Dr. Bimal Jalan - Governor, Reserve Bank of India     


Economic Reforms and Growth
- India International Centre: Golden Jubilee Lecture, New Delhi, November 27, 2012

I am grateful to India International Centre for giving me this opportunity to participate in this series of lectures to celebrate its Golden Jubilee. Needless to say that the Golden Jubilee of IIC is a momentous occasion in the history of post-Independence India. The initiative to establish a cultural and intellectually vibrant Centre of the highest quality was taken by a team of eminent leaders of our country in 1958, led by Dr. C.D. Deshmukh. The preparatory work, including construction of the building, was completed in 1962 - 50 years ago - and the Centre was formally launched by Dr. S. Radhakrishnan in the presence of Prime Minister Nehru and many prominent citizens from India and abroad.

As a fitting tribute to its founders, on completion of 50 years, the management and members of IIC have organized this series of lectures on "Governance" to take stock of India's current status in terms of political, social and economic developments to identify the challenges that lie ahead, and to work out the policy options that are available to achieve the objectives of our universally acclaimed Constitution. This series of Lectures covers a broad spectrum of issues, ranging from development and devolution to electoral reforms and demographics. Today, I have been asked to speak on the subject of "Economic Reforms and Growth." As it happens, in addition to being important in itself, this is also subject of some contemporary significance. After several years of high growth and rising expectations about India as an emerging global power, there is considerable concern recently about decline in growth rates, high inflation and failure to d eliver essential public services.

In the light of sharp fall in growth rate in the first two quarters of current fiscal year, in the past few months the subject has also been widely discussed among political leaders, policy makers, economists, and commentators in the media. Recently, the present government has also indicated its intention to initiate a host of measures to accelerate growth. In the light of what has already been discussed widely, I have been thinking about what I should say which may perhaps be of some interest to the distinguished IIC audience.

By any standards, India's domestic potential today is huge. India is a well-established democracy which grants full freedom to all its people to do what they wish and provides them with adequate powers to hold the government responsible for its performance. Unlike many other developing countries, our domestic savings are relatively high, and dependence on aid and capital inflows from abroad is relatively low. Our economy has also been considerably liberalized since 1980s. Today, we have full access to world-class technology and skills at comparatively low cost. As it happens, unlike the earlier period, at present our foreign exchange reserves are also sufficient to tackle any balance of payments pressures that might arise without having to seek assistance from abroad.

While our opportunities and capabilities are comparatively large, it is also true that actual performance in alleviating poverty and minimum essential social services to the people have been abysmally low. The best-known and internationally recognised measure of socio-economic progress is the Human Development Index (HDI) which is computed annually by the United Nations Development Programme (UNDP). The HDI is a composite of several basic components of human development, such as, life expectancy, literacy, standard of living and health. It is believed to be a more comprehensive measure of progress than per capita income or Gross Domestic Product (GDP). According to this index, India's rank in 2011 was 137 among 187 countries globally. In other words, India figured among the bottom one-third of the countries in the world in terms of human development, notwithstanding the fact that in terms of overall growth rate of the GDP, India was amon g the fastest growing countries in the world in the last three decades.

Why this sharp and persistent "disjuncture" between growth and human development, notwithstanding the universally acclaimed economic reforms of 1991? Growth and reforms are obviously not ends in themselves, particularly in a vibrant democracy "of the people, by the people, and for the people" like India's. High growth and reforms are "means" to achieve the ends of providing the basic components of human development, specially nutrition, health and literacy, to the people irrespective of their levels of income. And, this is where we have failed and our past performance has been well below the expectation of the founding fathers of our Constitution. It is also symptomatic of the persistent failure of our system of "governance" at the highest levels of government and bureaucracy.

To my mind, this is the primary challenge of the future − not growth per se but how to close this gap between growth and human development. I also believe that in order to achieve this task, macro-economic reforms in respect of various components of GDP are certainly necessary, but not sufficient. In addition to economic reforms, we also need some urgent political reforms to reverse the prevailing "incentives" for fragmentation of parties and their ability to join government without accountability, for criminals to enter politics, and widespread corruption in allocation of public resources by ministries.

