The story of India’s economy under the Nehruvian socialist framework has been a stunted one. Afflicted with License Raj, political patronage and crony favoritism, the Indian economy functioned largely as a political economy that bred an ecosystem of corruption and economic stagnation for nearly four decades after Independence. Even as the country slowly disentangled itself from the outdated crony socialist system by way of liberalization and economic reforms in the 90s, it reeled under massive surges in inflation and an out-of-control fiscal deficit despite a healthy growth-rate in the decade before 2014.
It is only now, under the visionary leadership of Narendra Modi, that the story of India’s economy is showing signs of a tectonic shift. As India surges ahead on the developmental fast track, the willingness to take risks, the proclivity for out-of-the-box solutions and the ‘can-do’ approach of the Modi government is making the world sit up and take notice.
Noted economist, author and environmentalist, Sanjeev Sanyal spells out his idea of leveraging the Indian economy into one based on social churn, reforms, innovation, risk-taking and most importantly, a framework grounded in the application and imposition of rules.
He elaborates on how fundamental changes like reforming the complex and indirect tax system, regulating inflation control thereby bringing down the Cost of Capital and strengthening manufacturing, reining in the fiscal deficit as well as boosting infrastructural expansion, are practicable only by introducing structural frameworks of governance that will not only maximize governance but pave the way for long-term economic development.
Thank you very much ladies and gentlemen, for taking time off on a very wet Saturday afternoon. The idea was to speak about, new economics for a new India. And the idea basically is to give you a sense of what on earth we are attempting to do, and what has been achieved over the last 5 years. The reason I wanted to give this talk specifically is that, usually when I give a talk, especially when I am in a press meeting or something, I am talking specifically about a certain specific policy. The idea here is to kind of give you a flavor, of the kinds of things we are actually attempting to do from a broad perspective, so that you get a sense of what is being attempted. This will allow you then to judge, what was being attempted, whether or not it succeeded, or we did a good job of it. That is for you obviously the people of India to decide. But at least, I hope that you will judge it, based on what was being attempted in the first place.
So, the most important thing to realize is that, the new India that Prime Minister Modi speaks about very often, is a vision which is not just a general vision of, let’s have an India that is more developed and so on. It is actually a fairly specific vision of an India, based on a very specific view of how economics should function. Now, the idea of this new India is basically, at a very simple level, to move India from a political economy based on patronage, rent seeking, and perpetuation of certain social groups, to one that is based on social churn, on innovation, risk taking, and most importantly on a framework that is based on the application and imposition of rules. So, it is a rules-based system, and consequently as you will see from my talk, a lot of what was being tried to do is really impose order, and to create a framework for governance.
If you remember the old term – ‘minimum government, maximum governance’, somehow some people tended to interpret it that this was some sort of a libertarian vision of moving into a world, where there is minimum government. But they didn’t remember the second part which was about ‘maximum governance’. And really a lot of what we have done in the last few years, particularly in the last two years is to introduce these frameworks of governance. Because if you do not introduce the frameworks of governance, and attempt to do minimum government, then you will end up with what Russia looked like after the collapse of the Soviet Union. So, it is important, in order to have this minimum government problem, to first introduce the frameworks of governance.
So let us go back to a few years ago, or in fact even better, relook at the last 25 years. What has been the last 25 years of reforms been all about. It has really been about unwinding a certain vision of crony socialism which was based on a top-down vision, which was based on a vision of government imposition, but largely very much one where there is continuous intervention in day-to-day life. That vision of India basically fell apart around about 1991. But what we didn’t do was replace it with anything else. Instead what we did was to keep unwinding that old vision. So, the last 25 years is about unwinding whatever existed, the Nehruvian socialist system. It was not about articulating a brand-new way of thinking. So, what I am going to do is spend a few minutes explaining what is it that we were attempting to do.
