better for the city and state.

Mumbai city and Maharashtra state battle over education, infrastructure, and public housing—the last item being crucial in a city with over 8 million living in slums. The Municipal Authority is controlled by the party boss Bal Thackeray, and his son Uddhav, who have ruled the city for two decades. They built their machine to fight the influx of non-Maharashtrans who flooded into the city’s slums. “Hordes of people are coming in,” Bal Thackeray recently told The Hindu. “Who will provide them amenities?”

Shiv Sena and their allies in the BJP have built their party on explicit appeals to the “Hindu civilization”—similar to the emphasis on “Western Civilization” or “Judeo-Christian values” at the center of American conservatism. The Shiv Sena also consistently argues against New Delhi, and argues for local control in decision-making, administration, and taxation.

Under Shiv Sena, local rule has been a mixed bag in Mumbai. It’s most recent accomplishment is the new Sea Link bridge that connects the northern suburbs to the financial and business districts, cutting a half hour of travel. On the other hand, Sea Link (and many other) projects have been notorious in failing to meet deadlines and failing to match their projected budgets. Government contracts regularly go to friends of the Shiv Sena.

The winning bids are preposterously low—so low that they could not possibly meet the specifications appropriate for the road or bridge in question. That leads most outside observers to suspect a bribe was also paid. So when the projects are then implemented, they come in way over budget. The city of Mumbai ultimately has to come back to Maharashtra or to Delhi to bail them out.

So Chief Minister Chavan is trying to beat the Shiv Sena based on a platform of cleaning up corruption. He is promising better administrative performance, especially on infrastructure. He also is targeting the non-Maharashtrans who have moved into the city slums. His big promise: greater and faster access to public housing.

The population in Dharavi—the place made famous by Slumdog Millionaire—are the emerging swing voters of Mumbai. Like the ghettos of New York in the early 1900s, many Dharavi dwellers have moved here to live and work—something my 9 year old-daughter could glimpse in a recent visit. Dharavi residents are not resigned to their fates. They are upwardly mobile. They wait for permanent housing, and hope for clean water, sanitation, and electricity. In appealing to the slum-masses, Chavan and his party argue that the state is a more capable and inclusive administrator than is the corrupt Municipal Authority.

If politics were only about wrestling with Mumbai city, Chavan might be able to muscle through. Instead, he also wages a battle with his own coalition partners in the state legislature. Chavan’s Congress Party controls 82 seats (21%), and forms a coalition with the break-away National Congress Party (NCP), which controls 62 seats (16%), as well as a number of smaller parties. Moreover, the Congress Party also needs NCP votes to form a government in Delhi. Though the NCP provides only 9 out of 262 votes in the national governing coalition, that is a critical block.

The NCP's boss is Sharad Pawar—a sugar magnate from Pune, and a former Chief Minister of the state. Pawar is happy to wield the enormous power that his NCP votes bring. In Delhi, he traded in his 9 votes in parliament so he could hold the post of Agriculture minister. In that job, he has gone slow on liberalization of farming—much to the chagrin of domestic and foreign investors in Mumbai who want to develop India’s agricultural riches.

In Maharashtra, Sharad Pawar also wields power. His nephew, Ajit Pawar, is the Deputy Chief Minister. His portfolio includes responsibility for finances, giving him an effective veto over anything Chavan wants to do. Like his uncle, Ajit has been deeply involved in agricultural issues. So while Chavan might fight to reform the power or water sector to help in the development of urban areas, the Pawar family will fight to make sure that agricultural interests are not ignored. In a state where about the half the people are still rural, that means steering resources to the countryside.

Given that tense alliance, every state or national election provides the Congress and NCP an opportunity to reset the balance. In advance of municipal elections in Mumbai, for instance, Sharad Pawar has enjoyed reminding voters that Chavan “has not been elected directly by the people.” Pawar taunts Chavan regularly, bragging that the NCP does not “look North [to Delhi] for directives.”

"The Congress Party is destined to fight an endless battle to defeat its friends," explained the great columnist and editor, MJ Akbar (and a non-resident Brookings fellow). The fighting doesn't end, since relative weight in state and national voting bodies is critical for how far any government leader can move an issue—whether it is reform of power, or water, or roads, or housing, or education.

How Chavan navigates these friends and ‘frien-emies’ will go a long way in determining the future of India's most important state and city. A strong Congress Party showing on Thursday would indicate that good governance may be a winning message with a rising working class, in Dharavi and beyond.

Once the municipal elections are over, however, Chavan’s attention will turn to national elections, which could happen as early as next year. And Chavan will naturally be pulled away from Mumbai, and will have to focus on the poorer, more agricultural parts of the state.

So if Chavan is going to follow through on his promises to Mumbai, he will have to empower—or more accurately, liberate—local authorities to act on his promises. That will mean doing something that few Chief Ministers have done in the past—building up real capacity at the city and neighborhood level.

If he doesn’t do that, then Indian politics may really resemble cricket, where the batters stay the same, but just keep changing places.

Authors

William J. Antholis

Image Source: William Antholis

India's G-7: Local Leaders with Global Interests

William J. Antholis — Mon, 06 Feb 2012 00:00:00 -0500

For a quarter century, the G-7 ruled the planet. From the mid-1970s to the late 1990s, leaders of the world’s seven top democracies would meet once a year to manage global affairs. They calibrated exchange rates, printed money, provided more development aid, imposed sanctions against outlaw nations, and issued political declarations. They even effectively went to war in Kosovo. The group eventually added Russia, and morphed into the G8. Then China, India and ten other countries were brought in to form the G20. But for years the G-7 was a compact, select, and like-minded body of advanced market democracies that led the pack.

