Joydeep Mukherji, director, Standard & Poor's, minces no words as hetells Arijit Barman on why he recommended the downgrading of India’s ratingfrom Stable to Negative. Excerpts from an e-mail interview that is remarkablyopen in its indictment of India’s politicians as the principal barrier toeconomic growth.
Would you say that the pace of reforms has been inadequate to address thedeep fiscal problems?
Yes. The fiscal problem is outstripping the pace of reform. The budgetdeficit is growing at all levels of government. The deficit that is hidden offthe budget, such as the government's oil pool account, is also growing (butconveniently excluded from the budget deficit figure to disguise the true extentof the fiscal problem--it would add another 0.5 per cent of GDP to the deficit).Actions to bail out financial institutions, be they public sector banks, IFCI,or the US-64 scheme of UTI, are simply off-budget fiscal activities that thegovernment forces on to other public sector entities. They raise the contingentliability that the financial sector poses to the government, re-shuffle the badassets and delay the day of reckoning. State government deficits are even worsesince they simply borrow by setting up public sector companies and guarantee thenew debt that they raise through them. Such borrowings are not shown in theirfiscal deficits. The picture is clearly unsustainable. That is what we aresignaling by changing the outlook on India's ratings to Negative from Stable.
What about tax revenues?
They are clearly insufficient. The combined tax revenues of India's centraland state governments are below 17 per cent of GDP, which is slightly lower thanthey were before the reforms began a decade ago. The fault lies in the tardypace of tax reform. Collections from direct taxes (personal and corporate incometax) have increased marginally as a share of GDP but they have been overwhelmedby the fall in indirect tax collections (customs, excise, sales). The lessonslearned in reforming direct taxes, namely that collections increase if the ratesare lowered and the system simplified, have not been applied adequately toindirect taxes. Despite annual announcements of plans to simplify indirecttaxes, and reduce the number of tax rates, the system is in a mess. Corruptionis another factor (but note that corruption did not block an increase in directtaxes). The other problem is that the tax system was designed for an economythat no longer exists. Over half of India's GDP arises from the service sectorbut the tax system remains geared towards the industrial sector. Services arebarely taxed in India. The biggest example is the IT sector, a fast-growingprofitable sector that pays no income tax.
While investing in a country like India, to what extent do foreigninvestors take into account the fiscal picture of the country? And to whatextent do other issues like infrastructure costs, labour issues, security,regulatory issues, market size drive decision making?
Investors want to know if they can make money and if they can do so withoutenormous hassle. If the country's fiscal picture points to economic instability,potential investors become cautious. Issues such as infrastructure, regulations,and the quality of governance are very important. For example, one reason whyIndia gets a falling level of foreign investment is that investors who want tomake products for export, such as toys, televisions, cell phones, largely shunIndia as the ports, roads, and highways are clogged. They cannot produce thingsin time to meet deadlines. That is one reason they go to China. On paper, Indiahas liberalised its investment policies a great deal. In practice, it has not.Attitudes have barely changed. The visible barriers to foreign investment havebeen reduced but not the 'invisible" ones. The hassles, time-consumingprocedures, and petty license and permit-raj that thrives at the local level arestill a huge obstacle. India has made some progress towards "one-windowapproval" but there is no 'one-window bribe" that can finally clear aproject and allow the promoters to proceed without repeated requests for morebribes, and unlimited delays. Foreign investment is seen by local officials andpoliticians as one more source of illegal income and thus receives all theattention that predators give to easy prey.
Why is India's share of global FDI investment shrinking?
Argentina, Brazil, even Egypt are way ahead, and let’s not even talk aboutChina. Botswana gets more foreign investment than India. In a competitiveworld, you have to meet global standards to win. Indians are not ready to acceptthis. They are used to inferior Indian standards developed over 50 years ofeconomic isolation from global currents. It does not matter if policies towardforeign investment are better today than they were a decade ago in India. Whatmatters is how they compare with policies in other countries. The ghost of theEast India Company is alive and well in modern India, which still has aschizophrenic attitude towards opening up to foreigners. Politicians in othercountries take credit for bringing foriegn investment to their country becauseit creates jobs and wealth. Which Indian politician is willing to publiclydefend a foreign investment project in India when it comes under attack from theswadeshi and the leftist crowd? They are happy to seek bribes from foreignprojects but will not speak in their favor when needed. It is not just cowardicebut also the reality that India is still in two minds about dealing withforeigners. Other countries have made up their minds, which is why they aregetting more foreign investment.
Would you then say the overt politicisation of the economy is the mainevil behind the declining FDI figures?
There are many factors. Politics is a fact of life everywhere. In India, itoften serves as a substitute for development. It would be difficult to imaginethat a country facing growing power shortages could become so adept at losingthe few foreign investors who put money into the energy sector. It is even moredifficult to imagine that many educated Indians who read your magazine, and whowill suffer from a power cut tonight, could support their expulsion based onmisguided notions of nationalism. How do more power cuts make India a strongercountry?
Do you think there has been no policy focus to attract foreign investmentsin specific sectors or specified regions or even specific companies?
There are many sincere attempts but they are overwhelmed by failureselsewhere. Many foreign companies once had interest in putting money into Indiathrough the privatisation programme. Hardly anyone is still interested today,having seen how the programme has been systematically gutted by vestedinterests. Investment in the service sector, such as IT, call offices, biotech,and back offices has been successful and should continue to rise. The visibleand invisible obstacles facing foreign investors elsewhere are less in thesesectors. Also, India's infrastructure problems can be largely avoided in thesesectors and political interference is minimal.
Some people feel that the investors are dissatisfied due to the drasticand frequent policy changes in sectors like aviation, telecom, power…
Policy changes hurt foreign sentiment and create expectations of morechanges.
Disinvestment: is it politically impossible in India? Or do we lack thewill?
The public sector has become a milch cow for politicians, bureaucrats, andcorrupt businessmen. It collects money from the country at large through taxesand distributes a growing share of it to these three groups. This unholy trinityis blessed by ideologues of the Left and the Right, allegedly because it is goodfor the poor or good for India's soul. Privatisation threatens the core of thissystem, which is why it has been successfully delayed and now made almostirrelevant.
You have talked about the recent political scam --are you hinting at thetehelka episode?
I mean the whole series of financial and political scandals in 2001 (lostcount of them). They have undermined the ability of the government to implementthe policies announced in its last Budget.
You have also said that politicians in India do not hesitate to getdomestic political mileage out of any issue, regardless of the damage it may doto the country. Can you give examples?
Dabhol, going back to the beginning.
