What Went Wrong With The India Growth Story?

India's economic growth has slowed rapidly to 5 per cent in the last couple of years and there is little sign of it meeting the 8 per cent target set by the Planning Commission for the 12th Plan any time soon. Nurturing the green shoots of long-term recovery will be arduous unless some critical pending reforms are implemented. TEAM INCLUSION attempts to diagnose the reasons for the economic slump and chalks out an action plan to reinvigorate the growth momentum

An old Soviet joke says it all. A speaker tells his listeners, “The socialist ideal is already on the horizon.” The audience musters the courage to ask: “What is a horizon?”

The answer: “A horizon? It’s an imaginary line where the sky comes together with the earth; it moves off into the distance when you try to get closer.”


"For the 12th Plan in order to achieve 8 per cent growth, two important things must happen. First, tax-to-GDP ratio has to rise it by 2 percentage points roughly. Through better administration and more efficient tax administration using a simplified rate structure, it is very much possible to increase by 2 percentage points. Secondly, rationalisation of subsidies is imperative. Subsidies as a percentage of GDP has risen quite a bit predominantly because of petroleum subsidy.”

— Montek Singh Ahluwalia, Deputy Chairman, Planning Commission

 

In the past, India too chased that imaginary horizon, defined by socialism and central planning. The result was the Hindu rate of growth: the disparaging term described the 3.5 per cent trend growth rate of India from the 1950s to 1980s, while per capita income averaged 1.3 per cent. During this period, the percentage of population living below the poverty line increased from 45.3 per cent in 1951 to 47.3 per cent in 1979-80. In fact, the Hindu growth rate got us nowhere near the socialist ideal of egalitarian society; rather, it pushed the swelling ranks of the poor into the trap of deeper poverty. The imaginary line indeed moved off into the distance when the country tried to get closer.

In this issue of INCLUSION, Finance Minister P Chidambaram, a key architect of India’s reform story, gives us a glimpse about how Kafkaesque the licence-permit raj era was, and the clarity of vision it took to reform India’s trade policy in 1991-92. Of course, the watershed event that changed the narrative of India’s economic history was the economic liberalisation programme started in 1991 as the country threw off its socialist-inspired economic policies and started opening up the economy to greater foreign investment. Over a decade later, the Indian economy was the envy of the world, with the GDP growth averaging 8-9 per cent. For three consecutive years from 2006 to 2008, the economy grew at 9 per cent, and a new term was coined to describe the growth momentum: ‘the India growth story’. 

Sustained high growth lifted millions of the poorest from abject poverty, substantially raised the standards of living of many Indians and helped the government build social safety nets. High growth rates have also enabled the government to introduce a number of programmes for the much-needed infrastructure development. In short, high growth rate was the enabler of the country’s new-found self-confidence.


“We need to have fiscal consolidation as part of our effort to sustain high growth. In doing that, containing subsidies plays an important part. The government aims to take it down to 2 per cent of the GDP in the next fiscal and further down to 1.6 per cent. To take the fiscal deficit down to 3 per cent, we need to act on both revenue and expenditure sides. On the revenue side, there is still scope of taking the gross tax revenue-to-GDP ratio to the 2007-08 level.”

— C Rangarajan, Chairman, Economic Advisory Council to the Prime Minister

 

Faltering Growth Momentum
However, in the past two years, the growth momentum has faltered due to a variety of factors, the two main being global economic slowdown and policy logjam at home. Gross domestic product rose just 5 per cent in the 2012-13 fiscal year, after falling to 6.2 per cent in 2012-13 from annual rates of over 9 per cent for a row of years before the global financial crisis of 2008. The sharp decline is blamed on a slowdown in manufacturing and services sectors. Data showed growth in manufacturing output slowed to 1 percent in the last fiscal year from 2.7 per cent the year before. Growth in services slowed to 8.6 per cent from 11.7 per cent while agriculture output growth slowed to 1.9 per cent from 3.6 per cent. Worse, foreign direct investment into India has fallen, while the amount of corporate money fleeing the country is on the rise. 

A vortex of business regulations and the delay in speeding up economic reforms continue to drive investment away and delay chances of economic recovery. Meanwhile, high inflation, combined with fiscal and current account deficits, has hammered the currency to such levels that a major business daily editorialised that “the expression ‘historic low’ has stopped being meaningful in describing the sharp descent of the rupee”.

While growth of 5 per cent would be high for a developed Western economy, such a rate is insufficient in India to create enough new jobs for a young workforce. One cannot take people out of poverty at 5 per cent growth, too. Suddenly, the famed India growth story is under a cloud; all kinds of questions and doubts are raised about its viability. Was the growth story of the past decade simply a flash in the pan or are we witnessing just a passing phase of deceleration before growth picks up again? With battle to remove poverty and social inequalities remaining undone, and the dream of reaping India’s demographic dividend a higher priority than ever before, there is little room for complacency. The growth has to be inclusive, it must lead to reduction in poverty and has to be environment friendly, as Chairman of Prime Minister’s Economic Advisory Council C Rangarajan cogently puts in an article in this issue.