Now the growth that you saw in the immediate last decade or saw has made us one of the fastest growing economies in the world. And in fact, right now, as you know, we claim to be the fastest growing major economy in the world. That is actually true. Now the immediate five years prior to when this government came to power, we did have, of course, many shocks to the system. Particularly the global financial crisis. Despite that, the growth performance of that government, if you really take into account, wasn’t terribly bad. I know there is a lot of debate about it. But in the end, if you look at it, actually the real problem within that period was not growth. And especially given the international context, the growth was actually quite good. The real problem of that period was, the lack of stability and order. That was the real problem. The problem was while we were growing reasonably well, we had massive spike in inflation, sometimes double-digit inflation. We had a massive spike in our fiscal deficit which went out of control. There was a huge amount of unregulated lending. Much of which we are now unwinding.
So, really what was the first and the most important thing that needed to be done when this government came to power in 2014, was to impose some sort of an order on the system. So, what was the first reform that this government attempted to do was to introduce something called the “monetary policy committee”, with very very strict targets for inflation control. Why this was because, until you have anchored inflation, nothing else can work. So, the RBI act was amended, a monetary policy committee was formed, with very clear target of an average of 4%, a midpoint of 4% with a range of 2% points on either side. So, a range of 2-6% for inflation. And this has been hugely successful. So, nobody imagined that we would manage to lower our inflation rate which used to run historically in the 8-10% range. In fact, very often was it double digits, to one where we are very comfortably managing to control inflation.
So much, so, some people would argue we have been too successful in fact the only time inflation has actually hit the edges of the target range is actually to the down side. It went out of it in 2017, and we are actually hitting it as we speak right now. The inflation as we speak is around 2%. And there is some argument, to say, it may even be overstating the number. So, this is a huge huge achievement. Any other country that was attempting to do structurally lower inflation by 500 basis points or thereabouts of what we were attempting to do, would have gone in to a complete recession. And yet we have done it. It’s not something we are claiming to do. We have done it. Yes, it was very painful. Because when you suddenly lower inflation in this way, real interest rates go spiraling out. And of course, it causes pain, particularly to the business community. But generally, even to the government, because obviously the real interest rate it was paying on government debt went spiraling out as well. So, what we ended up with of course was painful. For example, even today a small business pays 12% on its debt. With inflation running at just 2% you can imagine the thousand basis point real interest rate is being paid by the business community. Very very painful. And I will come back to this issue a little bit later. But, the first step in terms of radically lowering inflation rates has already been achieved.
Now, why is this such a great and important achievement. Because, you see, until you have anchored inflation on a long-term basis, on a structural basis, you cannot bring down the cost of capital. And why do we need to bring down the cost of capital? Well because if you don’t bring down the cost of capital, then all the other problems that we try to solve will not get solved. So, for example, we talk about the fiscal deficit. Now, the primary deficit, i.e., the deficit of the central government excluding the amount that we pay on existing debt is only 0.2% of GDP. In other words, for all the things that the finance minister actually has control over is actually doing a very good job.
We only have a primary deficit of 0.2% of the GDP. So where does 3.4% of GDP deficit come from? Well all of the rest is, interest payments on past accumulation of debt. So really we are all running very very fast, just to stay at the same place. And until you can structurally lower the cost of capital, you cannot fix the fiscal deficit. Same thing is true of our corporate sector, or the competitiveness of our exports. There is a committee that I am a part of, which is headed by Dr. Surjit Bhalla on export competitiveness, and we interviewed a large number of people as a part of that to ask them – okay, what is it that we need to do in order to get our economy competitive in exports, particularly in manufacturing, where we have been not very successful. And over and over again, the thing that came through to us was, sure we can do a little bit of improvement in our physical infrastructure, roads etc., but frankly unlike in the past, these things are not the binding constraints. The real binding constraint to many many exporters is a very simple one – the cost of capital. How can we, when we are borrowing at 12%, compete with a competitor who is borrowing at 6%? In fact, the exchange rate was the least important thing that most of these exporters wanted to discuss. It was therefore the cost of capital. Again, if we do not structurally lower it, lower inflation, we cannot bring down the cost of capital. So, there are many many things that I can go on about this. But until we had anchored this and stabilized it, we could not take the next step.
