India's Big Green Wrecking Machine: WSJ editorial on Jairam Ramesh

• EVIEW & OUTLOOK ASIA
• NOVEMBER 24, 2010

India's Big Green Wrecking Machine

Minister for Environment Jairam Ramesh is hostile to economic development.

It would be easy to dismiss Jairam Ramesh as a buffoon. The Indian minister for environment and forests likes to talk big, as when he recently declared that driving SUVs was "criminal" and called for "a penalty on the type of cars you don't want to see on the roads." This week he fulminated against the affluent American lifestyle and those Indians who aspire to it.

Considering the fondness of Indian politicians for cruising around in SUVs and partying in their villas, it's doubtful the government will act on these particular pronouncements anytime soon. But Mr. Ramesh continues to use his office to do serious economic damage. No industry can afford to be cavalier when the minister has them in his sights.

Mr. Ramesh's ministry, which awards and rescinds environmental clearances in an arbitrary manner reminiscent of the "license-permit raj," has held up dams in India's northeast as well as power plants and highways around the country. On Monday he finally withdrew his opposition to a new airport for Mumbai after raising objections for over a year. In the last month, panels appointed by Mr. Ramesh have recommended revoking permits for South Korean steel giant Posco's $12 billion project in the eastern state of Orissa, the largest ever overseas investment in India. This comes a full five years after the firm signed an agreement with the Orissa government to set up its plant.

Similar treatment was meted out to Vedanta Resources, which was ordered in August to stop mining bauxite in Orissa. State officials had given the go-ahead, which is crucial to the operation of the company's nearby refinery. The environment ministry decided that sacred land of primitive tribal groups had been violated. As a result, a $1 billion investment is in jeopardy.

Mr Ramesh is sometimes held up as India's first environmentalist minister of environment. Last month, he even set up a separate green court to punish polluters, making India only the third country in the world (after Australia and New Zealand) to implement such an idea.

But it's increasingly clear that what Mr. Ramesh is pushing is hostility to economic development. This represents a fundamental split within the Congress Party between Prime Minister Manmohan Singh, who advocates private sector growth, and Sonia Gandhi, who embodies the Nehru family tradition of statism. For now, the political power-brokers are tolerating Mr. Singh, whose reforms have helped lift millions of Indians out of poverty. But the risk remains that Congress will revert to its socialist ideology and the Jairam Rameshes in the cabinet will sabotage the country's growth.

India's Balanced Growth: WSJ editorial on balance of payments

• REVIEW & OUTLOOK ASIA
• JANUARY 7, 2011

India's Balanced Growth

Instead of fretting about trade deficits, India should open up more to foreign direct investment.

Late last year, New Delhi reported that its economy clocked 8.9% year-on-year growth in the July-September quarter, further closing the growth gap with China. And as the economics textbooks predict for a country growing this quickly, India is importing capital goods, as its investment cycle picks up again, and consumer goods, as a population with rising incomes aspires to a higher standard of living. Capital is flowing in to fuel growth and a trade deficit.

Yet this is hardly the norm among the fast-growing tiger economies of East Asia, which grow by running trade surpluses and accumulating massive foreign exchange reserves. So established has this model become that India looks like an outlier.

It is cause for celebration that India is bucking the trend. Unlike other countries in Asia that grew by subsidizing their export sectors, India is letting the benefits of free trade accrue to its entire population. The economy's main engine is a stable mix of domestic-oriented investment and demand, and its companies face the rigors of competition. This reduces the risk of malinvestment and balance-sheet recessions.

However, some observers are now sounding the alarm about balance of payments data released by the Reserve Bank of India last Friday, which show the current account deficit widening to $15.8 billion for the July-September quarter, from $12.1 billion in the previous quarter. Does this mean India is going off the rails?

The short answer is, not necessarily. The real worry, though, is that New Delhi still hasn't implemented necessary reforms so it can absorb foreign investment and continue growing at a fast and sustainable pace.

This isn't the first time there is alarm over India's current account deficit. Since it caught the 8%-plus growth train last decade, Indian policy makers have continually fretted about what sort of investment is financing imports. Much like now, from 2006 to mid-2008 low interest rates in the West drove institutional investors to seek higher returns in emerging markets; the flood of capital into India's stock market was contributing to overheating, at least until the post-Lehman shock sent the money flows into reverse for a couple of years.