Two main priorities
Talking of putting the growth rate back on track, Rangarajan says: “We need to have fiscal consolidation as part of our effort to sustain high growth. In doing that, containing subsidies plays an important part. The government aims to take it down to 2 per cent of the GDP in the next fiscal and further down to 1.6 per cent. To take the fiscal deficit down to 3 per cent, we need to act on both revenue and expenditure sides. On the revenue side, there is still scope of taking the gross tax revenue-to-GDP ratio to the 2007-08 level.”

Functions of Cabinet Committee on Investment

1. To identify key projects required to be implemented on a time-bound basis, involving investments of `10 billion or more, or any other critical projects, as may be specified by the Committee, in sectors such as infrastructure, manufacturing, etc.;

2. To prescribe time limits for issue of requisite approvals and clearances by the ministries/departments concerned in respect of projects in identified sectors;

3. To monitor the progress of identified projects including the time prescribed/taken to obtain each approval/clearance and delays, if any;

4. To review implementation of projects that have been delayed beyond the stipulated timeframe, including issues causing delay in grant of clearances/approvals;

5. To review the procedures followed by ministries/departments to grant/refuse approvals and clearances;

6. To take decision regarding grant/refusal of approval/clearance of specific projects that are unduly delayed, if deemed necessary;

7. To consider and decide measures required for expeditiously granting/refusing followed by the respective ministries/departments for decision making; 

8. To require statutory authorities to discharge function and exercise powers under the relevant law/regulation within the prescribed time frames for promoting investment and economic growth.

Source: Cabinet Secretariat, Government of India

India’s economic slump has hit a fresh low, but has it touched the bottom? Deputy Chairman of Planning Commission Montek Singh Ahluwalia says that every economy experiences ups and downs caused by the domestic and global factors. It’s understandable. But he underlines that India’s medium-term growth would depend on how we shape the recovery. “The state of global economy for the next five years will be wobbly, as the recovery is still at a nascent stage. For India, what is most important is that we need to address the policy bottlenecks that hinder sustainable high growth rate. There are macro imbalances that need to be corrected. Without that, foreign investment would trickle down. It’s also important to bear in mind that our economy is dominated by the private sector — about 75 per cent of its size is contributed by sectors like micro, small and medium enterprises (MSMEs), agriculture and the corporate sector,” he says.

His words echo what Prime Minister Manmohan Singh noted at an industry body meeting in April: “The Government is not the prime mover of growth. In a private sector-led economy — and I repeat, we are a private sector-led economy, with 75 per cent of investment being in the private sector, which includes farmers, small businesses and the corporate sector — the driver of growth is indeed private investment. But the private sector needs an environment in which enterprises can flourish and create both jobs and stimulate growth. It needs an environment which will ensure that this growth is inclusive.”

The bottomline is, India started the current fiscal year on a sluggish note, and it is very unlikely that it will meet the 12th Five-Year Plan’s growth goal for the second year. Why the growth story spluttered? Of course, manufacturing and services sector deceleration are the key elements that have choked it. 

Moreover, the government’s moves to toughen tax laws had triggered an outcry from global industry groups and were blamed for a drop off in investment flows to the country. The tightening of the transfer pricing norms and the policy flip-flop in retrospective taxation are two prime examples. The Finance Act, 2012 has expanded the scope of transfer pricing regulations to such an extent that the norms have not gone down well with multinationals operating in India. The transfer pricing regulations also scare away potential investor companies. Legal wrangling over the unexpected tax demands from the authorities have tremendously increased the costs of doing business in India, and that’s the main reason for the ebbing investor morale. 

Announcing the 2012-13 Union Budget, the then Finance Minister Pranab Mukherjee had gone overboard with the General Anti-Avoidance Rules (GAAR). The proposed amendments to the Income Tax Act, 1961 enabled the authorities to raise tax demands with retrospective effect on long-concluded offshore mergers and acquisitions that result in transfer of Indian assets. Even though GAAR was put on hold later in 2012 under pressure foreign investors and governments alike, the move had raised prickly questions about the capricious nature of the country’s laws and regulations.

Tough Policy Decisions

Nevertheless, experts believe that the roots of macroeconomic problems assailing the economy run much deeper. Even the 12th Plan document is quite frank; it says sustainable 8 per cent growth is possible only if India is able to take bold and politically difficult policy decisions in core areas of the economy. 

