The Economy is Broken. Montek Singh Ahluwalia Tells You How to Fix It.

How did we get here? How do we get out of here? Montek Singh Ahluwalia, former Deputy Chairman of the Planning Commission, answers this. IPC breaks down his insights and recommendations for you.

Backstage: The Story Behind India’s High Growth Years, an autobiography by Montek Singh Ahluwalia examines the great transformative changes the Indian economy has experienced. It does so through the eyes of one of the most significant architects of the Indian economy. Mr. Ahluwalia has had an illustrious career, serving as the youngest ever division chief in the World Bank’s bureaucracy, the first Director of the IMF’s Independent Evaluation Office, and held several senior posts as a civil servant including Special Secretary to the Prime Minister, Commerce Secretary and Finance Secretary, and served as the Deputy Chairman of the Planning Commission from 2004 to 2014. 

On July 4th, in a session organised by the Algebra Conversations and moderated by IPC’s editor Pragya Tiwari, Ahluwalia discussed his newly released book, his opinions on the current state of India’s economy, and his recommendations, going forward. Here are the key takeaways.

Where We Stand

- For a holistic understanding of the Indian economy today, we must examine its course since its liberalisation in 1991, a major break from the previous, state-run economy. 

- The effects of most of these changes actually took some time to unroll and did not occur immediately during the tenure of the Narasimha Rao government. Among other global events, the Asian Financial Crisis prevented India from realising the full effects of its marked policy change until the 2000s.

- Despite a number of different parties coming to power since 1991, there remained broad continuity, with regards to the liberalisation framework instituted, in this period.

- The first few years of the UPA government, which began in 2004, saw a period of high economic growth. This was significantly due to favorable global conditions, but also involved some specific policy decisions of the UPA. These were in the areas of decreasing the fiscal deficit and encouraging private and foreign investment. They attempted to institute a GST (Uniform Goods and Services Tax) to reform the tax system, that would have further upped the growth but unfortunately it could not make it through, mainly due to opposition from the BJP.

- There was also a great push towards inclusive growth, which was fairly successful. There was a significant drop in poverty (this was recognised internationally but not very well domestically due to political reasons) due to a heavy trickle down effect, push for agricultural growth, and programs such as MNREGA which were deliberately targeted at the more vulnerable sections of society. A trickle down effect is generally frowned upon as an ineffective way to reduce poverty but depending on what is causing the growth and the extent of the effect, it can be an important factor. 

- There was a dip in the later years of the UPA regime but recovery was quick and the uptick continued into the early days of the Modi government despite the issue of non-performing assets of banks (NPAs). 

- Part of the crisis of NPAs was caused by over-optimism on the part of investors due to the boom years of the UPA. When the NDA came to power in 2014, they promised double digit growth figures that did nothing to adjust expectations. To make matters worse the Modi government has not been able to address the issue of NPAs despite 6 years in power and things have, consequently, spiralled. 

- Demonetisation further proved to be an unnecessary shock, especially to the more vulnerable and cash dependent informal and agricultural sectors of the economy. The implementation of GST was also overly rushed and thus caused many problems for the states. The frequency of changes with regard to GST also led to confusion amongst traders and businessmen.

- Due to the events and policies described above, the economy faces a number of challenges today that have only been exacerbated by the COVID-19 pandemic and the resulting lockdown in India. The fiscal deficit is also close to out of control. 

- The pandemic has also exposed the sorry state of public health in India. Successive state governments and the central government have failed to address this issue effectively and until the voters demand it and make it an election issue, we may never see an improvement. 

Recommendations Moving Forward

- Major reforms need to be proposed and initiated in the banking sector. The problem of non-performing assets resulted, as mentioned above, from overconfidence on the parts of the government, the private sector, and the banks. If focused on earlier, the situation would not have deteriorated to the degree it has now. Simply recapitalizing banks, as the government has been doing, will not help and kick the proverbial can down the road. Only a complete overhaul of the system can provide a permanent solution.

- The fiscal deficit began to widen at the end of the second UPA regime and is in a dire situation as of now. The only way to reduce the deficit would be to curtail expenditure or increase revenue. Curtailing expenditure would only worsen India’s situation, as we are already lagging behind in terms of key research, health, education, industry and even defense. Instead, a better performance on tax revenue is needed, it is possible for India to gain 5-6 more percentage points of GDP through tax reforms. These would not involve an increase in tax rates, but a reform that would encourage compliance by increasing transparency.

- However, this cannot be done by the revenue departments alone. They are simply there to implement policies so it is policy reform alone that can increase revenues. An expert committee has to be set up. Take for example the current situation. If the government does not acknowledge the slowdown, the revenue departments will feel pressured to show business as usual revenues which will lead to unreasonable assessments and a further burden on taxpayers. 

- If revenue can be increased in a systematic manner, increased expenditure on public health is a must. Most countries spend 4% of their GDP on public health while India spends 1%. A lack of education and information leads to a lack of public demand and outcry for primary health, which would likely solve the problem.

- The current government stimulus issued in wake of the COVID-19 pandemic needs to be increased, As of now it comprises only 1% of GDP while other countries have been devoting a much larger percentage. The need of the hour is to increase demand. Supply side measures alone will not help. Furthermore, the weakened situation of the banks has prevented them from taking advantage of the stimulus, highlighting the need for reform. Finally, the states should receive much more financial help than they have been receiving (you can read more about the situation of the states here).

- With regards to the current economic strike with China, care must be taken to follow a consistent economic approach that will not further destabilize India. If the government does seek to de-link itself economically from China, it must strongly integrate with other global economies as China has been doing. Unfortunately, the government has not been doing so, as exemplified by its decision not to join the Regional Comprehensive Economic Partnership (RCEP). This is related to India’s need to actually increase its global economic footprint rather than adopt protectionist policies as Western countries have been doing. Unlike the West who are in many ways unable to compete with developing economies in the global market, India stands to gain by not resorting to protectionism. 

- Finally, and perhaps most importantly, it is important to reiterate that the government needs to acknowledge that with the global pandemic there will be a decline in GDP. As of now their projections seem overly optimistic and they should, instead, reflect this reality. Only then will we be able to implement adequate reforms to increase our growth rate with a fiscal stimulus, navigate sanctions against China, and chart the future of India’s economy.

You can watch the session here: 

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(Image: World Economic Forum - CC BY-NC-SA 2.0)