India has a G-7. And to a large degree, those states rule this country. India’s seven biggest states have about 736 million people — just shy of the G-7’s current 746 million. At current population growth rates, those seven states will likely surpass the original G-7 in the next 3 or 4 years. The seven largest economies in India (a slightly different group than the seven largest populations) make up over 50% of India’s GDP — about $800 billion USD. At expected growth rates (between 7% and 9% per year), they will lead India past most of the traditional G-7 nations.

What are the seven most important states in India? And who are their leaders? This is an admittedly arbitrary exercise. But it is also instructive. My choice would combine population, economic size, and economic productivity. Population is critical, since influence in Delhi depends on how many parliamentary votes one controls — or one could control. But economic productivity also matters — overall GDP, as well as GDP per capita and the rate at which economies are growing. To that end:

State	Chief Minister	Pop (mn)	GDP ($US bn)	GDP per capita ($USD)	Pop % Rural	Growth (2010-2011)
Uttar Pradesh	Kumari Mayawati	200	128	640	78	7.0
Maharashtra	Prithviraj Chavan	112	224	2,000	55	8.1
Bihar	Nitish Kumar	104	46	442	89	9.3
West Bengal	Mamata Banerjee	91	96	1,055	68	8.4
Andra Pradesh	N Kiran Kumar Reddy	85	123	1,447	67	5.7
Tamil Nadu	J. Jayalalithaa	72	119	1,653	52	9.4
Gujarat	Narendra Modi	60	104	1,733	57	10.2

Each of the seven chief ministers listed above is a major force in India. Open any newspaper or magazine on a given day here— in any city — and you are likely to see at least three of them, and sometimes as many as five. Unlike the G-7, they never meet as a distinct group. But, as the saying goes, what happens in Bihar doesn’t stay in Bihar. Politics in each of these places has real national and international impact.It is easy to cluster them into three categories.

First is “old India”— embodied in the poorer states of the “Hindi-belt” in rural North India. Here, politicians aim to out-deliver for the poor. Kumari Mayawati, from massive 200 million-strong Uttar Pradesh, aspires to be the voice of the most downtrodden. Next door, in the even poorer, caste-divided, land-locked state of Bihar, Nitish Kumar has made it hip to be square. He has brought a nerd-like focus to social and economic performance.

Second are the newly emerging industrial engines of India, where GDP matters. Narendra Modi, from mid-sized Gujarat (a mere 60 million people), leads the pack. Modi combines machine-like efficiency with charismatic (and many say destructive and divisive) nationalism. In sharp contrast is J Jayalalitha from Tamil Nadu— the South Indian film-star turned FDI queen, who spends considerable time courting multinationals to build cars and cell phones on the outskirts of Chennai. And technocratic Prithviraj Chavan has just taken over Maharashtra —the manufacturing and financial capital of the country.

Finally, straddling these extremes are states such as Andra Pradesh and West Bengal – each of which is bigger than Germany but as poor, per capita, as Nicaragua. Chief ministers in these states have learned the hard way that the rural poor may not be ready for a full-speed-ahead embrace of globalization. Globally-focused cities such as Hyderabad and Kolkata have prospered in recent years, but politicians have not necessarily benefited. Over two-thirds of the people in these states still live in the countryside, and they have made their voices heard when they’ve felt ignored.

How chief ministers balance local and global forces has a real effect on national politics. Chief ministers have significant influence over the members of parliament from their party who are sent to Delhi. And many of them secretly or openly aspire to be prime minister some day.

If a chief minister such as Mayawati is in a coalition with the governing party in Delhi, she can use her block of parliamentarians to extract promises or resources from the governing coalition. That includes messing with complex international decisions such as the rules on foreign investment.

If a chief minister, such as Modi, is from a party that is out of power in Delhi, his efforts at the state level can contrast with or even undermine efforts of the central government. That can include bucking national bureaucrats in attracting foreign investment or damming rivers, or regulating power. It also can mean condoning anti-Muslim sentiment that complicates India’s tense relations with Pakistan.

Some are “managers.” Some are “mission-driven.” Some are “populists.” Three of these seven chief ministers are women — each of whom found a different path to power in a male-dominated country. In contrast to the Delhi-based managers who have run the country for sixty-five years, the new breed brings a feel for local politics. But they also have distinct views of the international economy will transform India — for better or worse.

Over the next several blog posts, I will try to sketch who these people are, how they see the world, and where they are taking India.

Sources:

Population and rural/urban population totals: Government of India, Ministry of Home Affairs, Office of the Registrar, Provisional Population Totals 2011, http://censusindia.gov.in/2011-prov-results/paper2/prov_results_paper2_india.html

GDP for states and per capital GDP: Unidow, VMW Analytic Services, Economy of the Federal States For Year 2011 & Population for Year 2011. These figures are in nominal GDP, as opposed to Purchasing Power Parity, which would probably be considerably higher.

Growth rates for states: State Planning Commission of India, Per Capita Net State Domestic Product at Constant (1999-2000) Prices (as on 25-10-2011), http://planningcommission.nic.in/data/datatable/0211/data%20100.pdf

Authors

William J. Antholis

Obama, South India, and the High Ground of High Tech

William J. Antholis — Tue, 31 Jan 2012 00:00:00 -0500

Much of South India watched President Obama’s State of the Union last week ... live at 7:30am on a Wednesday morning. Many groaned when the president called for efforts to limit outsourcing. But others sensed that the president was ready to open America’s doors to tourists, foreign students, and fledgling entrepreneurs.

