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The Regulation Raj

Our approach seems to be,‘Have problem,do a quick-fix’. We need to learn that ill-conceived fiscal fixes will not work

Written by Jaithirth Rao | Published: May 5, 2012 12:19:41 am

Our approach seems to be,‘Have problem,do a quick-fix’. We need to learn that ill-conceived fiscal fixes will not work

A friend of mine told me with some anguish that the recent budget might be the worst in 40 years. The budget is one symptom. He was implying that we had not been witness to an environment which was as hostile to businesses,entrepreneurship and growth as we have suddenly acquired in the last few years. Have problem — let’s do a quick fix: that seems to be the approach of our present rulers. We have a fiscal problem in large measure because we were not disciplined in good times and to be fair,in some measure,because post-Lehman,fiscal laxity was seen as a necessity to prevent a recession.

The solution to the problem,as contemplated now,consists of a series of measures to “squeeze” tax revenue from the productive sectors of the economy using arbitrary methods,increasing enormously the discretionary powers of the income-tax department and setting inordinately aggressive targets for tax-collectors. If private companies are unpopular in Delhi,increase the corporate tax rate by a few percentage points. But for heaven’s sake do not start playing games,providing perverse incentives and increasing discretionary diktats. Theorists will tell you that organisations hurt themselves when they make do with second-order,sub-optimal solutions instead of doing a root-cause analysis and solving the real underlying problem. Patchwork solutions typically are put up by leaders who plan to retire in a year,not by leaders who want to create something solid and leave behind a good legacy. In which category would our present rulers like to be remembered?

India’s draconian pre-1991 import controls grew step by step as we tried to “plug” one loophole after another. It started with an innocuous memo from a joint secretary to the RBI,asking that “requests” for foreign exchange be “routed” through the commerce ministry. By the time we finished,we had suffocating agencies like the Joint Chief Controller of Imports and Exports (the infamous JCCIE),the Directorate General of Trade and Development (the impossible DGTD,which did its best to stifle trade and development of all sorts),the Director General of Supplies and Disposals (DGS&D) whose diabolical and malign role still remains a mystery to most of us and so on. The draconian measures started as “ad hoc”,short-term fixes for the acute foreign exchange crisis of the mid-50s. The pattern was similar: Have crisis? Let’s fix it by imposing arbitrary restrictive rules; let’s increase the discretionary powers of various government departments; let’s put a squeeze on productive businesses. No one bothered to look into the fact that the root causes may have been an overvalued exchange rate and a regulatory regime that was unfriendly to businesses and growth.

The irony is that in 1947 we had a decent share of the world market for textiles and the Chinese had zero market share. The rhetoric of the times cast mill owners as evil,blood-sucking capitalists (remember the Bollywood movies of that time?). The very first economic legislation of free India’s government was the Textile Industries (Development and Regulation) Act. We created a czar known as the textile commissioner who told mills how much inventory they could hold,what their product mix should be,how many spindles and looms they could have and so on. We taxed the industry mercilessly. We wilfully destroyed a glorious industry. Today the Chinese textile industry is several orders of magnitude ahead of us. In 1947,we had a dominant share in the world tea market. Tea-planting in Kenya grew fast after India imposed export duties (believe it or not we had duties on exports!) on Indian tea.

Controls on textiles and tea were justified each time in words that are eerily similar to the words used today to justify the transfer pricing guidelines,retrospective TDS on implied royalties,retrospective taxation of earlier exempt on-site revenues,and now the ominous General Anti-Avoidance Rule (GAAR). Is it the intention to weaken India’s flourishing IT and BPO industries,just as we did with textiles and tea? Is there a pattern here that suggests that we cannot bear to see an industry being successful?

The IT industry is one example. There is practically no sector today that does not face hostility. Of late,the hostility has ceased to be passive — something many can live with. The hostility has become active and aggressive. Angel investors are being told that they should not support fledgling entrepreneurs. In recent years,IIT graduates had started staying back in India; many were starting new ventures. Now the message seems to be that they should emigrate like the graduates of the 1970s.

The financial sector is confused. No one knows whether foreign investment is welcome,is tolerated or is positively unwelcome. For different reasons (again the patchwork approach),Vodafone,Cairn,Posco and virtually all FIIs have been given negative signals.

The net gainer may be Singapore’s financial market as trading in Indian instruments may move there in order to leverage a more predictable and welcoming environment. The arbitrary behaviour of the government vis-à-vis Coal India,ONGC and LIC means that domestic investors too have no choice but to become hesitant and wary. Like night follows day,low investment today spells low growth tomorrow.

We do not learn. Ill-conceived short-term fixes will not work. The singular gift of the present government may be to bequeath a fiscal and BOP situation just like the one prevailing in 1991. The long-term consequences are more frightening. Once industrial licensing and import licensing started,it took 35 years to get rid of them. As the countries of East Asia surged ahead,we programmed our country into poverty. No one in Parliament is opposing the draconian provisions of this budget or the creation of a generally anti-business environment. Once these silly laws and regulations are in place,getting rid of them will take 35 years. It looks as if we are determined to drive our growth rates to less than 5 per cent. We can forget about eliminating poverty in India in our lifetimes. Perhaps our grandchildren may (and they may not) see a prosperous India. Too bad.

The writer is a Mumbai-based entrepreneur

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