The big bang theory

The big bang theory

Better regulation,not just grand reform,is key to reviving investment

Better regulation,not just grand reform,is key to reviving investment

A fortnight ago,the government was still embroiled in the controversy over coal allocations,the RBI had made it clear that monetary easing was contingent on the government moving first,and a ratings downgrade was becoming more likely with every passing day of inaction. Then lightening struck twice. Diesel prices were hiked by Rs 5 — unprecedented in the Indian context,caps were placed on subsidised fuel consumption for the first time,the disinvestment programme finally got a jumpstart and FDI was introduced,and increased,into retail,aviation,power and broadcasting. There has clearly been a metamorphosis in the government’s political and economic thinking.

This metamorphosis is manifest in the government’s refusal to roll back its decisions. Different states could soften the blow differently,but the Centre wasn’t going to budge. This is important because even though the immediate impact of these measures on growth is limited,their true impact is on business sentiment and psychology. Hopefully the collective impact of all the recent moves will signal that the country is open for business again. Any kind of rollback at this point will reinforce the cynicism that good economics has become bad politics in India and that the future of market reforms lies in tatters.

The moves themselves are important in the medium-term. Take the case of multibrand FDI. With food inflation averaging a staggering 10 per cent over the last seven years why haven’t we seen a supply response? Put differently,if the terms of trade have finally turned so decisively in favour of agriculture — and away from industry — why haven’t we seen more investment? Why haven’t farmers re-optimised their production process in response to the higher prices of some food groups?


In part,because they often don’t see these higher prices. The highly segmented supply chain means consumers pay more,farms get less and the middlemen pocket the difference. So the transmission of price signals from fork to farm — so critical to generating an efficient response — is severely compromised right now. Of course,this is not the only distortion. Higher minimum support prices,for example,have also impeded an efficient response by skewing production unduly towards cereals and away from crops that most need it. The experience of several countries has shown that FDI — exploiting the economies of size and scale — has typically streamlined the chain,facilitated better price signal transmission and helped keep food inflation in check.

Our back-end infrastructure is also woefully inadequate. More than 30 per cent of fruits and vegetables rot before being sold due to the lack of cold-storage facilities and poor transport infrastructure. We have been unable to make any meaningful dent in these inefficiencies. FDI is not a panacea,but it is a means to fix the massive infrastructural shortfall and inefficiencies that characterise our food supply chain. And bringing down stubbornly high food inflation — which disproportionally affects the poor — achieves both growth and inclusion.

FDI in specific sectors may be contentious. But the benefits of FDI,more generally,through technology transfer and productivity gains,are evident in our own history. The 9 per cent growth of the mid-2000s was made possible,in part,because productivity growth’s contribution to overall growth surged to 4 per cent from 1 per cent. It’s no coincidence that FDI inflows almost quadrupled during that period.

But it’s not limited to just productivity gains. Between 2005 and 2009,FDI used to finance 80 per cent of our current account deficit (CAD),but over the last two years,it has financed only a quarter of the CAD — leaving us more exposed to volatile capital flows — a key reason why the exchange rate has gyrated so sharply over the last year.

But,as alluded to earlier,these are only medium term benefits. It’s unclear how many states will sign-up for now — especially given the current political imbroglio — and even when they do,it will be several quarters before this investment is set up. Similarly,the impact of the fuel price hikes — apart from influencing sentiment — is limited. So as important as last fortnight’s moves are for boosting sentiment — and eventually for growth and our macro balances — their immediate contribution to reversing the current unfavourable growth inflation dynamics is minimal.

The key to a near-term turnaround lies in resolving implementation bottlenecks on the ground. One in every 10 projects — in value terms — is currently stalled. Contrary to popular perception,this has very little to do with interest rates. Instead,it’s all about governance and regulation — land acquisition,environmental clearances,coal linkages,regulatory uncertainty in mining and power. Resolving these bread and butter issues won’t be classified as reforms. But they are critical to reviving investment on the ground.

So let’s give the government its due. Its courage over the last fortnight has caused domestic and foreign investor sentiment to soar. But for that sentiment to translate into anything tangible on the ground,focusing on the brass tacks of project execution still remains key.

The writer is India economist,J.P. Morgan