What are these policy decisions? Experts say the difficult policy decisions range from sprucing up investment climate (reviving investor sentiment, easing business environment, cutting red-tape on investment decisions), fiscal consolidation (reduction of current account and fiscal deficits, and control of subsidies), removal of foreign investment caps, and reform of land acquisition, agriculture and labour laws, among other legislations that keep hanging fire. Lack of progress on these fronts have resulted in the overall dissipation of domestic business and foreign investor enthusiasm in India’s economy. 

Though economic slowdown in the West has affected our economic growth, the persisting climate of political indecision at home is no less a cause of concern. The government’s key priority should be to take firm policy decisions to do away with the procedural and institutional irritants that come in the way of big-ticket investment. A big push to pending infrastructure projects will reverse the slide in investor confidence. How realistic is the government’s hope of Cabinet Committee on Investment (CCI) speeding up clearances for large projects? Is the current policy direction in sync with the core objectives of the Plan document? What micro and macroeconomic policy changes and follow-through measures are needed to achieve the 8 per cent growth objective? Will it open up sectors that were out-of-bounds to foreign investment? Will the government push big-ticket reforms as 2014 general elections near? Can the government stick to its fiscal consolidation plans? Can a slowing economy create the required 10 million new jobs a year? These questions should serve as the frame of reference for revitalising the near to mid-term growth.


“If you need 8 per cent growth, financial inclusion is a must and banks alone will not be able to achieve this unless the entire society supports this particular thing how it can be done.”

— K C Chakrabarty, Deputy Governor, Reserve Bank of India

 

For sustaining the high growth path, improving the foreign investment climate and increasing the absorptive capacity by bringing in the real sector reforms would be critical. The governance system must be improved to ensure that where investment approvals are still needed by the government, they are given speedily and transparently. At least in the case of large projects, an integrated view is required to be taken, as an integrated approval will help speedy implementation of projects. This is particularly true of projects in the infrastructure areas.

Ashish Kumar Chauhan, Managing Director & Chief Executive Officer of Bombay Stock Exchange, is spot-on when he says that for India to realise its true potential by creating hard and soft infrastructure and industry, “training our people and giving them jobs, and fast-tracking of investment approvals are absolutely important”. He says, “Each year of the next two decades, India needs to create a staggering number of jobs. Can we create these jobs in medium and small enterprises, large companies, infrastructure, export-oriented firms, through internal consumption, and in agriculture? We have to worry about creating new jobs.”

“Large projects can not only create huge jobs on their own but also ancillary jobs. We need to create those ancillary industries as well to help the small and medium enterprise sector to feed into them. Somewhere, we have kind of missed this opportunity, but we still have time to make up by kick-starting large projects — whether it is Posco or any other,” he adds.

Sequencing India’s Reform Puzzle

It’s not easy to strictly categorise the growth-enhancing reforms in India. While many dub the post-1991 economic measures as first generation reforms, some trace them to the Rajiv Gandhi government (1984-89). Former Finance Minister Yashwant Sinha once told INCLUSION that “the first generation reforms consist of articulation of new policy and management direction typically, but not always issued by a newly elected government. The second generation reforms consist of following through — steering of continued implementation of the reform process by the government. The third generation begins at the point of transition of political process.”

First Generation Economic Reforms
Much of India’s growth story owes to the first generation economic reforms initiated in 1991 to thwart a severe balance of payment crisis. Spearheaded by Manmohan Singh, the then Finance Minister in the Narasimha Rao government (1991-96), it dismantled the country’s highly restrictive trade policy and liberalised it, freed the private sector and buried concept of a bloated public sector for good. It marked an end to the notorious era, opened up the economy to foreign investment and introduced tax reforms. The reforms were carried forward by the United Front (1996-98) and NDA governments (1998-2004) that followed the Narasimha Rao regime. It went on to produce a GDP growth average (5.6 per cent) that looked impossible during the Hindu growth rate era.

Second Generation Reforms
The real economic growth momentum was generated by the second generation reforms (carried out by both the NDA and UPA governments). These were financial, tax, regulatory, education, land, labour and infrastructure sector reforms, among others. As Raghuram Rajan, Chief Economic Advisor to the Ministry of Finance, points out, the success of first phase of reforms created demand for the second generation reforms in areas like education, telecom, banking, etc. The demand for skilled workers post-first generation reforms created a huge market for higher education. The same goes with input markets such as land, labour and minerals. The second generation reforms were about taking reforms down to the states, districts and below. The reforms pushed up the growth rate to over 8 per cent for some years, but the economy has lost the trajectory since 2011. High growth with equity, it seems, brooks no delay of implementing the third generation reforms.

