The emerging economies have been transformed into the ‘Fragile Five’, now used to describe at least three of the erstwhile BRICS nations — India, South Africa and Brazil — for their excessive dependence on foreign investments, which has led to economic turmoil. In this context, the emphasis of the Indian authorities has been on restoring domestic balance by targeting inflation, while at the same time keeping the current account deficit (CAD) in check through a series of policy measures.

Issues of governance — corruption, delays in clearing projects, ill-routed subsidies — have had an equal, if not more, important role to play in impeding growth. Indeed what we have is a triple deficit – with governance added to fiscal deficit and CAD.

Both in terms of the ‘Ease of Doing Business’ (rank 134) and the ‘Ease of Starting a Business’ (rank 179), India compares poorly even with the remaining members of the Fragile Five. Indonesia, which ranks second lowest among the five, for instance has comparable figures of 120 and 175. Other reports — The Rule of Law Index (World Justice Project), the Global Competitiveness Report and Transparency International’s Corruption Perceptions Index — have all indicted India for its poor governance track record.

Governance deficit On the current account side, the tourism sector affects foreign exchange earnings (FEE) and thereby the CAD. There is enough anecdotal evidence on the fall in tourism following a deterioration in the law and order situation (especially against women) in India. With India ranking a low 96/97 on the factor ‘Order and security’ in the Rule of Law Index and the deteriorating crime and law situation, lower tourist arrivals and the consequent inflows of foreign exchange directly impact CAD. The average growth rate of FEE through tourism for the 2003-04 to 2006-07 (pre-crisis period) was 28.58 per cent and dropped to 11.1 per cent in the post-crisis period (2008-09 to 2012-13).

On the capital account side, lack of governance has serious implications for FDI. Poor institutions, uncertainty of contracts, poor law and order situation, as also high corruption not only tend to add to investment costs, but also make FDI with its high sunk costs unattractive. It has been found that a 1 point increase in the Government Effectiveness (Kauffman ) Index increases the FDI/GDP ratio by 4 percentage points. With India governance indicators deteriorating, the impact on the FDI flows is clear to see. The pre-crisis average annual FDI growth rate of 54.6 per cent is down to a mere 3 per cent in the post crisis period.

Growth impediments

A ‘Double Trust Dilemma’, where neither the innovator (who contributes his ideas) nor the investor (who invests his money) trust each other, impedes innovations – a prerequisite for development. With India ranking 186 in the ‘Enforcement of Contracts’, it is little wonder that the absence of a safe and secure environment, with adequate investor protection, has impeded growth. High corruption, within a poor institutional environment, makes for a higher fiscal deficit, thereby also constraining growth.

India will need to pay attention to governance issues to be out of the Fragile Five. The governance deficit is a bigger problem than the ‘twin’ deficits.

(The author teaches economics at the SP Jain Institute of Management and Research, Mumbai. The views are personal)

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