Of course, we now have to carry on and begin to take the next step, and I have been arguing for the last year and a half that the reserve bank needs to get on with the act of taking step 2, which is to begin to structural lower our interest rates. Because if you do not structurally lower our interest rates, oddly enough, unlike what many mainstream economists think, that always keeping interest rates high leads to lower inflation, that’s not true. If you structurally keep interest rates high, when inflation is low, what will happen is that many capacities that you would have otherwise built, won’t come on board, may infrastructure projects that you would have otherwise built won’t happen. So keeping interest rates high for long periods of time, is also not a good idea. We need to take advantage of this and bring interest rates down. But at least, the stage is now set for being able to do this.
Now, I will take you another step that what we needed to do. We had a very very complicated indirect tax system. It was indeed so complicated that it was more easy for Mumbai to trade with Shanghai or London, than it was for Mumbai to trade with Delhi. Now this is not a new problem that I have just discovered. This was clearly known to be an issue when I was in high school. And we kept debating this. As many of you know I am from Kolkata, so you can imagine we really debated it. Now, having debated it for all these decades, what did we do? We arrived we everybody agreeing that some sort of a GST thing needed to be done. And yet, we kept debating, oh my god, we need to change this, we need to standardize that, we need to improve this, we need to prepare more. But the fact of the matter is, when you are introducing such major major changes, and this was going to be the largest tax reform we have ever attempted. In fact one of the largest ever in the world.
We’ve actually never knew till we had done it, what was going to happen. So in fact the only way to find out what was going to happen, was to do it. And that is precisely what we did in July 2017. We were very often told if only you had waited another 6 months, and done more planning it would have worked better. But in fact, none of the things that the experts told that would go wrong went wrong. But there are many things that did go wrong. Nobody told us that the error correction button in the website will not work. Nobody told us that the real problem was going to be the refunds to the exporters. The only way to have therefore found out, was to have done it. And in fact, the people who, GST council and the others wo were implementing this, were fully aware that when it was going to be first introduced for the first three months there would be lots of problems and probably wouldn’t work at all. And that’s precisely what happened. Then few months later, it somewhat worked, and then it worked a little bit better, and now a year and a half later I can say we have a system, that by a large works, in fact it works reasonably well, and without doubt is a dramatic improvement on what used to be there before.
Now this does not mean that system cannot be improved upon, we can keep improving on it. In fact, Finance Minister himself has said that over a period of time perhaps this middle two rates will probably be merged into something, so we will have fewer slabs, and so on and so forth. But it is very very likely, that 50 years from now, we will still be using some similar framework. And we have shifted on to this framework, we can keep improving it, but for all time basically that I can see that we will be using this unified framework. So this is done.
Another very very complex and difficult reform that we needed to do was, cleaning up the banks. Now, one way, the simple way of cleaning up the banks would have been to essentially keep evergreening the way we were, and basically sum how keep growing out of the problem. This was how we used to do it. Which was that, whenever we had all these bad loans, we used to give even more loans. Keep the denominator expanding so that the numerator was kept manageable. And so, this is how we ended up where we did. Instead, what was done, was that, in 2015 and 2016, the reserve bank governor was given full authority to make sure that the recognition of the NPAs was done as well as possible. So, a huge amount of effort was put into recognizing the problem.