Third Generation Reforms
According to Yashwant Sinha, these are reforms that trigger socioeconomic and governance transformation. What about this bunch of reforms? Here is a quick stocktaking on some crucial areas where third generation reforms should be applied:

Administrative: From the Gopalswami Committee in 1949 to the Second Administrative Reform Commission in 2008, a staggering number of official reports have recommended options and strategies to overhaul the colonial administrative set-up, but with little success to check the discretionary and sometimes arbitrary powers wielded by the bureaucracy. According to Gurcharan Das, a well-known author and management guru, “The bureaucracy has become a prime obstacle to development, blocking instead of shepherding economic reforms.... Indians think of bureaucrats as self-serving, obstructive, and corrupt, protected by labour laws and lifetime contracts that render them completely unaccountable”. A series of right-based laws (from information to education) act as poor substitute to real administrative reforms.

Legal: India’s legal system looks out of sync. There are at least 10,000 laws that exist on all kind of issues and many of them are of colonial vintage (industrial, labour disputes). There are no effective laws to check corruption in the entire judicial process. Judges are armed with antediluvian contempt of court laws, which silence any criticism aimed at them. Millions of cases choke the judicial system, even as thousands of vacancies go vacant. For the most part, judiciary and criminal investigation processes have yet to embrace information and communication technologies to improve their performance. Progress on key bills such as Judicial (Standards and Accountability) Bill is stalled. 

Decentralisation: Decentralisation remains more of a constitutional promise. The progress on both 73rd and 74th Constitutional Amendments is not encouraging, despite a few bright spots (Kerala, Karnataka and West Bengal). As Mani Shankar Aiyar, former Union Minister of Panchayati Raj, wrote in the last issue of INCLUSION, “After the economic reforms process was launched, governance reforms through Panchayati Raj were also enacted by Parliament. The plan was to yoke economic reforms and institutional reforms together so that the chariot of progress could run on two wheels. Sadly, what has happened in the last two decades is that while the wheel of economic reforms has progressed very fast, the wheel of governance reforms, or what the Prime Minister calls institutional reforms, has either been punctured or allowed to be fall apart from the chariot altogether.” A recent expert group report of Planning Commission revealed that many states have failed to devolve the 3Fs (funds, functions and functionaries) to Panchayati Raj institutions. The case of urban bodies with regard to their finance base and capacity-building is even more alarming. 

Labour: Despite the advantages of a large domestic market, cheap labour and proximity to the fast-growing Asian markets, productivity growth has a long distance to go before it catches up with the ‘Tiger’ economies of Asia, including China and South Korea. This requires greater emphasis on flexible labour laws. Many of the provisions in the existing laws (at 160, we have too many of them) are archaic and could be changed without compromising genuine labour interests. We need to make our labour markets flexible while strengthening social safety nets. This will encourage investment in labour-intensive manufacturing. Rigidity in labour laws is a big reason why India has not succeeded in setting up robust labour-intensive manufacturing export sectors, as China has done.

Agriculture: It is the most crucial sector that has remained outside of the economic liberalisation. Even much remains to be done to improve the productivity of agriculture through scientific research and improved dissemination of knowledge, there are areas like marketing where reforms are badly needed. Equally important are the modifications to Agriculture Produce Marketing Committee Act to facilitate procurement of agricultural products, particularly fruits and vegetables, directly from farmers. India must move towards a more liberalised trade policy with respect to agricultural products, maybe with the exception of foodgrains, with no quantitative restrictions and minimal duties on exports and imports. Improved market structure for agricultural commodities, competitive pricing, greater investment in warehouse facilities and construction of more rural roads to enhance connectivity with urban markets can ameliorate the problems facing the sector. 

Land Acquisition: Cutting across various sectors, land acquisition and environmental clearances have become critically important in economic governance in order to expedite the time taken for translating investment decisions into investment on ground. The law relating to land acquisition and compensation needs to be passed as early as possible. Many infrastructure projects are held up because of lack of environmental and forest clearances. Environmental concerns are certainly important but it’s a governance challenge to formulate a holistic, problem-solving approach to this issue without harming the basic needs of protection.

Policing: Despite a whole hog of reforms, India’s police organisations have remained the same more often than not: insensitive, corruption-ridden, brutal and not citizen-friendly. While a modern economy expects its police force to be professional and responsive to help the state enforcing legal/commercial contracts and rule of law, the country’s police forces are at odds with changing socioeconomic realities. There are chilling statistics about misuse of powers, false cases, top-to-bottom corruption and protection rackets that scar the reputation of our police organisations. Given the fact that policing is a state subject, efforts to reform the area have made little progress. 

E-Governance: E-governance means seamless, effective, responsive and efficient governance. India is not yet ready to fully tap the advantages of e-governance, and the slow movement of the national broadband network is a key reason. Notwithstanding the success of Bhoomi, Mee Seva and e-Gram in providing million of citizens access to basic services and getting them closer to governments, e-governance projects have been very slow to make the impact envisaged in the National e-Governance Plan.


