In a recent Facebook interaction, Andrew Michael Spence, who got the Nobel Prize in Economics in 2001 with Joseph Stiglitz and George Akerlof, said India had suffered self-inflicted wounds to lower investor confidence. In an interview, he tells Dilasha Seth he was partially referring to GAAR and retrospective amendments to the I-T Act. Excerpts:
You said in a discussion on Facebook that India’ s low investor confidence was a ‘self-inflicted’ wound. Could you elaborate on that? Were you referring to GAAR and retrospective amendments to the Income Tax Act?
Yes in part. But it was only one of several factors. The GAAR (General Anti-Avoidance Rules) created unnecessary uncertainty. People understand that tax loopholes have to be closed, but this approach to tax capital transactions ran counter to most international norms. And, then, it wasn’t clear when and how it would be implemented, creating uncertainty and a sense that the government wasn’t serious about the investment climate.
Has the so-called inaction on the reforms front and allegations over various deals compounded the matter?
In addition, the scandals and lack of reform momentum also contributed. India has been very successful, but does not operate with a big cushion to fall back on. In this respect, India is unlike China, where the government has a huge balance sheet to deploy. Of course, they can misuse it, too. The reform momentum and public investment are key to sustaining growth and investor confidence. Business and government leaders understand this. Finally, the global economy is not supportive as well. Corruption issues are important and need to be dealt with, but not at the cost of having the government do nothing else.
What is your assessment of the Indian economy right now? The growth declined to a nine-year low of 6.5 per cent in 2011-12. The government is optimistic the economy will grow more than 6.5 per cent . What is your estimate?
My view is that global headwinds and a pause in reform momentum will cause growth to be a bit disappointing this year. It is not entirely within India’s control. If things go very badly in Europe and the US or even China, growth could dip below 6.5 per cent. But I don’t think that is the most likely outcome. I would expect a somewhat better global picture to emerge and a restoration of resolve and reform in India. The new finance minister (P Chidambaram) will take tough decisions and get things moving on that front. One won’t always agree with him, but inaction is not going to be the problem.
Does the government need to take bold steps like cutting subsidies in petroleum?
I view petroleum subsidies are a bad idea. But these have been in place for a long time. It is time to phase them out, but to avoid major disruptions, it probably needs to be done at a measured pace and with complementary support policies for lower income groups.
Talking of India's twin deficit problem, India's current account deficit was at an all time high of 4.2 per cent of the GDP in 2011-12, and fiscal deficit at over 5.7 per cent of the GDP. Which is the bigger deficit to handle?
They are both important. India can as its policy makers know well, run government deficits of modest size without expanding the public debt to GDP ratio, because of growth. That means sustaining growth is important and government investment is part of that. A short run current account deficit is okay, but not if it is persistent. In case of latter, it means essentially that the country is not saving enough to cover investment, public and private. And that is not a good idea. So it could turn into an unsustainable growth model and makes the country vulnerable over time.
The uncertain situation in Europe is only getting worse, with Euro zone close to a recession. What impact will a Euro zone disintegration have on developing economies like India, given that about 20 per cent of India's exports are to the Euro zone? US will face fiscal cliff by the end of the year. Where does this take the world economy?
If the Euro zone comes apart, which is still not the most likely scenario now but rather a fat left tail, or actually the bad equilibrium in what is clearly a bimodal situation, everyone will suffer a lot. India and China will experience slower growth for a few years. The us would tip into recession. Then the multipliers would make it worse. The fiscal cliff (expiration of various tax cuts) if left in place would tip the US into recession. That is not really controversial. Meanwhile negotiating an alternative probably won’t happen as we come into a presidential election. So the question to which no one knows the answer is will we have a government (president, administration and congress) post election that can act or will it be gridlocked. Just a lot of macro risk.