So far as economic reforms per se are concerned, there has already been a fair amount of consensus about what needs to be done. Government, at the highest levels, has also announced a large package of reforms that it wishes to introduce in order to boost investor confidence and growth. These measures, which were announced quite some time ago, but which are still waiting to be implemented, include inter-state Goods and Services Tax (GST), liberalisation of foreign direct investments, pension and insurance reforms, completion of public projects (such as, in power sector or roads) on time, and the need to reduce fiscal deficit to budgeted levels (5.1 percent in 2012-13). All these proposed economic reforms will certainly contribute to higher growth, if and when implemented.

In the light of what has already been said, the only point that I would like to emphasise is that, so far as investor and public confidence are concerned, it is much more vital to implement what we announce by way of reforms rather than reverse what has already been announced, or wait, because of differences among parties in coalition. From investment and growth point of view, uncertainty about public policy and public differences among cabinet members is more damaging than status quo in our macro-economic framework and India's widespread reputation as an attractive destination for foreign investments, leading supplier of IT, and high productivity with low costs.

In the rest of this lecture, I propose to deal with some of the political and administrative issues which require urgent attention and reforms in order to promote higher growth. It hardly needs to be emphasised that a fundamental "systemic" change, which dominates the working of India's politics today - unlike the first four decades after Independence - is the emergence of coalitions as a "regular" form of government since 1989. India has had as many as 9 governments during past 22 years - with an average life of about 2½ years. Of these, 2 multi-party coalitions survived their 5-year terms. Excluding these two full-term coalition governments, the average term of 7 governments - with enormous powers to allocate resources, control public enterprises and decide inter-state allocation of investments - was less than 2 years.

The crucial point, in view of past experience, is that at the time of formation of a multi-party coalition government, general expectation of small and regional parties is that enormous powers that their nominees, as ministers, enjoy may not last very long - or that it may change if a more powerful leader of one or two large parties in coalition so decides.

Under the present Constitutional provisions, as a consequence of amendments carried out in 1985 and again in 2003 to prevent defections, now there is also a "built-in perverse incentive" for fragmentation of political parties at the time of election. This is because smaller a party, the greater the ability of an individual legislator to defect to another party in search of political power. Thus, for example, a member elected from a large national party has very little discretion to defect without the support of a substantial number of other members, who also wish to defect. However, if the same person is a member of a small party of 5 or 10 members, a consensus to defect among all of them or only 3 or 4 of them, and switch from one coalition to another, is easier to achieve. The same is true of so-called “independent” members, who are supported by some political parties during elections. In a situation where multi-party coalitions ar e the norm, all regional or caste leaders with a handful of constituencies naturally have a much greater incentive to form their own separate parties rather than join a large party.

Let us just look around and examine what dominates the media headlines and our governance system today. In a House of the People, i.e. Lok Sabha, with 543 members, a party with, say, 10 or 15 members − or even less − can join the government, enjoy ministerial berths, and then veto or reverse even a cabinet decision on an important policy measure. Similarly, a party with even 3 or 4 seats can join the government and choose the portfolio that it wishes to command. If things don't work out, any small party or a combination of such parties can threaten to leave the government and destabilize it.

In order to reduce the present built-in incentive for fragmentation of parties and improve governance, it is of utmost importance that the anti-defection law must be made applicable to all parties and so-called independent members who choose to join a coalition government in power. In other words, those parties which join a coalition should not be able to defect without having to seek re-election. Such an amendment to the "anti-defection law" will go a long way in strengthening the principle of collective responsibility of the cabinet to the people, as enshrined in the Constitution.

A related urgent political reform is to reduce the attractiveness of politics as a career of choice by persons with criminal records. There is a natural reluctance among investigating agencies and ministries of government to speed up investigations and the prosecution of persons who are leaders of political parties and/or members of the cabinet. According to the statistical survey of elections to the Lok Sabha in recent elections, it has been found that nearly 20 percent of the candidates surveyed, cutting across party line (excluding independent candidates) had criminal antecedents. In the present Lok Sabha which has 543 seats in all, well over 100 members had criminal cases pending against them. No wonder that physical scuffles and assaults among some members on the floor of state assemblies, and even Parliament, is not an uncommon sight when tempers rise because of charges of corruption and wrong-doing by leaders of one political part y or another.

The present incentive for persons who have criminal cases pending in higher courts of appeal (either High Court or Supreme Court) should be effectively reversed by giving such cases highest priority if the concerned person is actually elected to Parliament or a State legislature. Their "presumed" innocence should be proved within six months of election before they can take their seats in Assembly or Parliament. Fast settlement of such cases would provide a big relief to persons with criminal charges who are actually innocent, and not only "presumed" to be so. And those who are actually guilty may choose not to contest elections so that they are in a position to delay hearings through normal legal procedures!