The Reserve Bank of India is worried that these flows might again prove destabilizing. For instance, in July-September 2010, flows into Indian stocks and bonds made up 88% of foreign investment inflows that totalled $21.7 billion. The central bank considers these flows "volatile." The more stable foreign direct investment trickled in at $2.5 billion, a far cry from, say, the $10 billion in FDI India absorbed in the April-June quarter of 2008. So, in a financial stability report published last week, the RBI marked the current account deficit as a downside risk to the Indian economy.

We're sympathetic to the concern that easy money in the U.S. is causing problems for developing countries like India. But we're not sympathetic to the kind of steps the RBI took in 2007 to "manage" India's capital account: Greater limits on foreign borrowings and more scrutiny on foreign investors, besides stalling on the introduction of new financial products.

To RBI's credit this time, despite last year's episode of "currency wars," it resisted putting new capital controls in place and intervening in foreign exchange markets to weaken the rupee. In fact, it has gradually proceeded with capital account liberalization in the past year: Last September's relaxation of the foreign investment limit in bonds is one encouraging sign.

When it comes to the RBI's lament over the composition of capital account inflows, it's worth noting that New Delhi's own policies skew that composition. As Cornell economist Eswar Prasad explains nearby, investment tends to flow into Indian stocks because that market offers transparent regulation and minimal restrictions. Managers of multinational companies will tell you that's not true for foreign direct investment; each sector from power plants to shopping malls comes with its own labyrinthine set of regulations, on top of general limits on FDI.

Since Prime Minister Manmohan Singh's government was returned to power in mid-2009, it hasn't relaxed any more FDI caps. Wal-mart still can't enter India's retail market because no FDI is allowed in multi-brand retail; the 26% cap in insurance means no global insurance major can enter as a majority owner. What's worse, the government's environmental activism has made FDI more uncertain. For example, Korean steel giant Posco has been nervously awaiting New Delhi's sanction for a $12 billion project in the eastern state of Orissa. Though a government panel on Monday gave Posco its clearance, the project needs final political approval. This explains why FDI into India is now slowing down.

India has the potential to establish a new model for more sustainable and balanced growth in competition with the East Asian export-led model. But if it fails to undertake reforms to make it a more attractive destination of foreign capital, it will cap its own growth potential. New Delhi deserves praise for remaining more open to portfolio investment than other Asian nations, but going to the other extreme of hampering FDI is inconsistent with its laudable record of balanced growth.

Mr. Singh's Lament: WSJ editorial on New Delhi power politics

• REVIEW & OUTLOOK ASIA | FEBRUARY 18, 2011

Mr. Singh's Lament

India's prime minister suggests the buck doesn't stop with him.

India's Congress-led government has been besieged by allegations of graft since the middle of 2010. But Prime Minister Manmohan Singh tacitly suggests it's not fair to hold him responsible when he has little control over his own coalition government. That was the message of an hour-long television interview aired on Wednesday.

Asked what he was doing when Andimuthu Raja—the former telecom minister who belongs to a southern Indian party that's part of this coalition—allegedly perpetrated a $40 billion scam selling telecom spectrum, the prime minister responded, "In a coalition government, you can suggest your preferences but you have to go by what the leader of that particular coalition party ultimately insists." Mr. Singh says the buck does not stop with him: "I did not feel I was in a position to insist [on] auctions" instead of the first-come, first-serve way in which spectrum licenses were sold.

It's no secret that Mr. Singh has been India's weakest prime minister from the moment he took office. This was evident not merely from errant coalition partners, but also ministers of his own Congress Party. For instance, Environment Minister Jairam Ramesh has implemented his own activist agenda despite Mr. Singh's warning that environmentalism shouldn't become a new avatar of the old license-permit raj.

Mr. Ramesh, Mr. Raja and many others understand that at the end of the day they are answerable only to the Congress President Sonia Gandhi. When the party won parliamentary polls in 2004, it was Mrs. Gandhi, a member of the Nehru-Gandhi dynasty that has dominated Indian politics since independence, who anointed Mr. Singh to the top post.