If the president does move on immigration, one audience in Chennai will certainly feel the impact. They're not Indians. They are a small group of Americans working here, on the front lines of globalization. Fourteen U.S. visa officers — our best and brightest young diplomats — are serving here on one of their first tours of duty. The current class includes several who started their careers as lawyers, professors, and IT professionals.

Each visa officer interviews over one-hundred South Indians a day. “While three of us conduct traditional diplomacy, more than two-thirds of the consulate staff issues visas,” says Matthew Beh, the senior political reporting officer at the Consulate. “And it doesn’t cost the taxpayer a dime. In fact, our team turns a profit for the American public.” Like most senior diplomats, Matt started out as a visa officer.

Depending on how you view the global economy, the U.S. visa officers stationed in Chennai are either sentries or synergists. In one view, they are protecting American workers in a flat world where computer chips and container ships make jobs magically disappear. In the other view, they are helping to build live human bridges that span borders and connect hills of innovation. In reality, they are both.

About 40% of the visas issued here are for tourists and students. In two minutes or less (on average), a consular officer must determine whether or not someone is legitimately going to stay for three weeks with their aunt or uncle in Michigan, or whether or not they really are attending MIT or UNLV. A nervous glance, stutter, or twitch might indicate that, in fact, they hope to indefinitely stay to work in a motel chain in South Florida.

More than half of the processed applications lead to interviews that last much longer— as long as seven or eight minutes. These are for the coveted high-skills temporary work visas. India's best and brightest line up and pay hard currency for the famous H1-B-visa (special skills), and the less well-known L-visa (intra-company).

Unlike tourist or student visas, the "non-immigrant work visas" lead directly to a well-paying job —especially by Indian standards. A mid-level programmer in India makes about $15,000 a year. The same position in America will earn them five or six times that amount.

Of course, that causes many Americans to fear that Indians are taking their jobs. So visa officers have to determine whether theapplicant has “special skills” required by the H1-B and L-visa regulations.

South India leads the world in sending high-tech workers and entrepreneurs to America. Last year, Indians received 53% of the roughly 200,000 temporary U.S. work visas issued worldwide. And a full half of these H1-B and L visas granted to Indians — over 25% of the global total — came through the United States Consulate here, which covers Chennai and Bangalore. Last year, South India sent twice as many high-tech workers to the United States as did all of China.

Many visa officers in Chennai were stationed here precisely because they had IT sector experience before joining the Foreign Service. In fact, one of them was born in Bangalore and came to the US on a student visa before going into IT work. He then became a citizen, married, and joined the Foreign Service. He and his colleagues are pretty tough judges of whether to grant these visas, especially if there are Americans qualified for the same position.

Yet visa officers are not just sentries. They are also potentially synergists. When they do their job well, they clear the way for Indians who bring high-tech dynamism to the U.S. economy. At first, these workers might get paid less than an American with similar skills. But that salary will be earned in the United States, not in India. That higher salary will be spent in America on food, real estate, health care, cars, and taxes. Moreover, by bringing in the best and most entrepreneurial of Indian talent, any single one could become the next Vinod Khosla — the famous Indian-born Silicon Valley engineer and venture capitalist behind some of the biggest breakthroughs in computing.

One South Indian entrepreneur made the case to me quite succinctly: “We are accustomed to talking about trading goods and the movement of capital. But there is a new world of trade—the ability of our ideas and our services and our people to move about the planet.” This gentleman should know. Born in Chennai, he received his masters and doctorate degrees in the United States in aerospace engineering, and spent 17 years in Michigan working for the research unit of an American auto company.

Now he is back in Chennai, working on various joint-ventures with western companies on advanced technology manufacturing. He also sits on the global technology advisory council of a major American manufacturer, where he preaches the importance of innovation in products and processes.

These businessmen make you realize that the world is not simply flat. In a flat world, information workers would just stay back in Chennai and Bangalore and send their services over the internet. In today’s hilly world, place matters.

It is one thing to say you work as a programmer for Infosys or Cognizant in Bangalore. It is another entirely to say you spent three years working for them in New Jersey or Boston, or went to the Bay Area to work for Intel or Cisco or Google. Or that you got your degrees at Princeton and Michigan.

Indeed, the battle is not between India and the United States, or even all of India and all of the United States. Chennai and Bangalore work with the Bay Area, Boston, suburban New Jersey, or central Michigan. Key industries from each of those places are doing battle with forces in their own societies who are opposed to expanded opportunities for people to cross borders, provide services, and share ideas face-to-face.

President Obama’s tough talk on outsourcing seems balanced by an understanding that the mobility of minds and bodies can bring value to the U.S. economy. Expanding these opportunities would mean that the high-grounds of high-tech would become better connected.

