India's Lingering Leviathan
The 2011 budget fails to honor the legacy of the 1991 reforms by cutting back regulation.
Twenty years ago, India's then Finance Minister Manmohan Singh brought out a budget that drastically reduced state intervention in the economy and kicked off a period of high growth. Today as prime minister, Mr. Singh is presiding over a government that is growing the state sector and imperilling future growth. Yesterday's budget increased social welfare spending while offering little reform to decrease regulatory meddling.
Reform-minded critics expressed concerns in the years after Mr. Singh's historic 1991 budget that those reforms didn't go deep enough. Later rounds of liberalization didn't either. And Mr. Singh, once he came to power as prime minister in 2004, never mustered the political will to push further reforms through. Instead, his Congress party-led government has kept echoing "inclusive growth" as its mantra, in an attempt to exploit class divides in a growing economy. The party has touted the idea of "two Indias," the urban rich versus the rural poor.
But if there's one reason the poor in rural areas have remained poor is that reforms never reached sectors such as agriculture and land. Instead the benefits have been concentrated in urban-centric industries.
Take agriculture itself, a sector that employs more Indians than any other. Farmers in one state often face restrictions in selling their crops in another. When they are allowed to sell, infrastructure bottlenecks slow down transportation and storage. Supply chains are notoriously inefficient in India, largely because restrictions on foreign direct investment prevent the entry of a Wal-Mart or a Carrefour. Whatever chains exist are dominated by a few traders, who don't allow new entrants into the market. Moreover, commodity exchanges that can offer farmers better price signals haven't been fully liberalized; they are still regulated by a political ministry instead of an independent entity.
Another threat to growth is the lack of an efficient market in land, a problem that's starting to affect urban industries as they try to expand capacity. The nature of India's eminent domain laws has left land acquisition and property rights murky. The greatest victim here is, of course, the rural poor who can't earn a proper profit from selling their land.
Then there are the socialist-era labor laws still on the books that prevent factories from providing employment to the poor, stalling the necessary process of urbanization. And New Delhi's stranglehold on higher education means the poor can't be easily educated.
As these examples show, growth could be much more "inclusive" if reforms were extended to more areas of the economy. But, as Niranjan Rajadhyaksha explained on these pages last month, Mr. Singh has in practice found it easier to promote "inclusiveness" by expanding the dole than by embarking on genuine deregulation.
Which brings us to the spending addiction that's characterized Mr. Singh's Congress Party-led government. So-called social-sector spending, as a share of total expenditure, rose to 19.27% from 13.75% in 2005-06. Finance Minister Pranab Mukherjee continued that tradition in his budget speech yesterday.
Mr. Mukherjee proudly announced that social spending will rise an extra 17% next year. In January, the government said it would index its rural jobs scheme, which guarantees 100 days of (often) make-work employment to the rural poor, to inflation. The government is also contemplating increasing its food subsidies dramatically through a new "food security" law; one liberal estimate pegs the increase in subsidy at nearly 1 trillion rupees ($22.1 billion). Total government spending is set to rise by 13.4% from last year's budgeted estimates—though readers should note that New Delhi ended up spending more last year than it budgeted for.
This level of spending in the past has been cause for alarm, especially with the bond markets. This time may be different, because increased revenue from taxes and one-time privatizations, as New Delhi estimates, can offset what it plans to spend. Of course, these estimates and plans invite skepticism, as Ruchir Sharma writes nearby.
Investors should nevertheless keep careful watch on spending and regulatory policies to understand the long-term sustainability of India's public finances. Asset sales to the private sector won't come every year; tax revenues are higher only because nominal GDP, thanks to high inflation, is buoyant. What investors should care about instead is New Delhi's recurring, or revenue, expenditure. It's a little suspicious that the one accounting trick Mr. Mukherjee pulled out of his hat yesterday was rearranging how the government measures the deficit between revenue spending and receipts.
Perhaps investors have already started to rethink the sustainability of India's growth. This year has seen foreigners pull $2 billion out of the stock market this year, as they question both regulatory and macroeconomic trends. FDI shrank last year.
The best way for New Delhi to reassure investors about the long-term potential of its economy would be to cut spending and, more importantly, enact a second generation of reforms targeting land acquisition and labor laws. It's past time for Mr. Singh's second supply-side revolution, one that finally reaches rural India.
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