Ashima Goyal, Professor of Economics in the Indira Gandhi Institute for Development Research, feels that administrative constraints and scams are dampening India’s growth momentum. But she sees some bright spots. “Last year, the Union government set up a high-level investment committee to fast-track approvals for major infrastructure projects. Regulators have started to overhaul pricing in the energy sector, which should boost investment in the power sector. The government has also made progress on such other important reforms such as reducing subsidies for fuel and fertiliser, as well as liberalising foreign investment in airlines and retail. These are encouraging signs,” she says. The CCI has already cleared stalled projects worth around $20 billion, according to Citigroup.

Armed with sweeping powers to clear projects in a time-bound manner, it has stirred expectations of investors. But nothing of the sort of big-ticket decisions hoped for has taken place so far, almost one year into the CCI’s existence. The main sticking points are land acquisition, environmental clearances and tribal issues; each one of them represents a potential minefield. Political cross-fire between the central government and an opposition-led state government on investment decisions has also hit big projects (Posco is a good example). On such issues, the CCI is obviously powerless, despite its ambitious mandate.

Analysts like Goyal expect that a positive climate in terms of implementing pending reforms and slashing bureaucratic red-tape would win back investor confidence. Corporate investment slumped to 10.6 per cent of GDP in the year to March 2012, down from 17.3 per cent in 2008. The slowdown is blamed on regulatory knots that stymied the much-needed infrastructure upgrades.

Engineering Job-Oriented Growth

For Nitin Desai, an economist, the chief concern is engineering job-oriented growth, because it alone charts out a path to inclusiveness. He, too, believes that India can’t get job-oriented growth simply by focusing on the large corporate sector. “The government will have to lay much more emphasis on the growth of MSMEs. This has been a weak area of Indian growth. MSMEs did not grow as rapidly as expected in the 2004-09 period. They need better place in the policy framework of employment generation,” he adds. 

Many observers say the government should allow greater foreign investment in local pension fund management companies and insurance firms. Rajiv B Lall, Executive Chairman of IDFC, the company that looks after the diverse needs of infrastructure development, says that managing fiscal discipline is the most daunting task in a democratic set-up. “It’s imperative to cut waste in government spending. Also, governance issues have affected the whole investment pipeline. Addressing these issues is central to reviving the growth momentum,” he opines.

The slow pace of manufacturing growth is alarming in this regard. With growth sagging and the current account deficit widening, growth of labour-intensive manufacturing industries has assumed wider significance. They not only create new jobs to India’s young and impatient population, but also fund the deficit through generating exports.

Rethinking on Subsidies

The government is saddled with unviable levels of current account and fiscal deficits, and aims to restrict the fiscal deficit to 3 per cent by 2016-17. Fiscal consolidation requires action on multiple fronts: improved revenue collection, reduction of subsidies, stepped-up disinvestment and accelerated economic reforms. Most importantly, efforts must be made to realise the revenue budgeted under tax receipts, on the one hand, and to contain and economise both the Plan and non-Plan expenditure, on the other. Subsidies require a second look. If the process of fiscal consolidation is to move along a clear roadmap, subsidies as a proportion of GDP must be brought down.

Sound fiscal management is essential to promote sustained strong economic growth. Here, the fact that the government is committed to its fiscal consolidation path is a positive sign. “The government has narrowed its fiscal deficit to 4.9 per cent of GDP in the last fiscal year, below the 5.2 per cent estimate made in the Union Budget announced in February. But the level is still way above the government’s 3 per cent target,” says M Govinda Rao, Member Fourteenth Finance Commission. 

He says that a rethink on subsidy is long overdue. “The time is for reckoning in policy circles as well as in the public that in the days ahead, there is no point in proliferation of subsidies the way India has been doing so far. The democratic polity sometimes misses to follow the course of proper interface of politics and economics — this paves the way for populist measures rather than inclusive policy supplementations. The need is to maximise the scope of direct cash transfers, instead of subsidies,” he adds.

Even Ahluwalia agrees. He points to two areas where macro balance will be critically affected, both of which interact with government welfare programmes. “For the 12th Plan in order to achieve the kind of Plan expenditure under discussion, and that relates to the second category of items, i.e., programmes, there are two very important things that have to happen. First, the tax-to-GDP ratio has to rise by 2 percentage points over the period of the 12th Plan. The fact is that the ratio has been falling — for a variety of reasons. The losing tax revenues as a ratio of GDP remains a big concern. Through better administration and more efficient tax system that follows a simplified rate structure, it is very much possible to get the increase of 2 percentage points. The very important contributor to this would be the movement towards the Goods and Services Tax (GST). The shortcoming in tax revenue is almost entirely due to indirect taxes. Direct taxes are not a cause of problem,” he says.


“It’s imperative to cut waste in government spending. Also, governance issues have affected the whole investment pipeline. Addressing these issues is central to putting growth back on track.”