Recently, there has been widespread public outrage about corrupt ministers at the centre and states regarding scams relating to allocations of public resources, such as, land, mines and gas. Some ministers have also been sent to jail by the Supreme Court and High Courts because of involvement in bribery and other illicit practices. To see our so-called Hon'ble ministers in jail is a sad commentary about the functioning of India's democracy. But let us also ask ourselves - how is it that these Hon'ble ministers had the opportunity and such enormous discretionary powers to accept massive bribes from corrupt corporates? Who gave them this opportunity? Was it the intention of our Constitution to confer such powers on elected representatives of the people?

Recent history is full of instances where important policy decisions, leading to considerable revenue losses to the government and/or unwarranted allocation of public resources for personal gain by political leaders, were taken without individual and/or "collective responsibility". A striking example was in respect of allocation of 2G Spectrum. Heads of ministries, which were involved in the process of allocation have been "passing the buck", as it were, to some other ministry or to their own civil servants on the ground that they merely concurred in the decision taken by some one else. It has also been claimed that in any case, the final decision was approved by the Cabinet. If this was indeed the case, then the question arises: what does the "collective responsibility" of the Cabinet mean?

Another development, which has gathered further momentum in recent years, is the politicization of India's bureaucracy. In theory, under Indian system of executive responsibility, there is supposed to be a clear division of roles between the permanent civil service and the political leadership. Government's policy priorities and its work program are set by politicians. However, bureaucracy is supposed to ensure that implementation of the approved program is done according to the laws and procedures in force, without fear or favor, for the benefit of all the people regardless of their political affiliations.

Over the years, slowly but surely, the role of the bureaucracy has been seriously compromised. Any party which comes to power and joins a multi-party coalition, is inclined to appoint favoured bureaucrats in sensitive positions who, in turn, are expected to carry out the wishes of its party leaders, irrespective of their merits or legality.

As emphasized by several former cabinet secretaries and other high level officials in their memoirs, most of the administrative powers which were earlier in the hands of the civil servants have now been taken over by political masters at the ministerial level who have no direct or indirect experience of administration. As politics has become more combative and personalized, and coalition governments have become less secure about their tenure in office, transfers of civil servants have also become very frequent. Some years ago in U.P., for example, where two parties resolved to have a 6-monthly tenure in government, there were as many as 1000 transfers within a year amongst members of the IAS and the IPS. First head of government transferred senior officers at an average rate of 7 per day. The second head of government, who took office after the expiry of 6-month period, decided to beat this record and transferred officials at the rate of 16 per day!

As a result of frequent transfers, administration has naturally become weak. What is even worse is that civil servants, instead of being independent of political leaders or parties in power, have now become sub-servient to them. Bureaucratic corruption has also become rampant, both to avoid transfers as well as to secure remunerative postings.

In view of growing political corruption and administrative apathy, it is no wonder that India today has one of the worst rankings in the Corruption Perception Index and Global Corruption Barometer compiled by Transparency International. In the latest perception index, India's score is 3.1 on a scale of 0 to 10 where zero is supposed to be totally corrupt and 10 is totally clean. What is even more disturbing is that, according to TI's corruption barometer, in the past 3 years, nearly 75% of those polled said that corruption in India had increased and only 10 percent thought that it had gone down.

What is equally startling is that, as recently confirmed on tapes and reported in the press, corruption now cuts across all professions, corporates, media, public administration - from top echelons to the bottom of the pyramid - and constitutes a serious threat to internal law and order.

Although corruption has always existed in some form or other and its intensity has varied from time to time, there is no doubt that we have now reached a point where it poses a serious threat to the security, freedom and well-being of ordinary citizens and our cherished democratic values.

It is not generally appreciated that adverse effects of high and rising corruption on a country's income, fiscal balance and investment is a "multiple" of the amount of actual illicit monetary benefit to the corrupt. An interesting finding of empirical research is that for every rupee of monetary gain to the corrupt, the aggregate loss to the society could be as high as three or four rupees. Let us call it the "corruption multiplier". Just as money supply in the economy is a multiple of actual money created by central bank (the so-called "money multiplier"), there is a "corruption multiplier" which occurs because of wrong choice of public projects, loss of tax revenues, low quality of goods and services by corrupt producers, and frequent breakdown of equipment (for example, in power plants).

