India’s economy A chance to fly

India has a rare opportunity to become the world’s most dynamic big economy Feb 21st 2015 

EMERGING markets used to be a beacon of hope in the world economy, but now they are more often a source of gloom. China’s economy is slowing. Brazil is mired in stagflation. Russia is in recession, battered by Western sanctions and the slump in the oil price; South Africa is plagued by inefficiency and corruption. Amid the disappointment one big emerging market stands out: India.

If India could only take wing it would become the global economy’s high-flyer—but to do so it must shed the legacy of counter-productive policy. That task falls to Arun Jaitley, the finance minister, who on February 28th will present the first full budget of a government elected with a mandate to slash red tape and boost growth. In July 1991 a landmark budget opened the economy to trade, foreign capital and competition. India today needs something equally momentous.

Strap on the engines

India possesses untold promise. Its people are entrepreneurial and roughly half of the 1.25 billion population is under 25 years old. It is poor, so has lots of scope for catch-up growth: GDP per person (at purchasing-power parity) was $5,500 in 2013, compared with $11,900 in China and $15,000 in Brazil. The economy has been balkanised by local taxes levied at state borders, but cross-party support for a national goods-and-services tax could create a true common market. The potential is there; the question has always been whether it can be unleashed.

Optimists point out that GDP grew by 7.5% year on year in the fourth quarter of 2014, outpacing even China. But a single number that plenty think fishy is the least of the reasons to get excited. Far more important is that the economy seems to be on an increasingly stable footing (see article). Inflation has fallen by half after floating above 10% for years. The current-account deficit has shrunk; the rupee is firm; the stockmarket has boomed; and the slump in commodity prices is a blessing for a country that imports four-fifths of its oil. When the IMF cut its forecasts for the world economy, it largely spared India.

The real reason for hope is the prospect of more reforms. Last May Narendra Modi’s Bharatiya Janata Party won a huge election victory on a promise of a better-run economy. His government spent its early months putting a rocket up a sluggish civil service and on other useful groundwork. But the true test of its reformist credentials will be Mr Jaitley’s budget.

The easy part will be to lock in India’s good fortune, with fiscal and monetary discipline. In addition India’s public-sector banks need capital and, since the state cannot put up the money, the minister must persuade potential shareholders that they will be run at arm’s length from politicians.

If India is to thrive, it needs bold reforms and political courage to match. The tried-and-tested development strategy is to move people from penurious farm jobs to more productive work with better pay. China’s rise was built on export-led manufacturing. The scope to follow that model is limited. Supply-chain trade growth has slowed, and manufacturing is becoming less labour-intensive as a result of technology. Yet India could manage better than it does now. It has a world-class IT-services industry, which remains too skill-intensive and too small to absorb the 90m-115m often ill-educated youngsters entering the job market in the next decade. The country’s best hope is a mixed approach, expanding its participation in global markets in both industry and services. To achieve this Mr Jaitley must focus on three inputs: land, power and labour.

Jumbo on the runway

All are politically sensitive and none more so than land purchases. In China the state would just requisition the land, and let farmers go hang. But India has veered too far the other way. A long-standing plan to build a second international airport in Mumbai is on ice. An act passed in the dying months of the previous government made things worse by calling for rich compensation to landowners, a social-impact study for biggish projects and the approval of at least 70% of landholders before a purchase can go ahead. Mr Modi has used his executive powers to do away with the consent clause for vital investments. It is a temporary fix; Mr Modi needs to make it permanent and to win that political battle he needs to show that prime locations do not go to cronies, but to projects that create jobs.

Power, or rather the shortage of it, also stops India soaring. According to one survey half of all manufacturers suffered power cuts lasting five hours each week. Inefficiency is rampant throughout the power network, stretching from Coal India, a state monopoly, to electricity distributors. The first auctions of coal-mining licences to power, steel and cement companies, which began this week, are a step forward. More effort will be needed to open distribution to competition. Regulators are cowed by politicians into capping electricity prices below the cost of supply—though people will pay up and leave the politicians alone if they know that the supply is reliable.

The third big area ripe for reform is India’s baffling array of state and national labour laws. Compliance is a nightmare. Many of the laws date to the 1940s: one provides for the type and number of spittoons in a factory. Another says an enterprise with more than 100 workers needs government permission to scale back or close. Many Indian businesses stay small in order to remain beyond the reach of the laws. Big firms use temporary workers to avoid them. Less than 15% of Indian workers have legal job security. Mr Jaitley can sidestep the difficult politics of curbing privileges by establishing a new, simpler labour contract that gives basic protection to workers but makes lay-offs less costly to firms. It would apply only to new hires; the small proportion of existing workers with gold-star protections would keep them.

Adversity has in the past been the spur to radical change in India. The 1991 budget was in response to a balance-of-payments crisis. The danger is that, with inflation falling and India enjoying a boost from cheaper energy, the country’s leaders duck the tough reforms needed for lasting success. That would be a huge mistake. Mr Modi and Mr Jaitley have a rare chance to turbocharge an Indian take-off. They must not waste it.