— Rajiv B Lall, 
Executive Chairman, IDFC

 

“The second major area where we need progress on resource mobilisation relates to subsidies. Subsidies as a percent of the GDP has risen quite a bit, mainly because of petroleum subsidy. In the 12th Plan, the target is that subsidies as a ratio of GDP should decline by 1 percentage point from about 2.3 or so they should go down to about 1.3 or 1.4 per cent. The rationalisation of subsidies is imperative,” he says.


“Each year of the next two decades, India needs to create a staggering number of jobs. Can we create these jobs in medium and small enterprises, large companies, infrastructure, export-oriented firms, through internal consumption, and in agriculture? We have to worry about creating new jobs.”

— Ashish Kumar Chauhan, Managing Director & Chief Executive Officer, Bombay Stock Exchange

Tax & Financial Sector Reforms

As the Deputy Chairman of the Planning Commission noted, designing and implementing a modern taxation framework has been hobbled by disputes over its precise shape, resistance on the part of some state governments bred by the fear of a loss of revenue from levy of state taxes and the need to amend the Constitution. Progress on the GST and Direct Taxes Code (DTC) has been held up by some of these differences. DTC represents the overhaul 50-year-old income tax laws, while the GST seeks to subsume various levies, including sales tax, VAT, octroi and streamline the indirect tax regime to make India a unified market. The reform of the income tax laws and consumption tax system to levy GST has become an essential need in to governance reforms. The GST is necessary not only to minimise the costs of collection, compliance and resource allocation but also to raise significant additional revenues. To universalise healthcare, augment expenditures on human resources development, invest heavily in infrastructure development and above all, contain the fiscal deficit at a desirable level, there is no gainsaying the need for mobilising additional resources. According to Raghuram Rajan, Chief Economic Advisor to the Finance Ministry, and Eswar Prasad, Professor of Trade Policy at Cornell University, if unleashed with proper regulation, the financial sector reforms have the potential to generate millions of jobs and can have enormous multiplier effects on economic growth and financial inclusion. Issues related to technology upgrade of the banking system, commodity future trading, and the next generation stock exchange reforms have not taken a serious traction as yet. The Financial Sector Legislative Reforms Commission had the mandate to recommend sweeping changes to herald a new era in a broad spectrum of financial service domains. But as S S Tarapore, Distinguished Fellow of SKOCH Development Foundation, writes in an article in this issue, some important recommendations of the Commission, for instance, on Unified Financial Authority, are either counter-productive or riddled with contradictions.

Reform Area: A Case Study The Invisible Challenge of primary Education
 

Whether in the short or in the longer term, national goals for growth or equity cannot be achieved unless India’s children become capable and confident in reading and writing, understanding and expressing themselves, and in problem solving, writes Rukmini Banerji

In many states across India, children have just moved into a new class. If you ask teachers or officials about the biggest challenge in improving quality — or more concretely, in improving teaching processes and learning outcomes — they will probably point to the numerous gaps in the system. Some schools continue to lack adequate infrastructure; several states still face a severe shortage of teachers and poor teacher preparation. These commonly identified challenges — inputs and institutions — are visible even to the common man. The assumption is that if these gaps are filled, the problem will be solved. This explains the push from within the government as well as from outside to ensure the timely provision of adequate inputs and the urgent need to build institutions that support schools and teachers. 

But there is another less visible, but dangerously debilitating and potentially worsening, problem that plagues Indian classrooms. This may be at the root of why children are not learning. Take a typical Standard V. All current available data on student achievement suggest children are performing far below the level that is expected of them. For example, the estimates from the oft-quoted Annual Status of Education Report (ASER) 2012 suggest that of all rural children enrolled in Standard V, only half can fluently read from a Standard II textbook. In arithmetic, only half of all Standard V children can do a basic two-digit subtraction problem with borrowing (this is a skill that is expected of them in Standard II). Of the children who have these basic skills, many have higher level capabilities too. But for the half who have reached Standard V and do not have the fundamental skills of reading or computation, there are very serious risks of not gaining much from continuing in school and completing eight years of schooling. 

The problem is made worse by textbooks and curriculum whose pace and content accelerate through the primary school years, leaving more and more children behind. An excellent paper by Pritchett-Beatty in 2012, titled The Negative Consequences of Overambitious Curricula, lays out the issue very well. Most countries have curricular standards and expectations that a majority of children at that grade level can handle. But not so in India.

The Challenge of Teaching
Try to imagine the challenge of teaching. In our typical school, the Standard V teacher uses the Standard V textbook, trying to cover the material and activities that the textbook lays out. But who is she teaching? Who should she teach? And how should she do it? Should she focus on those children who have basic skills, who are more likely to attend school regularly and therefore easier to teach? What should she do with all those other children – often half or more – who are in her class but are not even at the Standard I or II level? Using ASER figures, we estimate that over 100 million children in India are two or more years below their grade level. Such children are very unlikely under the current circumstances to reach the levels of capability expected of children after eight years of schooling as mandated by the Right to Education Act. 