But it's more than embarrassing when the leader of the world's most populous democracy throws his hands up at the hijinks of his own ministers. Accountability is clearly breaking down. India cannot be taken seriously on the world stage when its prime minister doesn't have the power to speak on the country's behalf. How much longer will the Gandhi family rule from behind the curtain?

Back to the License Raj: WSJ editorial on India FDI

• REVIEW & OUTLOOK ASIA
• FEBRUARY 23, 2011

Back to the License Raj?

Another example of the arbitrary interference that is slowing foreign investment into India.

Foreign direct investment into India shrank 22% in 2010, even as foreign portfolio capital increased more than 100%. The main reason FDI has started going elsewhere is the regulatory environment for foreign firms. A good example of the problem is the Cairn-Vedanta saga playing out in New Delhi's corridors of power this month.

Last August, London-listed mining firm Vedanta announced it would buy a majority stake in Cairn India, a local oil explorer owned by U.K.-based Cairn Energy. Shareholders in both firms approved the deal last year. But this $9.6 billion acquisition still hasn't cleared regulators.

India's oil ministry had earlier promised both companies that it would approve the deal by December; it later pushed the deadline to the end of February. Now that deadline also appears improbable, with India's cabinet stepping in last week to offer its judgment. British Prime Minister David Cameron wrote to his Indian counterpart Manmohan Singh recently to express concerns about the logjam.

Delays are one thing, but India is also changing the rules in the middle of the game. Regulators are now haggling with Cairn over the details of the contract that allowed it to explore oil fields in the northern state of Rajasthan.

As per that contract, Oil & Natural Gas Corporation, the Indian state-owned firm that owns a minority share in these fields, would bear the full burden of the royalty owed to the government for extracting oil. But ONGC offers a different legal interpretation of the royalty, which, if agreed to, could suddenly alter the valuation of the fields and imperil the deal. Cairn contests this interpretation, but New Delhi is invoking "national interest" to ensure that its ward's interests be met. Before the deal can go through, Vedanta and Cairn are supposed to give up their right to arbitration on disputes with the government. Both firms have rightly refused.

New Delhi's conduct here is of a piece with the treatment meted out to other investors. Mr. Cameron's letter, for instance, mentions Vodafone, the British firm that's battling a tax case over its 2007 acquisition of one of India's largest telecom operators. New Delhi says Vodafone is liable for $2.5 billion in capital gains taxes for a transaction that occurred between two non-Indian entities outside India. This is the first time such a transaction has been taxed, which is why a Mumbai court had to uphold the taxman's authority last September. New Delhi even changed a technical income-tax provision in 2008 with retroactive effect, just to allow the taxman to pursue the 2007 deal.

Then there's Environment Minister Jairam Ramesh. The problem with his activist agenda isn't just that economic growth is being sacrificed for environmentalism. It's also that Mr. Ramesh's ministry has either reversed local governments who had first given approval to industrial projects (Vedanta's aluminium mining in the eastern state of Orissa last year) or revisited those approvals to keep the company guessing (Korean steel giant Posco's plant in Orissa, finally cleared last month after five years).

Moreover, the minutiae in India's FDI regulations are driving seasoned investors to distraction. In early 2009, the government introduced amendments to its FDI policy that wrought confusion for investors, as they discovered new discrepancies, loopholes and backdoors in the rules limiting FDI. While some of these amendments have since been rescinded or clarified, the lasting effect has been to increase the power of the bureaucracy. Previously foreigners understood they were limited to a certain percentage stake in a company depending on the sector; now in some cases it's up to regulators to set FDI ceilings on a company-by-company basis.

Such arbitrary interference erodes the rule of law and takes India backward toward the practices of the infamous License Raj. Then almost all economic activity was subject to the whims of rent-seeking politicians and bureaucrats. Having largely extricated itself from this corrupt and inefficient morass 20 years ago, why is New Delhi determined to repeat history and drive foreign investment away?

India's Lingering Leviathan: WSJ editorial on the budget

• REVIEW & OUTLOOK ASIA
• MARCH 1, 2011

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.

The Price Is Always Right: My take on some privatization issues

• OPINION ASIA
• MARCH 10, 2011

The Price Is Always Right

The key decision for a government is selling state-owned enterprises, not how to price them.