Authors

William J. Antholis

Dynamics of Inflation "Herding": Decoding India's Inflationary Process

Gangadhar Darbha and Urjit R. Patel — Tue, 24 Jan 2012 14:22:00 -0500

Compared to immediately preceding years, that is, its own recent history, India’s inflation became unhinged (thereby reversing creditable performance) from as far back as 2006. In the last two years, among its major comparators India has the highest rate of consumer inflation; it is also volatile in relation to its peers in Asia and the BRICs. This paper puts forward an empirical framework to analyze the time series and cross-sectional dynamics of inflation in India using a large panel of disaggregated sector prices for the time period 1994-95 to 2010-11. It has been motivated in no small part to official pronouncements seemingly unencumbered by methodological rigor. There are several grounds for distrust by citizens regarding policy makers in this context. Firstly, officials have attributed the upswing in prices (measured by all indices) to food supply constraints, and therefore claim they are powerless to do anything about it. Secondly, they resort to hand wringing and public communication that essentially amounts to “we are staring the problem down” as the common refrain for an inordinately long time; in tandem, rolling “(mental) spreadsheet forecasts”—that have been optimistic by some distance—were, and still are, put out at regular intervals to give succor and hope to the public. Thirdly, a spate of recent statements seems to suggest that the medium-term objective of around three percent inflation articulated by inter alia the Reserve Bank of India (RBI)3 is being given a quite burial.

The operational methodology introduced in the paper facilitates a rigorous exploration of issues that have been, at best, loosely posed in policy debates such as diffusion or comovement of inflation across sectors, role of common and idiosyncratic factors in explaining variation, persistence, importance of food and energy price changes to the overall inflation process, and contrast the recent experience with the past. It is found that the current period of high inflation is more cross-sectionally diffused, and driven by increasingly persistent common factors in non-food and non-energy sectors compared to that in the 1990s; this is likely to make it more difficult for anti-inflationary policy to gain traction this time round compared to the past.

The paper has also introduced a novel measure of inflation, viz., Pure Inflation Gauges (PIGs) in the Indian context by decomposing price movements into those on account of: (i) aggregate shocks that have equiproportional effects on all sector prices; (ii) aggregated relative price effects; and (iii) sector-specific and idiosyncratic shocks. While aggregate Wholesale Price Index (WPI) inflation by the end of 2008-09 had declined to about 1 percent (from about 8 percent in 2007-08), PIGs were running at around 3 percent; in contrast to the headline inflation, the most recent trough for PIGs was 2005-06 and not 2008-09. The decline in (and the level of) headline inflation in 2008-09 may have conveyed to the authorities that they had less need of (or more time for) tightening than was the case looking at inflation measures corrected for sectoral and idiosyncratic shocks. If PIGs, in conjunction with our other findings, for example, on persistence had been used as a measure of underlying (pure) inflationary pressures, the monetary authorities may not have been sanguine regarding the timeliness of initiating anti-inflationary policies.

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Authors

Gangadhar Darbha
Urjit R. Patel

Image Source: Kim

Rising Power Unions

William J. Antholis — Tue, 10 Jan 2012 06:08:00 -0500

My family and I have just arrived in Tamil Nadu, or Tamil Land. We are here for January—the first of a five month study tour across India and China.

If Tamil Land were its own country, it would be the 19th largest in the world—it’s 72 million people ranking just behind Turkey and just ahead of Thailand and Iran. It is bigger than France, the UK or Italy, and it is twice the size of California.

As India’s fast-growing economy has exploded on to the world scene, Tamil Land is often forgotten by the western press. Its capital city, Chennai, is generally ignored. People have to be reminded that it was previously known as the British colonial city of Madras. A city of a mere 9 million people, it is overshadowed by high-politics New Delhi, high-finance Mumbai, high-tech Bangalore and Hyderabad, and high-poverty Kolkata.

Tamil Land is the slow and steady industrial giant of India—fourth largest in GDP and in per capita GDP. Ford makes cars, Caterpillar assembles trucks, and high tech giants Infosys and Cognizant have major operations here.

Tamil Land is urbanized and urbane, with an 80 percent literacy rate—quite high by Indian standards. It also has a large Christian population, as early as the first century, with the local Catholic, Syrian Orthodox, and Anglican communities all claiming the legacy of the Apostle Thomas, who is said to have been martyred in Chennai.

If Tamil Land were an independent nation, it might have a foreign policy very different from the rest of India’s. And for that reason, it is the place I chose to begin my study tour.

Over the next five months, I hope to learn and describe for American policy-makers how the states and provinces of India and China affect—or do not affect—their foreign policies. Call them the “Rising Power Unions.”

China and India are at least three times the size of the United States and EU, and each has around thirty provinces/states. Both countries very much are “unions”—with all the ups and downs that that brings to policy-making. They span multiple languages, and border on a variety of regions. Yet few western diplomats have a basic map of how those instruments work in China and India, not to mention how they come together to produce an orchestrated sound.

To give a glimpse of this, I’ll focus on three pressing global matters: global trade, climate change, and nuclear non-proliferation. Right now, I have a lot of questions and few answers. Obviously, I want to understand how the process works of translating local ideas and interests into national policy. I also want to sketch some of the outcomes that habitually happens. But I also want to get to know the personalities and the parties, the corporations and the coalitions, the NGOs and the unrepresented.

And hopefully, in the end, I will have some observations about how the United States and EU should think about these emerging powers. What is too much to expect of these emerging giants? But also, where are the opportunities for greater collaboration and cooperation with them?

Authors

William J. Antholis

Image Source: ï¿½ Babu Babu / Reuters

Public Finance and the Energy Sector in India

Urjit R. Patel — Tue, 27 Dec 2011 00:00:00 -0500

Herbert Stein’s “Law” is expressed as: “If something cannot go on forever, it will stop.” From a public finance perspective, India’s energy sector challenges now encompass its federal structure in an almost “symmetric” manner. The petroleum sector has become a fiscal morass for the central government, and the electricity sector in many states is equally problematic. But, unlike Delhi, states neither have recourse to RBI’s printing press for rupees nor can they “impound” the central bank’s foreign currency reserves.

