The litmus test of economic reforms

The economic reforms record of the NDA government in the past two years has recently been the subject of media headlines. The trigger was rating agency Moody’s decision to retain India’s rating at the lowest investment level.

The rating agency says it would consider an upgrade if “tangible reforms” were undertaken in the next two years in the following areas - land acquisition, labour laws, tax administration and public sector banks revival along with significant infrastructure investments.

The government, of course, seems to be seriously disappointed with Moody’s decision. It has highlighted the fact that the GST Bill has been passed and its implementation is now work-in-progress. The government side also has pointed out that its overall reforms record of the past few years is impeccable for its depth and unidirectional nature.

It is quite clear from the foregoing that there is a big gulf between the government’s and Moody’s perception of reforms.

Even without a ratings objective, it would be interesting to list out the NDA government’s reforms record, the cornerstone of which is the GST.

Such an exercise would be particularly relevant in the backdrop of comments on the economy by no less a person than the Prime Minister himself.

In a recent TV interview, the PM says that he refrained, in the larger public interest, from issuing a White Paper on the precarious state of the economy in mid-2014 when he assumed office. In the past two years, apart from ending big-ticket corruption, the PM says his government has brought about the biggest tax reform, the GST. Given these comments from the PM, it would help to do the following: understand the precarious state of the economy as it was in mid-2014; and examine the “reforms” that have been introduced to consider if India would not land in a precarious state again.

If the NDA government’s reforms in the last two years can be seen as ensuring that India would not land in a macro-economic crisis again, then one can accept the measures as impeccable.

On the contrary, if it is not so, then there is nothing to claim credit for.

In other words, the benchmark for assessing the government’s reforms record should not be what Moody’s says is “tangible” or what the Finance Ministry claims is “deep, continuous and unidirectional reforms”.

The sole yardstick for evaluating the reforms record would be whether they can ensure that India does not go through a macro-economic crisis of the 2013 type again. That is implicit from the PM’s observations.

For seven years till 2013, India experienced inflation perilously close to double digits. In the period prior to 2006, it was in the high single digits.

For an economy exposed to global instability, running this fundamental macro-economic imbalance for such a long time inevitably culminated in a run on the Indian currency in the summer of 2013. The CAD was at a record high and relative prices in India were completely out of kilter with global prices.

The US Federal Reserve’s “taper” was just a trigger. The rupee fell 50 per cent between 2011 and 2013. India was teetering on the edge of a macro-economic crisis.

It was almost a repeat of 1990-91. The contributory causes too were the same: rampant government budget deficits and their unbridled monetisation by the central bank through the 2000s. At one point, the RBI even funded oil imports by buying the oil bonds issued to oil companies. Note that central banks can buy just about anything, as the western central banks are doing only now.

The source of the budget deficits — large negative supply shocks in key commodities such as oil, the resultant large subsidies and their accommodation by the RBI and significantly enhanced other discretionary spending by the government.

Indeed, a White Paper should have been issued in 2014.

Now, for the reforms since 2014. Economic Survey 2015 lists them:

Auction mechanism for allocation of natural resources such as telecom spectrum and physical minerals such as coal; increasing FDI cap in defence; instituting the Expenditure Management Commission to recommend expenditure rationalisation; de-regulation of diesel prices; replacing cooking gas subsidy by direct transfers on a national scale; increasing FDI cap in insurance; a major programme for financial inclusion called Jan Dhan; and pushing coverage under Aadhaar.

The high point, of course, is the GST. But can any impartial observer say that these “reform” measures can ensure that India will not land in a precarious macro-economic state — of the 1990-91 and 2013 variety — again?

You need root-canal kind of corrective economic policies to ensure that a country does not go through a macro-economic crisis it somehow survived in the past. Unfortunately, most of the measures listed above could be classified only as superficial, incremental and peripheral, relative to the over-riding objective of avoiding another crisis. For earth-shaking reform, the government should purposefully root out the causes of the 1990-91 and 2013 crises. That will call for a rigorous firewall and even an operational divorce between the government and the RBI.

In such an arrangement, the government can run whatever deficits it wants to run. It, though, will finance itself completely in the markets — no recourse to the RBI. Hair-splitting about 3.5 or 3.6 per cent deficit will be irrelevant then. To be sure, the recent move to an inflation-targeting policy framework for the RBI is a step in the right direction. But, the framework is constrained by so many obstacles that it may be impossible to implement.

So, how good is the performance relative to the benchmark?

The writer is a Chennai-based financial consultant