The worst effect of the "corruption multiplier" is on total factor productivity and delays in completion of public projects, particularly infrastructure projects. As it is, government procedures for approval and financing of investment projects involve a large number of ministries and agencies, at the Centre and States, at different levels of administration. If there is a corruption at any stage of approval, then the "corruption multiplier" gathers momentum and total investment, because of delays, declines by a multiple of actual money transferred to the corrupt.

Another adverse economic effect of corruption is that the poor are the worst affected and, as a result, corruption further aggravates inequality in an unequal society. As is well-known, in order to enhance the scope for corruption, government expenditures are inflated and wasteful projects and programmes are taken up, including purchase of spurious drugs and unsafe equipment causing hazards to safety, life and longevity. While the better-off have access to private providers of essential services, the poor have to necessarily rely on unsupportive public agencies. It is abundantly clear that unless Indian authorities take some measures to improve governance and reduce the "demand and supply" of corruption in the economy, there is simply no way in which India can reduce the rising disparity (and despair) among the bulk of its people.

Given the current political scenario of multiple-party coalitions without a shared agenda, the prevailing view is that dramatic reforms or "hard" measures to improve administrative efficiency may not be feasible in the near future. However, hopefully, with the emerging pressure from the civil society and the media, over the next few years it should be possible to evolve a consensus on introducing a package of reforms which are relatively benign and are likely to be in the overall interest of the country as a whole.

An important priority for the future is to redefine the primary role of government in the economy. At the macro-economic level, the political (i.e. ministerial) role of the government should be to ensure a stable and competitive environment with a strong external sector and a transparent domestic financial system. While the macro-economic priorities (for example, the so-called trade-off between growth and inflation) may be decided by the government, the instrumentalities for achieving these objectives must be left to autonomous regulatory and promotional agencies. Similarly, government's direct role in economic areas should be re-set in favor of ensuring the availability of public goods (such as roads and water) and essential services (such as health and education) to the people. In these areas, the government's role must expand substantially. At the same time, its role in managing commercial enterprises deserves to be correspondingly re duced. The latter objective should be achieved without in any way affecting the financial and other benefits of those who are presently employed.

It is also necessary to simplify administrative procedures and reduce the number of agencies, at different levels, involved in providing clearances for undertaking any activity. For example, at least thirty different clearances involving several agencies at the Center and the states are required for setting up even a modest-sized industrial factory. Except in selected areas where strict time-lines can be prescribed for giving approvals (such as, forest and environment clearances), it is desirable to cut through the elaborate red tape and rely primarily on 'self-certification'. The government can lay down standards and norms (for example, in respect of pollution or fire safety), and the entity concerned may be required to 'self-certify' at the highest levels of management that these have been complied with as per the notified procedures. Government agencies can make random checks and in case there are clear-cut violations, appropriate pen al action can be taken. Similarly, the present complexity in regulations should be reduced drastically. Such simplification has been tried out in some areas with success (for example, foreign exchange transactions).

A related area is transparency in the decision-making process within the government. A major step in this respect has been taken with the enactment of the Right to Information Act, 2005. The beneficial impact of this legislation in making the government accountable and citizen-friendly is already visible. A further step in this direction is to make it mandatory for all ministries and departments of the government to voluntarily make information on the decisions taken by them available to the public (excluding security-related subjects). It may be clarified that information should be released by the ministries themselves without the need for any member of the public to ask for it. If this is done, the free media and civil society institutions will constitute an effective instrument for enforcing accountability in the decision-making process itself.

There is, of course, a lot more to be done to tackle the challenges of the future. But let me not take much more of your time. The over-arching points that I wish to convey for consideration are really two-fold. First, growth of GDP is certainly important and we must do all that is needed to put India on a high growth trajectory. At the same time, high growth is not an end in itself. We must also ensure that the benefits of growth reach all the people, particularly the disadvantaged sections of our society. Second, in order to achieve this objective, reforms have to be broad-based. Highest priority has to be given to some urgent political reforms to enforce collective accountability of multi-party governments combined with administrative reforms to reduce corruption, simplify rules, and easy access of citizens to public services.

I believe that India today has the capacity to achieve its full potential as an emerging global power, provided we have the necessary will and determination. Despite some current problems in governance and the working of the political system, the innate ability of our people is immense and has been demonstrated beyond reasonable doubt. The open and participative democratic system ensures that a change where necessary can be delayed, but it cannot be avoided altogether.

Thank you.

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