Both sectors, from a fiscal perspective, are partly off-balance sheet vis-à-vis government accounts. Much like social claims in the EU, energy entitlements in India can impinge on broader fiscal stability. The quasi-fiscal hole due to non-remunerative pricing in the electricity and petroleum sectors each account for about 1% of GDP (see table).

Internationally, retail prices of kerosene, diesel and petrol are usually in the same ballpark; in India, the prices are, respectively, roughly in the ratio 1:5:7. The concomitant distortions in fuel use are becoming more severe. More than kerosene, diesel consumption has reached a level where the refined product has to be imported because of the skewed consumption pattern; diesel is now being substituted for furnace oil—the price of which is market linked—as an industrial fuel.

Bond markets, and even credit rating agencies, eventually take off-balance sheet liabilities, current and prospective, into account. The implications of several years of under recoveries are far reaching. First, government debt management issues; the stock of oil bonds issued by the government in lieu of cash is R1.4 trillion, and outstanding borrowing of oil marketing companies (OMCs) is around R1 trillion. Second, the extant process by which subsidy is provided imparts ambiguity in the central government’s budgetary accounts, which in turn catalyses needless uncertainty in the financial markets. Only a hypothetical amount of R30 billion is included in budget estimates under the central government’s 2002 scheme. Third, the much touted energy security as a strategic objective is undercut. Upstream PSUs are, due to burden sharing, “relieved” of (potentially) investible resources to the tune of 0.6% of GDP. Regarding private sector investors, price caps that are way out of line with prevailing international prices, for example, in the case of natural gas undermines long-term sector economics. Moreover, the pervasive discretionary backdrop is demoralising for all exploration and production stakeholders.

Given the scope of the burden on account of the petroleum sector, the financial sector is often caught off balance in the short run; abrupt requirements for stopgap liquidity and bridge loans transpire under these circumstances. Oil bonds do not have SLR status, so banks don’t have to buy them, or accept them as collateral; OMCs may need explicit government guarantees to access further credit (much like Air India). Of course, the Centre can have RBI print rupees on its behalf, which can be used by OMCs to buy dollars to import crude. Or, as in 2008 (before the crisis), RBI directly gives dollars in exchange for oil bonds (outright purchase or collateralised repo), so as not to destabilise markets. Hence, Stein’s Law may be kept in abeyance for some time.

Turning to the power sector, whilst shortages continue, state government-owned distribution companies (discoms) are curtailing supply in many parts, at the same time as merchant power generators can deliver more electricity (Stein’s Law has kicked in). The primary driver of the financial morass that states find themselves in is the gap between the average cost of supply (ACS) and average revenue realisation (ARR) of 73 paisa/unit, up from 27 paisa/unit in 2005-06 (lower panel of table). Aggregate technical and commercial (ATC) losses continue to be high as curtailment efforts lose traction, with about 27% of electricity generated not being paid for; the cross subsidy in favour of agriculture and household consumption continues to incentivise theft. Tariff revisions have been infrequent and inadequate, much like in the case of petroleum products; it is rather silly to expect regulators to be independent when the sector is dominated by state governments.

Many state governments are only partially releasing budgeted subsidies, down from 94% in 2006-07 to about 55% currently. Not surprisingly, the private sector is feeling skittish; for instance, IPPs reliant on merchant transactions face problems as market prices remain soft and elevated cost of imported fuel is absorbed. A sector workout (akin to 2001) seems imminent, while power sector bonds estimated at R130 billion, which are liabilities of state governments, remain to be liquidated from the previous bailout! It has been extensively documented that lenders to the power sector are nervous. Regulatory forbearance, viz, maturity elongation of loans could temporarily window dress NPAs and mitigate the Centre’s bill for recapitalising its banks. Given the systemic nature of the power sector, how long can central government entities be ring-fenced? Can NTPC really cut supply to a Congress-ruled state, or to any other state that will have assembly elections soon? Coal India Ltd is already claiming payment defaults. Open-ended unconditional subsidised consumption of energy is the “road to fiscal perdition”.

Authors

Urjit R. Patel

Publication: The Financial Express

India Must Not Let Slip Its Moment for Reform

Eswar Prasad — Sun, 18 Dec 2011 10:07:00 -0500

The Indian economy is in the doldrums: industrial output has stalled, inflation remains high, the rupee has plunged to an all-time low and foreign investors are retreating en masse. Is this a temporary rough patch or is the shine coming off?

India, like many other emerging markets, is not immune to global economic turmoil. Yet there is a palpable sense that the economy is losing its direction as political paralysis sets in, stalling reforms that the country desperately needs.

After a few glorious years, when the economy seemed to have switched permanently to a high growth path, the domestic narrative was that India would soon decisively eliminate the growth gap with China. Unfortunately, rather than pushing forward with reforms to cement these gains, a sense of hubris set in.

The main problem is that the government has not created a broad constituency for reforms, as the benefits of growth have been very unevenly distributed. Endemic corruption, which hits the poor hardest and heightens their sense of unfairness, has exacerbated this problem and strengthened the hand of those opposed to reform.