Then having recognized the problem, by beginning of 2017 we recognized we have to do something about this. Not good enough to just recognize the problem. So there was many options. One of the options was to create a bad bank and shift all these bad stuff there, recapitalize the banks so that the banks can go back to lending, and all of this was stuffed into a bad bank where we would try and fix it. Now, in some ways this would have been a less painful option. But, it would have solved nothing. The recapitalized banks would have gone back to doing whatever they were doing before, all these assets would have festered in a warehouse something similar to the BIFR, we have done this BIFR kind of thing before, we know it doesn’t work. We also have seen what happens, in fact I have personally seen, as I used to be the chief economist for the Deutsch bank for countries like Indonesia and various parts of Asia which went through the Asian crisis.
They created bad banks, and the experience was the ultimately the old promoters bought back their old assets for 20 cents to the dollar. So, the idea then became, that look, rather than do this, we shall use a completely brand-new tool, called the Insolvency and Bankruptcy Code (IBC), to try and resolve this. So what was done? Now, remember, this is a very risky thing to do. Just like with GST, we didn’t quite know exactly what will happen when we try to do this because, none of the institutions of the IBC were in place in the beginning of 2017. The courts NCLT, NCLAT didn’t exist, the procedures didn’t exist, the insolvency professionals did not exist, and nobody knew how any of these things would hold up when challenged in the supreme court or the high court and so on. But the risk was again taken, and in order to get going, 12 of the largest cases were identified. 12 of the largest cases were important because, the idea was, oh my god, how will these new institutions deal with so many thousands of cases.
Now one of the good things about elite capture is there are actually very very few cases to deal with, in fact 50 cases accounted for basically 2/3rds of the bad loan problem. So since it was so concentrated, we said look, we don’t want to solve every case, and any case the size of the case is not correlated to its complicatedness. So lets identify the very largest cases. We started with 12 cases and broadened it to 50. The earliest set of 12, went through their 180 days, plus 90 days etc., by July-August of last year, began to come on stream. One by one they are getting resolved. And some very very large cases like Bhushan steel have gotten done. Some very large cases are almost done like SR steel which is I think in the last edges.
And these are not small cases. Bhushan steel we recovered 35,000 crores, plus another 5,000 crores in equity. So, 40,000 crores. In the case of SR steel if it gets through, the bid that is, the worst bid that we could possibly get it is probably the one that ArcelorMittal is got. I think it is something like 42,000 crores. But if one of the others gets it, it will be even more. But at least 42,000 crores will come back. But this is not even the big gain from this. These large amounts of money. What has happened as a result of this, is that people have begun to believe that, creditor rights will be imposed. There has been a major change in business culture, that old culture of impunity has been broken. As a result some of the largest businessmen in the country, with very powerful connections now do not assume that they can take large loans from the public sector banking system and not have to repay, or for that matter have to repay their operational creditors and so on. And you have seen some of the biggest names, in this country, being hauled up in front of the courts and being forced to pay. That is a very very big deal. And, as a result of this business culture, we have had literally lakhs of crores of money is being voluntarily paid back to the banking system by those who had earlier been reluctant. So, combining the actual cases that went through the NCLT system, plus those who have just voluntarily come back and behaved better, something like 3 lakh crores of money has come back into the banking system which we thought we had lost to NPAs. No this is a big big change.
I have just given you three examples – GST, the IBC process, the NPC, as three examples of frameworks of governance. Other frameworks of governance have also been tried. One other one, big problem that we had in India was, the problem with real estate developers generally behaving badly. So, a framework law called RERA has been introduced. Somewhere it may have succeeded, may not have succeeded. But you can clearly see what is being done. We have similarly tried to improve things like, economic offenders, fugitives bill, and so on. Various kinds of laws and frameworks have been created, in order to create the kind of economic order and culture that is very important for us to take to the next stage.
