A P: A dialogue with a friend

Given the good impression of India and the new government, the market has nothing to fear

I happened to meet an old friend of mine last week, who had just returned from India. He had spent an entire week interacting with all the powers that be.

Having just spent quality time with most of the decision makers in India, be they from the Congress, BJP, communists, or senior bureaucrats, I could think of no one better to fill me in on the state of affairs in the country. My friend is a senior economist at a global think tank, an old India hand, and has no political biases I am aware of.

He began by admitting that he had gone to India quite sceptical (having spoken to many global investors), but felt far better after having spent four days in Delhi and Mumbai.

After interacting with leaders on all sides of the political spectrum, he felt that the only two economic issues where progress was unlikely were privatisation and labour reforms. These two areas were clearly very contentious and he did not feel that the Congress would try to use up any of its political capital trying to push the envelope in these areas.

Having said that, he did not feel this was such a disaster. For, even if the NDA had come back to power, there was the strong possibility that not much would have been done in this sphere.

Having tasted blood in the ONGC divestment, the NDA had already veered around to the view that this was a far simpler and easier way to raise resources and thus divestment and not privatisation would have been the mantra. In the opinion of my friend, the UPA alliance would follow the same path, maybe a little slower, but the same end game.

On labour reforms it was quite clear that nothing much would have happened in either regime. The NDA had planned to empower the states to do as they pleased on this issue, and that may still happen.

While labour reforms were the key to stimulate fresh employment in light assembly operations akin to China, most industrialists who my friend met did not feel it was such a big issue. Most felt the VRS route, while expensive, gave them enough flexibility.

Except for the above two issues, he clearly felt that the Left would allow the Congress to follow its economic agenda, kicking and screaming maybe, but the Left would not precipitate a crisis on other economic issues.

FDI investment limits would be rationalised. And the current mish mash of 20 per cent limits in some sectors, and 26 per cent, 40 per cent, 49 per cent, 76 per cent, and 100 per cent in others""depending on the power and extent of domestic industrial lobbies""would be harmonised into a more transparent and rational structure.

On infrastructure, things looked pretty much on track. While the National Highway Development Programme (NHDP) was delayed, there was no desire to roll back anything or break something which was working. On ports again no change, with new private sector ports on track, the same for railways, where no reform ever seems possible.

Even the contentious issue of airport privatisation would be resolved quickly and positively was his clear sense. On power, no amendment of any substance to the Electricity Act was a big positive, but the free power movement sweeping the states was an equally big negative.

The consensus among the policymakers was that the Electricity Act now imposed a hard budgetary constraint on states giving out free power and there was no way this could last. The privatisation of electricity distribution, again, while delayed, was not finished, and UP would be the next front here.

The clear sense that my friend got was that in the short term the economic priorities of this government rested on fiscal consolidation linked to tax reform, and an attempt to revamp government expenditure and its delivery. The Kelkar report Part II came up again and again.

It seemed clear that the government was focused on using whatever political capital it had in trying to push through the implementation of this report. Congress circles were quite confident of getting at least 75 per cent of the report implemented. It was pointed out that this was the best possible chance for VAT to be accepted.

The trader lobby of the BJP was no longer powerful, and both the Left and Congress were of one mind on the issue. My friend also pointed out that before this trip, he had not really grasped the full importance of VAT and the impact of its implementation.

VAT was critical not only from a revenue mobilisation perspective (the Haryana example was given time and again), but even more so for improving the competitiveness of Indian industry. While the revenue buoyancy brought about by VAT would be visible only after three to four years, its impact on Indian manufacturing would be immediate.

By getting rid of the cascading effect of multiple levels of taxation, Indian industry would be in a much better position to integrate seamlessly into global production chains. The organised sector would see a significant reduction in costs, and logistics and distribution would finally be rationalised.

India would also effectively become a single seamless market for the first time. The losers in this would be really the unorganised sector and middlemen whose economic survival depended on the avoidance of tax. Most investors in his opinion have not yet fully appreciated the importance and significance of VAT and its likely implementation. Many sectors would benefit tremendously. The markets are likely to be in for a pleasant surprise on this score.

The second over-riding message was one of revamping expenditure. The clear message coming through again and again was that enough money was being spent currently on rural and social schemes but not enough was actually getting through.

It was clear that a total rethink of these schemes and their targeting and delivery was on, and being driven through the Planning Commission. The government did not want to ramp up spending in these areas unless wastage reduced and effectiveness improved. There was clearly no desire to keep throwing good money after bad outcomes.

The quality of the economic team of the UPA also came out strongly. In meeting after meeting neutral, bi-partisan observers kept hammering home this point. For the first time you have a PM, FM, and Planning Commission head who truly believe in and understand reform. Do not underestimate this, my friend was reminded again and again.

It was also apparent that 6 per cent real GDP growth was considered the base case by this government. If the UPA can't boost this growth to at least 7 per cent over a five-year cycle, they can consider their term to have been a failure.

Net net my friend walked away from his trip quite enthused. There was a very strong economic team in charge, clearly targeting high growth, and their constraints from the Left were limited to only a couple of areas. He felt the quality of economic decision making in this government would surprise, and one had to block out all the noise and focus on action. The February Budget would be big and clearly highlight this government's priorities.

If such is the impression of India and the new government that observers who make an effort to search beyond the headlines walk away with, then the market has nothing to fear.

The majority of investors are still sceptical of the UPA, and if my friend is right then a positive surprise awaits them. This can only be positive for the markets in the long term.