Opinion After the fireworks

The key to this change was the formation of a new economic team in Delhi in July. While previously the space for policy action was seen as circumscribed by fragile coalition politics,it was now felt that the eventual political damage from continued growth slowdown and a possible credit downgrade outweighed the risks of upsetting the coalition allies. Rather than blaming the global economic slowdown,the new team focused on domestic policies to counteract its impact.

Markets and corporate India naturally celebrated the policy blitz. But in the last few days,markets have turned more cautious,seeking clarity on where the reforms agenda was heading and what these changes meant for a turnaround in growth.

Added to that is the concern that the data flow over the next two to three months will not reflect the market euphoria. While everyone understands that it takes time for reforms to have an impact,a turnaround in data is needed before the market’s patience runs out. A revival in corporate investment is key to this. And it is here that the market is most nervous.

Will India Inc act soon? Is there enough in the reforms to unclog investment? In part,this reflects the sudden unleashing of reforms. One really hasn’t had time to step back and separate the wheat from the chaff that several policy changes have glossed over,and which may well turn out to be critical for investment.

Consider the initial reforms of raising diesel prices,limiting the use of subsidised cooking gas,and FDI in multibrand retail. These were all political lightning rods and it is quite likely that the government chose these reforms precisely because they were politically sensitive enough to demonstrate decisively that “policy paralysis” was over. And the reforms did the job admirably.

What about their economic impact? On the face of it,the increases in fuel prices were sorely needed and substantial: 12-13 per cent for diesel and 40 per cent equivalent for cooking gas. The effect on inflation in the coming months will be telling,adding 1.5 percentage points to the headline rate. However,the purpose for which they were undertaken,namely,budgetary saving,is likely to be less than 0.1 per cent of GDP. Fuel prices need to be raised much more just to keep to the budgeted subsidy bill.

What about FDI in multibrand retail? Recall that this was first proposed late last year,surprisingly,in the midst of a particularly contentious parliamentary session,only to be retracted at the first sign of opposition from allies. Resuscitating this was more a reflection of the symbolism it carried than its impact on growth. Can Walmart change India’s agricultural supply chain? Perhaps,but we won’t know for many years and the potential capital inflow is likely to be modest.

Beyond these “no guts,no glory” reforms,let me highlight three that have been less noticed. First is the direct cash transfer that,it is planned,will eventually cover all household subsidies. While putting India’s rating on a negative outlook,credit agencies had cited rising subsidies as one of their two key concerns. The cash transfer builds on India’s ambitious biometric identity card programme,which will take time to reach its mandated target of 600 million. But this still remains the government’s best defence against the accusation that it is not doing enough to cap the subsidy bill. Leakages from the subsidy programmes are large and cash transfers could cut the cost significantly.

Second is the operationalisation of the infrastructure debt funds (IDFs). In the last few years,the private sector has funded 30 per cent of infrastructure investment,mostly through bank financing. This has increased the indebtedness of several infrastructure companies and ominously concentrated bank loans in this sector. The proposed IDFs,by refinancing debt,are expected to reduce the debt service of the infrastructure companies and free up bank financing. The former is still difficult. Many firms are significantly leveraged,such that they are likely to need to raise capital before IDFs are even willing to lend to them. However,even if financing of only some of the stalled projects is eased,the best hope is to revive investment quickly. Helpfully,the reduction of withholding tax on infrastructure bonds and the easing of investment norms of insurance companies have opened new sources of demand for IDF bonds.

Third is the change in the government’s attitude towards capital markets and the rupee. By all accounts,the new economic team appears keenly aware that containing the deficit requires continued strong capital markets and an appreciated rupee: the former to raise the budgeted 0.8 per cent of GDP in disinvestment and spectrum sales,the latter to keep oil subsidies from blowing up and forcing another round of large fuel price hikes. The acceptance of this path of least resistance is likely to continue to influence policy changes and reforms. And in this regard,one expects the government to raise the foreign investment limit in government securities and cut the associated withholding tax.

Separately,there are two reforms that are game-changing for medium-term fiscal sustainability and growth,but both need to be passed by the legislature. The first is the nationwide GST. The current differences are small and can be resolved by following the suggestions of the 13th finance commission. But it requires the government to work with the opposition to get the constitutional amendment passed and ensure that it is ready for implementation after the general elections in 2014. One compromise could be passing the bill but leaving the implementation to whoever wins the elections. If such a consensus can be reached then the second concern of the rating agencies will also be addressed.

There is also the land acquisition bill. This is a key implementation risk that projects face. The cabinet is yet to approve the revised bill and reaching a consensus on this is understandably difficult. But if the government can progress on these two reforms then a strong recovery in 2013 is pretty much assured.

The writer is India chief economist,J.P. Morgan Chase. Views are personal

express@expressindia.com