Whilst debates about what India's Finance Minister should do on 29 February are getting into a frenzy, there is agreement that India's GDP needs to increase by around 10% per annum for at least two decades, as China's did, for India to transform itself. India must complete a marathon, not waste its energy in sprints. When I was training to run the Boston Marathon, I was cautioned not to get excited by the cheering of crowds to run faster in the early stages of the race. India has emerged as the fastest growing economy in 2016 because others have slowed down. Run faster some are urging: increase the GDP, reduce interest rates, damn the deficit. We will run out of breath, others caution, some even suggesting that GDP is not a good measure of our performance. We should be concerned about the quality of the growth, and its sustainability, they rightly say. The Finance Minister should heed these cautions, and strengthen the economy for a marathon run.
Consider three critical subjects that the Finance Minister will have to deal with in the Budget. These are taxation, provisions for building infrastructure and the development of the social sector.
India has emerged as the fastest growing economy in 2016 because others have slowed down.
Finance ministers everywhere are pressed to reduce taxes to provide more incentives for investors. When even the very rich, who can afford to pay more taxes, say they want to pay less taxes to stimulate their 'animal spirits', the Finance Minister's task of balancing the budget becomes doubly difficult. What is surprising is that, even when taxes are not high, investments in infrastructure and manufacturing projects have not been easily forthcoming from foreign and Indian investors.
A root cause analysis reveals the real constraint. It is this: projects are difficult to implement; money remains stuck; and 'non performing assets' increase. Why would an entrepreneur (or bank) risk money when the track record shows that it will be very difficult to produce a return? Taxes are due when profits are made. But when will profit be made, if at all? The time value of money has to be factored in too. It takes too long to get things going in India compared to other countries. And when things get stuck, as they often do in India, solutions through courts take much too long. So further investments are prudently held back.
[P]rojects are difficult to implement; money remains stuck; and 'non performing assets' increase. Why would an entrepreneur (or bank) risk money...?
'Implementation' is India's biggest problem. Poor implementation reduces the productivity of money. The improvement of implementation is not an economic problem: it is principally a management problem that results in economic problems. Indeed, the Governor of India's Reserve Bank, which has been pressed to reduce interest rates to stimulate the economy, has firmly stated that it must remain focused on good monetary policy, and should not be expected to solve problems that the Government must solve. Similarly, Mr Chidambaram, Finance Minister in the last UPA government, also said that the Finance Minister cannot solve problems of implementation that lie within the remits of other ministries and the states.
The Reserve Bank and the Finance Minister should not be expected to reduce interest rates and increase budget deficits to compensate for failures of implementation when they fear that such steps could create further economic problems. Solutions to what are 'management' problems must be found elsewhere. They lie in developing capacities of institutions to design and implement processes that will produce desired outcomes effectively.
Turning to the social sector, India is doing very poorly, compared even to its peers in the developing world, on many measures of education and health. The principal problem is not insufficient allocation of financial resources, though some economists and social activists focus on the insufficiency of allocations. The principal problem is that the money allocated and spent does not produce the outcomes desired on the ground. Innumerable evaluations by many Indian and international agencies have documented the poor productivity of resources in India's social sector schemes. An estimate of approximately 85% wastage, first mentioned by Rajiv Gandhi, seems to be validated by many studies.
In physical infrastructure sectors (urban infrastructure, roads, power, etc.) as well as social sectors, a root cause for insufficient progress is poor implementation.
No doubt hundreds of millions of people around India are suffering from lack of good education, health, sanitation and other essential facilities. When the loss is so high, between the overhead tank into which resources are allocated by the Finance Minister and outlets on the ground from which people obtain outcomes, it cannot be a good strategy to just keep putting more and more resources into the tank in the hope that more will trickle down to the people. The Finance Minister has to keep budgets reasonably balanced too. Therefore, delivery institutions in the social sectors must be fixed on a high priority.
In physical infrastructure sectors (urban infrastructure, roads, power, etc.) as well as social sectors, a root cause for insufficient progress is poor implementation. Results have to be produced on the ground around the country, in the states, in cities and in villages. When state and local governments are not able to deliver effectively, and citizens' demands for results increase, a natural instinct of the Centre is to take charge. It devises solutions, imposes them, and monitors implementation. Until it is found that this solution of centralization is making the problem worse. 'One size does not fit all'. Local bodies cannot develop their own capacities if they are not expected to manage. Thus, while there can be occasional successes with centralization, the root-cause problems of poor implementation and insufficient institutional capabilities actually become worse.
[PM Modi] has energized the concept of federalism and empowerment of states... the strategy is right.
Institutions must be built and strengthened. The total factor productivity of the economy must be increased, so that more outcomes can be produced with fewer resources. Therefore, implementation must be improved. Poor implementation is the Indian economy's weakness. For example, according to a report by India's Comptroller and Auditor General, the Indian Railways had spent around ₹ 92,000 crores on 479 projects, some dating back to the 1970s and 80s. But due to shoddy contract and project management, costs have more than doubled, and the Railways need another ₹ 183,000 crores just to finish these ongoing projects! Tardy and shoddy implementation makes India a less attractive place for investors in infrastructure and industries than it should be considering the huge potential in India's market. The Finance Minister knows very well that social infrastructure, for education and health, has to be improved considerably for India to advance, but larger allocations of money alone will not solve the problem. Here too, poor implementation is limiting the outcomes in spite of increased outlays over the years.
Prime Minister Modi recognized that the time had come to reverse the over-centralization of management in India. He has energized the concept of federalism and empowerment of states. Cities are being empowered to manage their own 'smart city' plans. Mr. Modi abolished the central Planning Commission, and replaced it with the NITI Aayog whose charter is to develop capacities for local level planning and implementation, and systems of cooperation between stakeholders.
Capacity building does not require much money. The amounts required will be a very small fraction of the investments required to build physical and social infrastructure.
This strategy is right. The Finance Minister can use his budget as a significant opportunity to help implement this strategy. It will help him achieve his own objectives of better outcomes for citizens with less strain on the government's finances. Institutional capabilities -- for local management, for inter-agency coordination and stakeholder cooperation, and better regulation -- must be improved urgently. These are areas in which institutional capacities in India are falling short of its challenges and aspirations. Capacity building does not require much money. The amounts required will be a very small fraction of the investments required to build physical and social infrastructure. Whereas the improvements that better capabilities can make to the overall productivity of investments are very large.
The Finance Minister's budget is an occasion for him to strongly signal the need for a national thrust for building institutional capacities for implementation, and to enable this thrust with resources. The PMO can provide the 'Muscle' for the thrust, as it seems inclined to. The NITI Aayog can provide the 'Mind' (the architecture and design of processes required), as it has been chartered to, and for which the previous Planning Commission had already left some blue prints in the description of the India Backbone Implementation Network and processes for developing urban and rural local management capacities. The Finance Ministry can provide the 'Money'. Their '3M' cooperation in this strategic thrust will put India onto a trajectory of faster, more inclusive and more sustainable growth.
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