Pall of Gloom

 

Dr Suparna Karmakar

Pall of Gloom

Reasons for the slowdown that the domestic economy is faced with are completely indigenous

Developments in the last couple of months give a different perspective on India’s growth prospects. Contrary to our earlier assertion that despite being embroiled in multiple corruption cases across sectors, global confidence in the long term prospects of India seem undiminished, it appears from recent data that at least in the near and medium term, the impact of the neverending emergence of skeletons from the UPA government’s corruption closet has had a perceptible impact on business sentiments in the country. Also, indicators for the predicament seem to lead to the lack of governance in the country.

Notwithstanding the relative bullishness of the Indian consumer visa- vis its Asian peers, the inability of the incumbent government to institute and implement necessary reforms has started to take a toll on the growth prospects of the Indian economy. Add to that the recently acknowledged failure of the NSSO to provide credible data, the concern is not only that the policy is being made on the basis of incorrect and imperfect data but also that the data is not sufficiently reflective of the socio-economic composition of the country any more. We are not only risking making useless policies, but given the penchant of this government to increase inclusiveness through subsidies and transfers, we risk incorrect directing of the transfer funds, thus compounding the already high level of inefficiency and corruption in this regard. Little surprise then that the recent policy measures (viz. inflation curbing policies) have been ineffective.

On the other hand, thanks to governance failure and lack of reinforcing reforms business confidence in India is moderating. Thus, the private sector engine of growth that famously operates in India despite the government, is likely to stall or at least slow down significantly in the near term, increasing the concerns of unemployment and development. Growth is a necessary condition (though not at all sufficient) for poverty reduction and for promoting inclusiveness; redistribution is only possible when there is something to redistribute.

The fact remains that the domestic economy is once again weighed down by high costs. However, this is more a result of delays in project implementation, especially in the case of larger projects, than rising interest rates and the general inflationary conditions. Industrial investments are caught in the cross-currents of issues such as environment and ecology, laws and regulations relating to extraction and use of natural resources, land availability, interest of indigenous people and abatement of corruption. And if the domestic industry is bogged down by these issues, it is hardly surprising that foreign direct investors have been keeping their distance from the country. In the recent past, India has had the unfortunate distinction of being the lone fast-growing and emerging Asian economy to have experienced a decline in FDI inflows, at a time when weak growth prospects in the OECD countries have encouraged multilateral firms to diversify into the more dynamic Asia-Pacific economies.

However, given the failures discussed above, the seemingly positive policy proposal from the Department of Industrial Promotion and Policy (DIPP) for a removal of sectoral caps for FDI in all sectors, at least up to a limit of 49%, is likely to have little net impact. It is undeniable that low sectoral caps send out unwelcoming signals to the foreign investor community, given that ease of entry has always been a necessary condition for those taking strategic cross-border investment decisions. However, while important, these are usually not the determining factors (sufficient conditions) for the locational decision. All econometric analyses of determinants of FDI into India seem to suggest that it is the growth prospects of the economy and importance of the sector in the economy, and the overall business environment that determine location decisions of foreign investors.

And among the latter, as most surveys of doing business in India indicate, it is poor infrastructure, lack of transparency in regulations, red-tapism and ad hocism in policy implementation (including retrospective implementation of laws) that are the key deterrents for foreign firms operating/waiting to invest in the country. Thus, while the suggestion/move of removal of sectoral caps up to 49% is laudable and would go a long way in improving the image of the country as a favourable investment destination, if the main objective is to enhance the FDI inflows in any significant manner, the government needs to retrain focus on facilitation and creating an amenable business environment in the country.

The view from the ground is clear: it is the spate of corruption cases in 2010 (in construction and telecom sectors) and the dilly-dallying by the government on approvals in key investment proposals (notably in the mining sector) in the last couple of years which has dampened investor interests in India. It will, therefore, not be wrong to surmise that simplification and fast-tracking of the approval processes, a relaxation and fair implementation of regulations, and a general improvement in the physical infrastructure and moral fabric in the country will attract FDI in significantly greater numbers as compared to the relaxation of sectoral caps.

Domestically, it is a turbulent business environment that industry faces. However, if a favourable environment is created, Indian industry is confident that it can take the economy on the road to sustained high double-digit growth. Hence the imperative is to remove barriers to industrial investments and growth. Policy makers should start sifting the wheat from the chaff of their multitude of good intentioned but ineffectual policies.

Suparna Karmakar specialises in international trade and open economy macroeconomics. Views expressed are strictly personal. She can be reached at suparna.karmakar@gmail.com