In this context, the recent U-turn on the liberalisation of foreign direct investment in the retail sector takes on considerable significance. While it is easy to blame external forces and speculators for rising commodity and food prices, an underlying problem is that India’s food distribution system is highly inefficient, with extensive spoilage and high price mark-ups at different stages.

It is particularly perverse for those opposed to greater competition in the distribution chain to cling to inefficiencies on the pretext of protecting jobs and the poor. The reality is that India’s poor suffer the most from high and rising food prices. Moreover, other policies then have to compensate for this. The central bank had little choice but to temper rising food price inflation by tightening monetary policy, hurting growth in the industrial sector. Using monetary policy to deal with the consequences of structural problems in food supply and distribution ends up costing high-paying jobs and hindering the transformation of India’s economy.

The challenge is to ensure that reforms deliver greater benefits to the poor and lower middle class, so they share more in the benefits of India’s growth and provide a political base for economic reforms. What should the government do?

First, it should tackle corruption head on. The prime minister is an honourable man, seen to be above reproach. But Manmohan Singh and his government have been playing defence rather than attacking graft. There is an important lesson in the groundswell of support for the anti-corruption activist Anna Hazare. A package of reforms that included a bold strike against corruption would resonate with the public and help build support for other reforms.

Second, the government should improve the social safety net. Replacing food and energy subsidies with cash transfers would staunch corruption that bedevils the delivery of benefits, reduce inefficiencies in these markets and deliver greater benefits directly to the poor.

Third, the government should push ahead with financial sector reforms. India desperately needs a more efficient financial system to channel domestic and foreign capital into productive investment that generates jobs. In this area there has been slow, methodical progress. But a great deal still needs to be done to develop a broader range of financial markets, including corporate bond markets, and free up the banking system from various strictures. Broadening access to the formal financial system so more people can obtain saving, credit and insurance products is also important.

The reform agenda hardly stops there. Restrictive labour market regulations and industrial policies, large government budget deficits and a dysfunctional education system are stifling the intrinsic dynamism of the Indian economy. It is high time for another concerted push on economic reforms – the benefits of those put in place over the last two decades have run their course.

To reinvigorate reforms, the government needs to first focus on measures that spread the benefits of growth more evenly in order to build broader support for the overall agenda. Otherwise, India’s shining moment may dim into a dull glow.

Authors

Eswar Prasad

Publication: Financial Times

Do New Democracies Support Democracy?: The Multilateral Dimension

Ted Piccone — Wed, 26 Oct 2011 10:57:00 -0400

The world’s six most influential rising democracies—Brazil, India, Indonesia, South Africa, South Korea, and Turkey—are at various stages of democratic consolidation. Freedom House ranks them all as Free in terms of political rights and civil liberties except for Turkey (which is at the top of the Partly Free category), and all six have enjoyed remarkable economic growth and improved standards of living in recent years. Yet when it comes to supporting democracy and human rights outside their borders, they have differed quite a bit from one another, with behavior ranging from sympathetic support to borderline hostility.

One revealing indicator of their stance toward international action to support democracy and universal human rights can be found in the votes that they have cast on relevant issues in international organizations. United Nations voting data compiled since 2004 by the Democracy Coalition Project, as well as a review of each country’s behavior at the UN Security Council and on the international stage reveal positions ranging from pragmatism to fairly strict allegiance to traditional principles of state sovereignty and noninterventionism. This essay presents a comparative examination of the voting patterns of these six countries in three key UN bodies—the Human Rights Council, the General Assembly, and the Security Council. The UN voting records of these countries must be understood within a larger context, however, and so we begin with brief accounts of the overall place of democracy and human rights trends in their foreign policies over the past decade.

Brazil

Formerly a country with a relatively quiet, inward-looking, and defensive foreign policy, Brazil has evolved into a more assertive regional—and increasingly global—player, a transformation that has coincided with the huge political and economic strides that the country has made in recent years. Brazilian diplomats often credit the country’s democratic consolidation and economic progress for its growing credibility and influence on the world stage. When it comes to wielding that influence in support of democracy in other countries, however, Brazil has been ambivalent and often unpredictable. If supporting democracy or human rights will help it to further its own goals of consolidating regional leadership, protecting business interests, or winning a seat on the UN Security Council, Brazil generally favors multilateral strategies geared toward pro-reform outcomes. But in the recent cases of Cuba, Iran, Venezuela, and most recently Syria, Brazil has taken a more ideological or “soft-balancing” approach, siding against the United States and Europe by avoiding criticism of human-rights abuses and ducking behind the defense of noninterventionism favored by diplomats in the foreign ministry.

India

The world’s most populous democracy was a founding member and leader of the Non-Aligned Movement during the Cold War. Its foreign policy is deeply rooted in the twin principles of anti-imperialism and noninterventionism. Yet as India has grown into a global economic power, its identity as a secular, pluralist, and democratically governed state has begun to influence its behavior in multilateral organizations. Thus, on the global stage, India has become increasingly vocal in favor of democracy, which it believes can be a strong foundation for international peace and cooperation. At the same time, the South Asian powerhouse maintains that democracy must not be imposed on other countries; rather, nondemocratic countries should seek out the assistance of India and other democracies if they themselves wish to make the transition to free societies. It will take some time for the traditionally noninterventionist diplomats in charge of multilateral affairs to implement the increasingly clear prodemocracy sentiments coming from the top political leadership in New Delhi.