Now it is fully understood that imposition of this kind of rule based system, when it was first done, was going to be painful, it was also understood that when many of these frameworks would be imposed there would be all kinds of unintended consequences, because obviously the institutions didn’t know, did not in some cases exist, those who were trying to impose these rules didn’t know exactly what would happen when done, the general population on whom these things were being imposed did not know what was expected of them. So it was a big risk to do it, but, I am pleased to say that thanks to the cooperation of all of you, who willingly took on what I would argue is a fairly painful set of reforms, and in a country where, for the most silliest of things we end up having large crowds agitating, rioting etc., we went through so many painful reforms, and while many many people grumbled, they in the end took it. Therefore, to have wasted this point in history and not imposed all these great changes would have been a real waste.
So all I can say is, whether or not these things succeed or not, I’ll let you decide. But I wanted to make sure that you knew that, 1. What is it that we were trying to do? 2. We are entirely aware that many of these things were done were painful to have been introduced, not matter what their long-term gains, the introduction of them were painful. However, I have some very bad news for you, which is this. That if, this government is given another opportunity to come and do more, we will do even more painful things. So, let me give you some flavor of the kinds of painful things that will be attempted if somebody like me is given another opportunity. First and foremost, the most important reform we now need to do is judicial reform.
This is now the single biggest constraint to the growth of our economy and is not just about the narrow business of the judiciary. There is a whole ecosystem of things that need to be cleaned up. There are things that we need to do for example with the bar councils which are probably likely to be the biggest roadblocks to actually judicial reform, not the judges themselves. This has to be done to an institution that constitutionally has been kept separate, for good reasons. Therefore, it requires, not just the government, but also the judiciary to cooperate together to do this. But however, we cannot call ourselves a civilized country with 34 million cases stuck in our legal system. The inability to enforce contracts, if you look at any economic issue, whether it is infrastructure projects getting delayed, or tax collections and refunds not coming on time, or whatever maybe the issue. You dig it down, you will find that the root of the problem is something to do with the judicial system. Sometimes it is judiciary who is not keeping up part of the bargain, sometimes bad procedures, sometimes bad laws, whatever it is.
But this is something that has to be paid attention to, and in fact if you gave me 10,000 crores of money to do whatever I wanted to do with it, I wouldn’t build a highway, I wouldn’t build an airport, in fact the one thing that I would spend it on is building more courts and hiring more judges, and speeding this thing up, and giving it better infrastructure. The best investment that this country can make is in upgrading its judicial system. This is something I would very strongly argue is the best thing that we need to do. And when we do it, it will cause all kinds of unintended consequences and problems that will arise from it, but it has to be done.
The second major area of reform that we need to do, is administrative reforms, which includes, everything from bureaucracy to the police. We have ended up with a colonial era bureaucracy overlaid by a socialist era bureaucracy, overlaid by a bunch of institutions which we have created in the last 25 years as part of our market transition. The net result of this accumulation of institutions and bureaucracy is, that we basically have a bureaucracy that is completely dysfunctional. So much so that every time I have to go abroad for an official meeting of some sort, and some of this is planned months in advance, even then, every time I have to go abroad I have to get 27 separate signatures. Now this is completely absurd.
This is something, which by the way if you happen to be a businessman, you have to do 27 signatures for everything. I am doing it for something very trivial, but you set up a restaurant, or you build a building, or you set up a factory, you will have to get far more than 27 signatures, for every step along the way. And we keep by the way building more and more institutions, as a way to somehow solve this problem. We have to go back and relook at this whole thing and begin to clean it up. So this is the second big reform that we need to think about. There are a whole bunch of other reforms I can talk about. But these two I would argue would be the top of the list of reforms that a future government must ultimately look at. I think I have spoken now for about half an hour, and I figured that maybe it might be more fun to have a Q&A.
But my purpose for giving this talk was really the following: to give you a sense of the kind of thinking that was being done, why is it that a certain set of reforms were done and not many other reforms that maybe others would have, and also to give you a sense that, based on this thinking, what are the kinds of reforms that this thinking process leads you to in the next phase. So that you have some flavor of what is being done, and hopefully you will judge the success or failure of this approach based on the outline that I gave you over the last half an hour.
Thank you very much.