By ABHEEK BHATTACHARYA

Everyone knew last month's privatization of Indonesian airline Garuda had gone badly, but exactly how badly is only now coming into focus. Previously it appeared that the big problem was the government's failure to price the initial public offering correctly—the range of 750 to 1100 Indonesian rupiah (9 to 12 cents) per share was well in excess of what the underwriters had advised, with the predictable result that 40% of the shares went unsubscribed and the price tanked 17% in the first day of trading.

Now, however, an even worse effect is coming into view: The episode appears to be deterring Jakarta from pushing forward with more privatizations. Witness remarks this week from Deputy Minister for State-Owned Enterprises Pandu Djajanto, as reported by the Financial Times, that the government plans only one other privatization this year, down from the five to 10 it had previously intended. This confirms a policy shift observers had predicted.

Indonesia's economy is falling victim to a long-running controversy over the pricing of privatization IPOs. Garuda's sin was asking for too much, but previous episodes have stirred controversy for asking for too little. Take last November's listing of Krakatau Steel, which raised 2.68 trillion rupiah ($299 million). Many concluded that the government could have gotten more given that the shares shot up some 50% on the first day of trading.

But as much fun as political food fights about fair valuation are, they miss the more important economic reasons for privatization. Over the longer term, the sale price of the asset is only a small part of the value a privatization creates for a government and society.

Consider Maruti-Suzuki, a joint venture formed in 1983 between Japan's Suzuki and a state-owned Indian carmaker. The government offloaded its shares in the venture in stages starting in 1992. The company grew stronger, especially once Suzuki acquired majority control in 2002. "Decision-making became smoother and more focused" after that, Maruti's former managing director and current chairman R.C. Bhargava says, thanks to which costs were trimmed. Suzuki helped turn around the firm after record losses in 2001. More importantly, once Suzuki was in the driver's seat, it was willing to rev up R&D and introduce Japanese models that proved very popular in the Indian market. Maruti is now one of India's best brands.

Also consider Taiwan's Chunghwa, the state-owned telecom firm from which Taipei began divesting in 2000. By the late 1990s, deregulation of the telecom industry had undermined Chunghwa's earlier dominance; compared to its competitors, the "national champion" found itself stifled by political diktat. Once the government started shedding control, the firm trimmed its labor force and improved its marketing and customer service. For the past two years, Chunghwa has been voted one of Taiwan's best-managed companies in FinanceAsia's polls of 300 regional institutional investors.

In both cases, the pricing was controversial. After New Delhi divested 10% of Maruti in 1992, political opponents harangued then-Finance Minister Manmohan Singh for selling too cheaply. And in 2003, securities analysts worried that the automaker's IPO was too expensive. With Chunghwa, Taipei insisted on maximizing its proceeds in multiple stages of the privatization process. More than one public offering met with a lukewarm market response, with the government criticized for setting too high a price. But the controversies turned out to be irrelevant in the larger scheme of things.

Regardless of the controversy, the lasting benefits of this process are undeniable in terms of encouraging growth and, yes, tax revenues. It's not just Maruti and Chunghwa. Cross-country evidence compiled by William Megginson at the University of Oklahoma and others shows how privatization frees trapped assets to be put to growth-producing uses bureaucrats could never envision. On average, a firm's productivity increases by 20%.

The danger is that politicians will lose sight of this fact amid pricing controversies. For instance, the government of Mr. Singh, India's prime minister since 2004, now presents state asset sales as an important leg of its fiscal strategy, which involves expanding welfare programs. This practically begs his opponents to question whether the government is "getting enough." Once the political debate gets sidetracked in this fashion, it jeopardizes future privatizations, as Indonesia is discovering.

It takes political will to keep the larger picture in mind, since pricing will always be controversial. Price too low, and policy makers will worry about fiscal losses while cronyism will become a concern for the public. Price too high, and investors could be dissuaded from buying the stock—emboldening political opponents of privatization.

The choice of asset pricing, in effect, becomes exactly the kind of strategic business decision that governments are fundamentally bad at. That's the very reason governments made another choice—to hand over that asset to the market—in the first place.

Mr. Bhattacharya is an editorial page writer with The Wall Street Journal Asia.