Navigating India’s “Perfect Storm” - Six Suggestions To Keep The Economy Going

It’s final now. The run of good luck Prime Minister Modi enjoyed has tapered off.

The monsoon is likely to be deficient by 12%. This would be the second year in a row. True, agriculture only accounts for only around 15% of the economy and didn’t grow much last year either. But when you target 7.8% growth, every basis point, added or lost, counts.

Manufacturing and services growth is already slow. Companies are at best cautiously optimistic but the caution makes new investment sticky. The money- and jobs-spinning realty sector, driven earlier by negative interest rates, is in a slump.

To complete the “perfect storm” scenario, there are two important state-level elections around the corner—Bihar later this year and UP in 2017. Neither state has BJP governments currently, so doing well in these will inevitably be a metric of how strong the Modi magic remains.

The good news of course is that every threat is also an opportunity. This is PM Modi’s opportunity to show that he is the Lion we think him to be.

First, the threats.

Fiscal overrun is disaster-prone

More will need to be spent on drought relief, restructuring of bank loans for farmers and income support schemes for farm workers. Delhi, admittedly with a miniscule rural area, has already distributed Rs 50,000 per hectare as relief to farmers hit by the April 2015 unseasonal rain. FM Jaitley is possibly right that the drought will be localized in North and Central India. But these regions account for around 45% of the farmers. Retaining the targeted revenue deficit at 2.8 % and public investment at 14% of the budget will consequently be tough.

Postponed subsidy reform

It is unlikely that subsidy corrections will now be possible this fiscal. Cheap electricity, water and fertilizer are here to stay with a possible relaxation of the tight minimum support price policy of the last few years.

Higher wage cost

A significant expansion in the wage bill looms. For the armed forces, it is the One Rank One Pension promise of the PM. For the Civil Service, the recommendations of the 7^th Pay Commission are to kick in from 2016. Luckily, the wage bill is low by international standards: 1.6% of GDP and 14% of the budget. But even small incremental increases, unless accompanied by efficiency-enhancing restructuring, are not affordable this year.

This perfect storm of shocks cannot be wished away. Better to deal with it upfront.

Here are six suggestions:

1. Winning the market perception battle

Don’t be cowed down by stockmarket fluctuations or seek to pander to them. These are short-term adjustments by speculators and not reflective of annual economic prospects. Consequently, rather than play down the “perfect storm” scenario, it makes sense for the government to highlight the extreme shocks they are battling with to keep economic growth growing. Even in this David versus Goliath scenario, what is key is to share a plan of action on disaster management; income support; and realigning revenue expenditure to retain the revenue deficit and investment target.

Nothing much was heard about the recommendations of the Bimal Jalan Expenditure Management Committee (August 2014). But it could provide some useful strategic, short-term revenue expenditure rationalization measures.

2. Cut the Red Tape

Stressful times also create an environment conducive for administrative reform. PM Modi can quickly kick babudom into shape through positive strokes. He should consider setting up a lean but empowered “Decision Support Team” in his office, manned by 10 senior Joint/ Additional Secretary level officers selected for their expertise in key sectors, their ability to persuade and their flair for collaborative performance.

They would be mandated to speak for the PMO and be tasked to work with the key ministries and state governments to cut through red tape holding up investment decisions. Working against weekly targets with real time feedback to the PM, the mantra for this team should be “ANA—Achievement, Not just Activity”.

Those taking up such high-tension assignments should expect to be on the fast track to become Secretaries in the GOI. The PM is known to be cagey about trusting officers beyond a tiny circle familiar to him. This is not surprising given that he has never worked closely with the babudom in Delhi. But he should experiment by subjecting a larger group to the agnipariksha of performance. He will not be disappointed with the results.

3. Forget the optics of who gets the credit

The knotty problem, particularly in Bihar and Uttar Pradesh, is how to be proactive in the face of state governments, which have the incentive to rebuff such support as being politically motivated.

The farmer does not distinguish between the state and the Union government (Lokniti Survey 2013) – 58% held both the state and the Union government responsible for the sorry plight of agriculture. If farmers fall through the gaps of political finger pointing, they will punish both the BJP and the SP in Uttar Pradesh, and the JD(U) in Bihar. The beneficiaries of apathy will be Bahenji (Mayawati, the BSP supremo) in UP, and Lalu Prasad in Bihar. Doing little is not an option for the Union government, despite some of the shine rubbing off on the SP and the JD(U).

4. Don’t rattle the private sector

It would be a big mistake to take too seriously the campaign to paint the BJP as a consort of the corporate sector. When stern action is warranted, it must be taken transparently and without rancour or bluster. But a “Preet Bharara type” of regulatory action is not what we need. Jobs are what the average citizen wants, which only the private sector can generate.

Strong arm regulatory actions against foreign investors are bad optics—both for investment and for citizen sentiment. If our regulatory agencies are seen to be handmaidens of the government, they lose credibility. But the government also loses by devaluing an efficient instrument for regulating the private sector in a hands-off, technical manner.

5. Sticky revenues

Boost revenues. The tax receipt scenario is grim. First, projections for the year were overoptimistic at Rs 14.5 lakh crore (US$ 230 billion), around 16% higher than the previous year. Tax receipts are bound to slide with slow external and domestic demand and lower corporate profits, despite the 15% increase in the rate of service tax. A tax receipt equal to last year’s estimate of Rs 13.7 lakh crore (US$217 billion) or 9% more than the actuals of last year is the best we can hope for: 5% due to inflation and 4% due to growth of the taxable base.

Getting more tax payers into the net is a worthwhile but effort-intensive option with limited upsides. In 2013-14, there were 47 million direct tax assesses. New assesses have varied between 1 to 3 million per year since 2011. Even doubling the number of new assesses helps only marginally in additional revenue.

6. Transfer the crown jewels to citizens

Fast track disinvestment. Listed Public Sector Undertakings (PSU) account for 13% of the valuation of the Bombay Stock Exchange or around Rs 13.6 lakh crore (US$ 215 billion). Of this, some equity is already held privately by minority investors. But an additional 10% can be sold without diluting government’s majority control.

The problem is that, in the past, Institutional Investors have been the primary takers for such shares. Retail investor appetite has been largely absent from the tumultuous stockmarket for some years now and market momentum has been primarily provided by Foreign Institutional Investors.

Selling PSU shares in large volumes, without transferring majority control to the private sector, dampens the market price. Even the private IPO market is slow. Government is wary of inviting the charge of crony capitalism by selling shares to large institutional investors at cheap rates.

On the other hand, selling directly to retail investors is more defensible even if the price is low. After all the “crown jewels” really belong to citizens. Dispersing the ownership of PSUs widely also meets multiple objectives. Why not borrow a leaf from Dhirubhai Ambani’s 1982 market making strategy and incentivize the retail investor back into the market?

Link disinvestment, as a sweetener, to the issue of government debtfor retail investors only—special convertible bonds—with a fixed return for three years at the prevailing Government Bond rate. 50% of the face value could be optionally convertible on termination in 2018-19, into a balanced bouquet of public sector equity at a 15% discount to the then prevailing market price.

A sequenced, mega issue of Rs 1 lakh crore (US$ 16 billion) of an asset-backed government security can reduce the short-term risk profile of PSU equity investments and pull in finance from an alternative source.

Government must come out with an evidenced strategy to deal with the “perfect storm” India faces. Of course, the PM is a “lucky General”. The drought may not materialize; the world economy may sort itself out and the opposition in Bihar and UP may self-destruct. But waiting for this to happen may be pushing the gods too far.