A five-step ignition to private investment

After several months of high voltage politics, the next government that takes office later this month will inevitably have to shift focus to the economy. The new government will inherit an economy growing reasonably fast with only moderate inflation. That should permit a generous dose of ambition. Of course, a new government, even a reelected one, will have a plethora of items on its agenda, not  least the gamut of manifesto promises. That could diffuse focus. It would make eminent sense for economic policy in the next six months to singularly focus on one variable: private investment.

The fact is that growth is being powered by consumption and government spending. The other two — arguably more powerful — engines of growth, namely, private investment and exports are still sluggish. Indeed, if private investment gains momentum, the consumption and government spending engines (as also exports) get more fuel. When India grew its fastest (2003-08), private investment as a share of GDP was around 36 per cent. It is hovering around the 29 per cent mark now.

The outgoing government did well to spend, particularly on infrastructure, to make up for the sluggishness of private investment. As a short-term strategy, it works. In the medium term, government capacity to spend productively and speedily is limited. It is also distracting for the finance ministry, which is the most pivotal ministry in any government. Its focus tends to be entirely on maximising revenue and building elaborate expenditure plans, rather than plotting structural reform. For private investment to be at the top of the menu, within the ministry of finance, the balance of power needs to shift away from the departments of revenue and expenditure to the departments of economic affairs and financial services. This doesn’t mean the government should adopt austerity, but if the challenge is to deliver more jobs and better paid jobs, then priority must be given to reviving private investment.

The agenda for reform is huge but action and commitment on a few headline items could ignite animal spirits. First, the new government must commit that it will not apply any policy change with retrospective effect and that it will not change the rules of the game abruptly and suddenly. The Modi government missed a trick by not repealing UPA’s infamous retrospective tax amendment and while it has been mostly disciplined on policy certainty, there have been a couple of missteps. 

Illustration: Binay Sinha
Second, the new government must execute the strategic disinvestment/privatisation plans approved by the outgoing government. A loss-making and inefficient public sector is a burden for the whole economy and causes distortions which deter private participation in several sectors. If there are no buyers forthcoming for these PSUs, they must be closed down rather than being forced down the throat of the handful of performing PSUs. And if the government really wants to give a booster shot to private investment, it must put out its better and larger assets, PSUs and others like roads, airports, ports, for strategic sale. It can do so via the stock market and diversified shareholding or through transparent auctions.

Third, the government must do away with all FDI caps that remain across sectors. They make no sense in a 21st century economy, especially when import dependence in the most strategic sectors like defence is growing steadily and when Indian firms don’t have the capacity to take over failing firms in some other critical sector. For example, if only foreign airlines were permitted to own 100 per cent of an Indian airline (it is capped at 49 per cent), there might be buyers for Jet Airways and Air India which would save thousands of jobs and benefit consumers through competition and lower airfares.

Fourth, rein in the taxman. While it is the duty of the tax department to collect all taxes which are due, the current approach of setting targets for tax officials is often counter-productive. The system cannot become coercive and extractive and therefore a deterrent to investment. A reorientation in strategy is urgently required.

Fifth, there needs to be a dialogue within the government on alternative (to courts) methods of dispute resolution. There is not likely to be any immediate solution to the massive backlog at various levels of the judiciary but the government should strive to take out some of its disputes from that morass and resolve them in a different forum, like arbitration perhaps. If the alternate framework has fewer levels of appeal, it would only help.

If the new government can rev up the engine of private investment in its first six to 12 weeks, it would have accomplished much of the hard work for its entire five years.

The author is chief economist, Vedanta

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