Indonesia

Indonesia’s remarkable transformation from an authoritarian system to an open, pluralist democracy—the third largest in the world—has been accompanied by a significant reorientation of its foreign policy. In the past, Indonesia rejected international norms of democracy and human rights, claiming that they were incompatible with “Asian values.” Now the country strongly endorses the principles and values of democracy in its foreign-policy rhetoric, though it continues to oppose most human-rights initiatives at the UN. This transformation, accompanied by consistently high levels of economic growth, a growing middle class, booming foreign direct investment, and (for the most part) internal and external peace, is precisely its greatest asset when it comes to projecting its interests and values in Asia. Although Indonesia has—in word, if not in deed—pushed for democracy in the region, its advocacy thus far has had little impact. Today, the majority of ASEAN members are nondemocratic, and there is no meaningful regional mechanism to support democratic change. Nonetheless, Indonesia can claim credit for advocating the establishment of an ASEAN human-rights mechanism, albeit a weak one, and for bringing its foreign-policy rhetoric—though not its UN votes— more in line with its domestic credentials.

South Africa

Although South Africa’s record of democracy and human-rights promotion is in some ways laudable, it is perhaps the most disappointing case among the six. The country’s remarkably peaceful transition from apartheid to democracy under the inspiring leadership of Nelson Mandela raised high expectations that South Africa would become a strong ally of peaceful democratic movements in Africa and elsewhere. Yet when faced with tough choices, South Africa’s four postapartheid presidents have generally aligned themselves with nationalist or pan-African movements, either acting in “South-South solidarity” or choosing neutrality vis-à-vis autocratic regimes. Faced with deep-rooted economic and social challenges at home, South Africa tends to prioritize foreign relations that help it to achieve such domestic priorities as rural development, job creation, and crime prevention.

South Korea

After emerging from three decades of military rule in the early 1990s, the newly democratic Republic of Korea quickly became a reliable supporter of multilateral efforts to promote democracy and human rights. Its generally strong voting record on these issues at the UN during the past two decades, particularly under President Kim Dae Jung (1998–2003), is no doubt influenced by its security alliance with the United States. South Korea’s record of democracy support has been somewhat constrained, however, by its attempts at rapprochement with North Korea and by its heavy dependence on oil exporting states such as Iran. An active participant in the Community of Democracies since the organization’s founding in 2000, Seoul hosted the group’s second ministerial meeting in 2002. As there is no East Asian regional body with a democracy agenda, South Korea has instead relied on ad hoc initiatives to offer cautious support for democratic transitions abroad.

Turkey

A candidate for European Union membership, Turkey stands apart from the other countries considered here. As part of the EU accession process, Turkey has been a recipient rather than a provider of democracy assistance. The goal of EU accession has undoubtedly helped to bring Turkey’s own democratic standards and practices more in line with liberal international norms, although it still has progress to make. Nonetheless, its improvements in human rights and democratic practices thus far are a testament to the positive role that EU enlargement has played in expanding the circle of democratic, rights-respecting states throughout wider Europe. Because Turkey has fairly successfully managed its own transition from a military-dominated state with weak checks and balances to a thriving, competitive, multiparty, and multiethnic society in which Muslim democrats now win elections, it has great potential as a defender of democracy and human rights abroad. It deserves some credit, for example, for its willingness to stand up for democracy and human-rights activists in the context of the “Arab Spring” despite complicated geopolitical interests.

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Ted Piccone

Publication: Journal of Democracy

India’s Energy Policy and Electricity Production

Charles K. Ebinger — Wed, 26 Oct 2011 00:00:00 -0400

Editor's Note: In an interview with the National Bureau of Asian Research, Charles Ebinger outlines India’s current and future challenges in meeting electricity demand. Ebinger argues that without serious energy and electricity sector reform, India runs the risk of derailing its rapid economic growth.

National Bureau of Asian Research (NBR): What are India’s current and projected power-generation needs?

Charles Ebinger: Currently, India has the fifth largest electrical system in the world, with installed electricity capacity of around 180 GW. However, more than 400 million Indians have no access to electricity, and by 2035 India’s power demand is expected to more than double, providing a prodigious challenge for the country.

India’s electricity mix comprises 69% coal, 14% hydro, 10% natural gas, 4% oil, 2% nuclear, and 1% renewables (solar, wind, biofuels, waste, etc). While the amount of off-grid power in India is debatable, depending on one’s estimates, it can skew India’s electricity growth projections dramatically. India’s power deficit in 2010 at peak load was more than 10%. This needs improvement through more investment, particularly from the private sector, in generation, transmission, and distribution. While investment is beginning to occur, the rate at which this is occurring is woefully insufficient.

NBR: What are the most serious challenges India must overcome in its energy sector in terms of policy and natural endowment?

Ebinger: The most serious issue India must address is that the gap between energy demand and energy supply is wide and growing. Two reasons for this trend are demographics and economics: not only is India’s economy growing, thereby demanding more energy and electricity, but the population is as well. There is also massive urbanization, which is putting more pressure on energy and the environment.

India’s power network comprises five regions spanning the country. While each is connected with a neighboring region, there are inadequate interregional connections through high voltage transmission lines, creating difficulties for moving power from electricity surplus states to those in deficit. This also creates difficulties on a seasonal basis, as power is often in short supply during the dry season and abundant in some regions during the monsoon but cannot be moved to help other states.

An additional complication is that India’s investment in power transmission and distribution has not kept up with generation. Thus, in some cases, new generation cannot move to the market because of transmission bottlenecks, such as with wind power in Tamil Nadu.

