A mixed bag

Moody's rating should persuade the government that good economics pays

By Bhaskar Dutta
  • Published 8.12.17

The last few weeks have been a period of mixed fortunes for the National Democratic Alliance government, filled with bad and good publicity. First, came a massive shot in the arm for the government with a World Bank release announcing that India had achieved a giant leap in the bank's "ease of doing business" ranking. Unfortunately, this was soon followed by a barrage of opinion pieces and news items reminding everyone that November 8 was the first anniversary of the demonetization exercise, surely a government 'reform' which is a perfect example of public folly of historic proportions. Mid-November brought news of a drastic rollback and simplification of the goods and services tax. While the rollback was welcome news to everyone, it did raise questions about the government's level of competence. Why were the initial rates so high and why was the original system so complicated? Finally, there has been a strong endorsement of the economy from the global credit rating agency, Moody's, which has just upgraded India's sovereign ratings.

India jumped 30 places to 100 among 190 countries in the World Bank's ease of doing business ranking. The overall ranking was based on a set of 10 criteria, and India showed marked improvement in eight of them in Delhi and Mumbai, the two cities which formed the basis of the country report. The country's corporate law and securities regulations have been recognized as highly advanced, placing India in fourth place in the global ranking on protecting minority investors. A common factor underlying the improvement in several other dimensions has been the increasing use of online platforms and the concomitant computerization in the delivery of public services. There is no doubt that these steps have made it significantly easier to get access to new electricity connections, getting permits of various kinds, paying taxes - a few of the criteria in which the improvement has been particularly noticeable.

However, to put everything in perspective, it must be remembered that the World Bank report is based on just two of the most advanced cities in India. Raipur, Bhopal, Patna and Bhubaneswar - cities like these - must also improve their public service delivery systems if the country as a whole is to experience balanced regional growth, without which regional inequalities will continue to increase. It might be thought that a natural outcome of different states competing against one another in order to attract entrepreneurs to invest within their state boundaries would be for states to improve the environment for doing business, by improving infrastructure and by removing bureaucratic and other constraints involved in setting up new enterprises. Unfortunately, this has not happened in a majority of states for quite inexplicable reasons. Consider, for instance, even a state like Bengal which clearly wants to attract investment - the state organizes regular "Bengal Global Business Summits"; its chief minister has been very proactive in travelling outside the state to meet industry leaders. But, nothing much seems to have changed on the ground. Certainly, the flow of investment funds from outside the state has at best been a trickle.

Much has been written about the demonetization exercise announced by the prime minister on November 8, 2016. A year has passed, but the shock waves have been so intense that the debate continues. The demonetization of the 500- and 1000-rupee currency notes was supposed to be an attack on black money, on counterfeit notes and was supposed to promote the increasing use of digitization and non-cash payments. These were all very good goals. Unfortunately, none of these objectives has been achieved. What is particularly incomprehensible is that anyone with a passing acquaintance with elementary economics should have been able to convince the prime minister that demonetization cannot eliminate the problem of black wealth. The proportion of black wealth stored in currency notes and hidden under mattresses is a minuscule proportion of the total stock of black money. The major way to make a dent in the problem is to closely regulate the activities (for instance, real estate transactions) which generate black incomes.

The scrapping of the high denomination notes does not even seem to have reduced the counterfeit problem since the Reserve Bank of India has reported that virtually the entire stock of the banned notes has been returned to it. And with over 90 per cent of rural centres remaining unbanked according to the RBI itself, how were these areas supposed to function without cash? So, there has hardly been any positive effects. On the other hand, there has been much short-term suffering, with the rural economy being particularly affected. The jury is still out on the precise long-term effects of the exercise. However, there is little doubt that the marked economic slowdown during the last three quarters is at least partly due to the short-term disruptions in the economy caused by demonetization.

The introduction of the GST has been clubbed with demonetization in being responsible for the economic slowdown. However, the two are very different. The GST is an intrinsically important piece of reform. It had the potential to transform the economy by creating a national market through taxing goods and services on a uniform value added basis. Unfortunately, the original scheme was severely flawed with multiple rates, the highest being a staggering 28 per cent, the choice of which commodities to put in specific slabs defying all economic rationale, and a record-keeping system impossibly difficult to implement for all but the largest corporations. Not surprisingly, the government came in for a lot of flak, particularly from traders, an important vote bank of the Bharatiya Janata Party. Now, the GST council has finally woken up from its slumber, reduced tax rates on many items and effected some simplification in procedures. But, as I have remarked earlier, the fact that the government could devise such a complicated system initially does not inspire much confidence in its ability to govern.

The ratings upgrade from Moody's is the first for India since 2004. The agency expects that economic and institutional reforms will continue and will over time allow the economy to reap its full potential - it grew at close to 10 per cent not so long ago, and there is no reason why this target cannot be achieved again. The improved rating from a major ratings agency provides a much-needed pat-on-the-back for a government that has faced increasing criticism for its seeming paralysis in positive decision-making - the GST notwithstanding - and its inability to prevent the economy from slowing down quite appreciably. The endorsement from Moody's will improve the country's ability to attract foreign investment. Since the improved rating also signals that the government is less likely to default on its sovereign debt, it will result in a lower cost of borrowing for the government.

Hopefully, the certificates from the World Bank and Moody's will convince the government that good economics does pay in the long run. Much will depend on the results of the December elections. Any setback for the BJP may make the party nervous about prospects in 2019 - it may then opt for populist policies that will be bad news for the economy. But a satisfactory electoral outcome will allow the government to focus on the economy.

The author is professor of Economics, Ashoka University