For the last 100 years or more, schools all over the world have been organised by age and grade. According to their progression in age, children move from one grade to the next. Regardless of the underlying age distributions or composition of students, most countries follow the age-grade organisational pattern. What if we were to tweak this organisational principle of schools and group children by level of learning rather than by grade? Would these changes in grouping accompanied by appropriate changes in instruction lead to more effective teaching situations and better learning outcomes?

Teaching by Level
Using the principle of “teaching by level”, several large-scale experiments have been tried in recent years in India with promising results. In the June 2008, the Bihar government conducted month-long “summer camps”. Children enrolled in Standard III, IV and V who were not yet at Standard II level were targeted for the camps. The groups were organised by the child’s current learning level rather than by age or grade. Each teacher or instructor had children who were at the same learning level. Appropriate materials and methods were used for children at each level. Although the camps were hurriedly organised, an external evaluation by MIT’s Poverty Action Lab using randomised control trials showed that the effect of the summer camp on the target children who attended was significant. Even more interesting was the fact that the gains that the summer camp children made were visible even two years later. 

In 2009-2011, the Punjab government implemented a state-wide programme to improve basic learning outcomes by grouping children by level. The difference from the Bihar summer camps was that this effort was done for two hours a day during the school day and continued for the whole school year. In the last school year, in two districts in Bihar (Jehanabad and East Champaran) and another two districts in Haryana (Kurukshetra and Mahendragarh), similar interventions have been implemented by district administrations. For example, in Jehanabad in August 2012, of the 16,000 children who were assessed, only 30 per cent in Standard III, IV and V could read simple paragraphs or short stories. That number rose to 72 per cent by the end of February 2013 despite many discontinuities due to holidays in that period. An external evaluation of the Jehanabad programme also showed substantial increases in children’s ability to read. Further, the Jehanabad effort also led to increased attendance in schools, increased parent awareness not just about schooling but also about learning and also to a visible energising of the entire school system and improved school functioning. The experiments by different districts in Bihar have led the state government to think seriously about a scale-up in the 2013-14 school year. 

It is urgent that we face our realities. If we do not see or acknowledge a problem, we cannot begin to solve it. A mindset which assumes that business as usual will not be sufficient to bring about the substantial jump in learning, especially in basic skills that is urgently needed. The education chapter in the 12th Plan document places children’s learning outcomes at the centre-stage. The spirit of the Right to Education Act also is to guarantee that by the time children complete eight years of schooling, they become capable of dealing with whatever lies ahead of them. 
For the coming school year, each state must publicly declare their learning goals and articulate concretely their plans for achieving higher learning outcomes for at least the next two to three years. Whether in the short or in the longer term, national goals for growth or equity cannot be achieved unless 200 million children become capable and confident in reading and writing, understanding and expressing themselves and in problem solving. 

Rukmini Banerji is Director of ASER Centre, Pratham

Financial inclusion is an essential element of reforms in the sector. Reserve Bank of India Deputy Governor K C Chakrabarty is a strong advocate of financial sector reforms in order to achieve financial inclusion. He says that sustainable high growth sans financial inclusion is next to impossible. Equally important is productivity and efficiency where financial sector intermediation is called for in order to bring all sections of society under the financial inclusion net, he adds.

“If you need to have 8 per cent growth rate, financial inclusion is a must and banks alone will not be able to achieve this thing. Unless the entire society supports this particular thing, how it can be done?” he asks, underscoring central bank’s belief that it needs the support of policymakers, other regulators, IT solution providers, software and hardware vendors, end-users, media, civic society organisations, and public at large.

Governance Problems: A Case Study

The draft 12th Five Year Plan lists 12 strategy challenges vis-a-vis inclusive growth. These include improving governance, enhancing the capacity for growth, generation of employment, development of infrastructure, improved access to quality education, better healthcare, rural transformation, and sustained agricultural growth. All these are inextricably linked to overall improvement in governance, which should be India’s long-term concern.
As we noted in the previous issue of Inclusion, over and above all, India must address governance reforms. Governance, or the lack of it, impinges on all of us. Improving governance is closely linked to increased participative governance and a bottoms-up development approach. Inevitably, governance reforms touch on administrative, legal, labour, healthcare, education and electoral components.


“Last year, the government set up a high-level investment committee to fast-track approvals for major infrastructure projects. Regulators have started to overhaul pricing in the energy sector. The government has also made progress on such other important reforms such as reducing subsidies for fuel and fertiliser, as well as liberalising foreign investment. These are encouraging signs.”

