Three mistakes

Populism without reforms, failure of PSU divestment, and targeting foreign investors to mop up tax revenue


By Mohan Sule
The more things change, the more they remain the same. Rewind to Indira Gandhi’s Garibi Hato days of loan melas. A ‘foreign hand’ was blamed for the people’s wretched life under the Hindu Growth Rate. The remedy? Nationalisation of banks and increasing government say in running businesses, be it issuing licences for new capacity, determining bosses’ pay or releasing foreign exchange. Unwind to the present day of Sonia Gandhi’s loan write-offs, rural employment guarantee scheme, and the proposed food security bill. Inflation, slowing growth, and debasing of the rupee due to flight of foreign capital and costlier imports are attributed to the euro-zone crisis. After nearly eight years in power, the government notes that petrol is deregulated but forgets to add that it had abandoned the practice of fortnightly price revision, initiated by the NDA government, which resulted in small doses of ups and downs in retail prices. The bottom line is that the nation is paying a heavy price to keep the UPA II government afloat. Looking back, of the many mistakes that the Grand Old Party committed, three stand out. The first is acting on the insecurity that this might be the last chance it has got to govern. As a result, the party that was willing to let its government collapse on the US civilian nuclear deal was afraid of offending its partners on various issues including 51% FDI in multi-brand retail and 49% in insurance, removing the cap on voting rights in banks, and increasing railway tariffs. The land acquisition and mining bills are embedded with anti-business bias in terms of valuation and royalty payment.

The ripple effect of these short-sighted policies is being felt not only on investment in the power sector — problems in buying land to set up plants on one hand and in acquiring coal blocks on the other — but also in the manufacturing sector. In its second term, the Congress is already occupying the left-of-center space vacated by the Left parties, shedding off any pretense of being centrist. Initially, most of the posturing was with an eye to the Uttar Pradesh elections. Hence, the compulsion of coalition politics that Prime Minister Manmohan Singh has bandied about in justification of the scam in allotment of second-generation telecom spectrum in 2008. All these populist stances could have proved to be aberrations and corrected subsequently had the vigorous campaigning of Rahul Gandhi paid off. In fact, the strategy has boomeranged, with the party retaining its miserly seat total in the state and also facing the prospect of increasing dependence on regional satraps to form a government after the 2014 elections. The second error of judgment was the bet that PSU divestment would bail the government out from the fiscal mess caused by increase in spending on social schemes and subsidies to the oil and fertilizer sectors. The calculation was that PSUs would be attractive investment propositions due to their monopoly status. The first blow to the myth was in the form of lukewarm response to the ONGC follow-on offer due to the high price combined with the auction method implemented for the first time since its introduction.

The fact is foreign investors are wary of buying into a company that is sharing the subsidy burden of downstream refineries. The vocal opposition to the Central government’s direction to Coal India to sell its products cheaply to power plants is the beginning of the end of days when big-ticket foreign fund managers would meekly buy into PSU shares. With the divestment proceeds falling short of the target and non-plan expenses ballooning, the finance minister resorted to raising indirect taxes in the budget, contending that these were being restored to their pre-2009 stimulus level. This upward revision would have not caused a flutter if the economy were firmly on the growth path and inflation under control. In a slowing economy, the temptation of increasing taxes to compensate for the fall in revenue due to sluggish industrial activity is always strong. But this proves self-defeating as the move contributes to inflation and further slowdown in sales. Compounding the problem is the third mistake of amending the income tax laws retrospectively to tax capital gain arising to foreign entities on transaction of Indian assets and plugging the tax avoidance loophole exploited by foreign investors by registering in Mauritius. As has been time and again demonstrated, besides hard numbers, the market also runs on sentiment. And the perception is that the UPA government is unable to think out of the box and going back to the days when getting rich was looked at suspiciously and helping the poor meant handouts instead of inviting investments.

Mohan Sule