India’s power sector is also plagued by the dual responsibility of the states and the federal government. Power produced and sold in the same state is subject to the oversight of the State Electricity Board and the State Electricity Regulatory Commission, whereas power sold between states is subject to federal oversight and regulation. As of September 2011, about 46% of generating capacity was owned by the states, 31% by central government institutions, and 23% by the private sector. Complicating this situation is that there are far too many state and federal institutions involved in energy decision-making. In the absence of a single institution responsible for the energy sector, comprehensive and sound policymaking is impossible.

Although domestic energy supplies exist, some are limited in amount (e.g., oil) and others (e.g., coal) are located in areas where they are geologically and technically hard to extract. In the case of coal, although India has large reserves, much of it is located far from demand centers or in areas where insurgencies affect production.

These issues are further exacerbated by the country’s policies, politics, and infrastructure. For instance, coal resources, far from their final market, must depend on India’s dilapidated railroad infrastructure that is prone to delays. Many power plants cannot get enough coal and must rely on the expensive spot market or risk power shortages. At a recent talk here in Washington, D.C., Vikram Mehta, Chairman of Shell India, mentioned that coal stocks at roughly 60% of India’s thermal plants were only enough for a seven-day supply. Many plants only have a one-day supply.

In the case of oil and natural gas, the problem is pricing and infrastructure. Because India’s government has not created a positive climate for foreign investors, the country’s reserves have not benefited from the best technology and expertise available. This hurts production. Whereas the average recovery rate of oil in the global petroleum industry is 40%, in India it is only 28%. One way India can promote exploration and production is through pricing reform: currently, private sector investors have no incentive to invest in India due to poor returns on investment. Similarly, the government has not invested enough in infrastructure: its gas pipeline network is woefully under-connected, and although the situation is slowly improving, large parts of India’s south and northeast are not connected to a gas grid.

Moreover, India must also enforce regulations against energy and electricity wastage and cheating. Often it is the wealthy landlords who waste free and cheap electricity rather than the poor farmers it was intended to help. Bribes are often paid to meter-readers, and many government and military buildings and offices pay no electricity fees at all. Providing regulators with enforcement capacity would dramatically curb consumption and increase efficiency.

One final issue is the land acquisition bill under debate in India. This bill must be comprehensive and fair to both owners and purchasers. Most importantly, however, it must be transparent and enforceable. While India’s energy sector is improving, the biggest problem for investors is that translucent regulations and processes drive up private sector costs. A clear and egalitarian bill can accelerate projects in the national interest while providing fair compensation for those displaced.

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Authors

Charles K. Ebinger

Publication: The National Bureau of Asian Research

Energy Supply and Costs in India

Charles K. Ebinger — Tue, 04 Oct 2011 00:00:00 -0400

Editor's Note: In an interview with The Times of India, Charles Ebinger discusses energy costs in India, arguing that the country could enjoy an effective and sufficient energy supply if the government adopted a new approach.

THE TIMES OF INDIA: After so many years spent working in the sector, why does your book Energy and Security in South Asia describe a story of lost opportunities?

CHARLES EBINGER: India has tremendous power needs. To your north, you have Nepal that has staggeringly large amounts of hydropower. The 10 years that I represented the government of Nepal in negotiations with India for hydropower exchange, we made the case that dislocations might happen to people in Nepal in building a hydropower plant. These should be reflected in electricity tariffs—this, combined with benefits to India of electricity, flood control and irrigation would benefit both countries.

Yet, successive power ministers in India simply said "no"— not to negotiate but "no" to the idea, that it was a separate issue. So, you have Nepal with 83,000 MW of power—the whole country uses only about 600 MW—and probably only two-thirds of that developed. India could be buying 40-45,000 MW of power—and it's not.

For years, Bangladesh has had all this gas but does not trade with India. For years, we've been talking about a gas pipeline from Iran that would cross Pakistan. Again, the opportunity is lost because of political and security considerations.

TIMES: But it's not just local factors; don't American concerns also influence projects like the Iran pipeline?

EBINGER: Yes, the U.S. is a big factor, it being opposed to anything with Iran, so also with Afghanistan through Turkmenistan. However, India is embarking on mega coal projects with natural liquefied gas coming in from other countries. Both Bhutan and India have benefited greatly from hydropower. Each time a new hydropower project is done with India, the GDP of Bhutan doubles! It's incredible why it works with Bhutan and not with Nepal.

TIMES: Geopolitics aside, how important is the issue of energy pricing within India?

EBINGER: We need to address energy pricing reforms. The idea that people can't afford to pay for energy is a myth. If they can get power during planting and harvesting seasons, they will find a way to pay. It is the politically powerful rich landlords and industrialists who don't pay.

You need to look seriously at energy conservation and energy efficiency. It's not about using less energy for development but to rein in wastage that can help save up to 20 percent energy available currently. Put money in existing transmission grids rather than rushing to build new ones. Go after power theft. Streamline ordinary billings and collections. Before you start building an expensive nuclear plant, go for the low-hanging fruit.

TIMES: You've mentioned bureaucracy being a major cause for energy mismanagement in the region—why do you say this?

EBINGER: If one energy source is important, a bureaucracy is created to deal with it. Then another energy source comes along, and yet another bureaucracy is created. There is a need to have a centralised ministry to deal with all energy. In India, different ministries don't use the same set of energy data. Planning commissions start with different assumptions as to the installed capacity.

Authors

Charles K. Ebinger

Publication: The Times of India

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