The two main national parties have released their election manifestos in the days leading to the actual voting across India.
The Bharatiya Janata Party (BJP) leads its manifesto with issues of national security. The Indian National Congress (INC) leads its manifesto with the challenge of job creation. The positioning tells us something about the relative importance of these issues in the campaigns led by the two political parties. There are common themes as well—especially their recognition of problems in rural areas. And inclusion in general.
The parts in the two manifestos on economic policy make for interesting reading. The INC manifesto says that the party was responsible for the 1991 economic reforms. The stated commitment to liberal economics seems to be an attempt to break away from the economic philosophy of the United Progressive Alliance. The BJP manifesto puts the goal of making India a $5 trillion economy by 2025 and a $10 trillion economy by 2032. The party rightly claims credit for putting the Indian economy back on track after 2014. Demonetization is mentioned only in passing.
The big takeaway is that both parties are banking on rapid economic growth to transform India, with targeted transfers to support those who are in danger of getting left behind. This is welcome, though as Rathin Roy of the National Institute of Public Finance and Policy has perceptively argued in a series of brilliant columns in recent months, there needs to be more discussion on whether inclusion should be pursued by a development state that seeks to build public goods or a compensatory state that restricts itself to giving income support to the poorest.
The rest of this column will focus on one core challenge that neither party seems to have focused on, but which will be important in the next decade. It is the challenge of bringing down the cost of capital.
India is currently the fastest-growing major economy in the world, which is no small matter. The question is whether the current growth rate is enough to create quality jobs for a growing population. The experience of the two previous economic booms—in the mid-1990s and in the years before the global meltdown of 2008—is that a shift in trend growth requires an investment boom led by the private sector. One of the requirements for that is competitive cost of capital.
There are three ways to think about this challenge.
First, the direct tax system has to be overhauled. The indirect tax system has already been transformed with the introduction of the goods and services tax (GST), albeit in a messy form. The other leg of the tax reforms agenda has not been pursued. The proposed Direct Tax Code continues to be a good model to build on. The goal is not just lower taxes but also a cleaner tax code that minimises distortions.
Second, the cost of borrowing in India is too high. One important reason is that India has been an inflation outlier compared to the rest of the world. Sustained low inflation should help bring down the cost of borrowing. The fact that nearly a quarter of bank deposits are impounded by the government to fund its fiscal deficit also pushes up borrowing costs for the private sector. Many Indian companies have accessed cheaper foreign debt to fund new projects, but the depreciation of the Indian rupee over the long run—sometimes in sharp lurches— has wrecked many corporate balance sheets. Low inflation should also hopefully put the Indian currency on stable ground, and thus reduce the risks to corporate finances from sudden depreciations.
Third, investment activity quickens when the relative cost of intermediate goods falls. In other words, machinery has to be competitively accessed. Chapter three of the new edition of the World Economic Outlook published by the International Monetary Fund (IMF) is aptly titled: “The Price of Capital Goods: A Driver of Investment Under Threat?" IMF economists Weicheng Lian, Natalija Novta and Petia Topalova have written in a recent blog: “Prices of machinery and equipment have been falling relative to overall prices for decades, thanks to rising trade and sweeping technological improvements that led to more efficient production of capital goods. This has helped countries around the world raise real investment and improve living standards."
India has experienced a sustained investment slump over much of this decade because of reasons ranging from domestic excess capacity and the global glut in some sectors caused by Chinese over-investment, to the “twin balance sheet" problems of Indian companies and banks. Meanwhile, much of the policy focus in recent years has been on easing regulatory constraints on enterprises. Moving up the global Ease of Doing Business ladder has become almost an obsession. Far less attention has been paid in policy discussions—as well as in the recent BJP and Congress manifestos—to the high cost of capital in India. Such neglect needs to be corrected.