— Ashima Goyal, Professor of Economics, Indira Gandhi Institute for Development Research

Just to get sense of the kind of governance reforms we still wait to happen, take education. Primary education is the building block of all the study that follows in one’s life. But as the write-up in this issue makes clear, the primary education scene in India is infested with dangerously debilitating and potentially worsening problems. If this is the standard of education India is stuck with, all the breezy optimism about the demographic dividend through skill development is bound to end up in smoke. 
 

Team Inclusion Recommends
  • Revive the growth momentum through speedy clearance of big-ticket infrastructure projects. The Cabinet Committee on Investment must produce visible outcome in the near-term to shore up investor confidence. It must initiate many mega projects like the Delhi-Mumbai Industrial Corridor to create millions of news jobs and speed up urbanisation
  • Major liberalisation of overseas investment rules, including an increase in the foreign direct investment ceilings for politically-sensitive sectors such as defence production, insurance, pensions and multi-brand retail. Drying foreign investment had led to a weak rupee, widening current account deficit and concerns about health of the economy
  • India needs a new strategy to spur a manufacturing sector revolution. This is a necessary precondition to harness the country’s demographic dividend in two best ways: creation of new productive jobs and fostering inclusive growth
  • Sensible fiscal management by the Centre and the states. The widening current account deficit and unsustainable levels of fiscal deficit sap domestic and foreign investor confidence. It also induces capital flight out of the country
  • Pass legislations on insurance and pension sector reforms and tax rationalisation (Goods and Services Tax and Direct Taxes Code, in particular). Removing uncertainty in tax litigations (transfer pricing, double taxation) is also necessary
  • Financial and banking sector reforms must aim greater inclusion by putting in place viable business models. For instance, the Banking Correspondent model, despite all the promise it held, collapsed owing to a non-viable model
  • Complete the second generation reforms and launch the next generation, such as administrative, legal, labour, decentralisation, education, agriculture, healthcare, policing and e-governance
  • Explore a feasible political campaign finance regulatory architecture and alternative funding options. Rising costs of elections is the single biggest factor in the subversion of governance. It engenders rent-seeking, venality and black money
  • Accelerate the use of emerging technologies (ICT, cloud, etc) to improve governance and the public delivery system. It is critical to cut the red tape, corruption and mismanagement that plague almost all spheres of governance in India

We may have a demographic advantage compared to the West and China, but that doesn’t necessarily translate to a dividend if we export shoddy goods and services to our overseas markets. On the other hand, India will be hoist with its own petard if it doesn’t give its burgeoning young and increasingly impatient population productive jobs. India’s demographic dividend can be realised best by the generation of more productive job opportunities — especially in the manufacturing, services and infrastructure sectors — and by fostering inclusive growth through improved governance. Active governmental and institutional support to MSMEs and ambitious entrepreneurs assumes even greater significance in this context.
The realisation is seeping down to the highest levels that while rapid expansion has brought India immense gains, more change is needed — and needed soon. As P Chidambaram, Union Finance Minister, noted in his address during a recent ADB meeting in New Delhi, “At the forefront of all this (recent reform measures) is the focus on inclusive growth. What is ‘inclusive’ growth? It is growth that is broad-based, shared and one that focuses on the poor. A recent estimate was that for every 1 per cent of GDP invested in infrastructure, India creates almost three-and-a-half million direct and indirect jobs.”

The Finance Minister has hit the nail on the head. But even if it regains the 8 per cent growth rate, it’s obvious that India can never qualify to the league of advanced countries unless it undertakes serious governance reforms. The next generation reforms should go the whole hog.

Need for Rebalancing the Economy 

 

As we noted earlier, with 5 per cent growth, India can’t take people out of poverty. To put it in another way, lower levels of jobless growth is fraught with the danger of squandering all the gains in wealth creation, poverty alleviation and social safety net programmes made when the going was good. It may even breed social unrest. 

Now, even the Chinese are thinking about rebalancing of economy through the launch of the next generation economic reforms. For decades, China’s stunning growth was propelled by exports and massive investment in infrastructure. But high wages and slackening demand for its products in the West (because of economic slowdown) have made this growth model superfluous by now, and the Chinese government knows it. The leadership is now making carefully-calibrated moves to rebalance the country’s economy towards domestic consumption, because the old approach is delivering diminishing returns and poses a potential threat to the very political legitimacy of the government. The authoritarian government is savvy enough to understand that pragmatic economic management lies at the heart of its legitimacy.

In India, too, there is a deep understanding in political and policymaking circles that our economy needs a rebalancing wrought through the next generation of reforms. The question is, why delay it when the odds are stacked against postponing them?

Overwhelming evidence — and plain common sense — suggests that until the next wave of reforms is not carried through, the imaginary horizon of equitable, inclusive growth will keep moving off into a distance for the vast majority of Indian people.

 

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