The high cost of policy uncertainty
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The damage that policy uncertainty has wreaked on business confidence has rarely been properly understood in India.
The past three years have seen all sorts of policy tangles that have played a big role in the subsequent collapse of private investment, which is now at its lowest in a decade when measured as a proportion of gross domestic product (GDP). Most official explanations preferred to focus on other factors such as global financial volatility, borrowing costs and weak external demand. The damage by retrospective taxation, confusion on mining clearances, pricing of natural resources and the cancellation of new telecom permits have hurt.
The International Monetary Fund (IMF) has delivered some empirical evidence to show that around half the decline in investment activity since 2011 can be explained by policy uncertainty. The lender has provided this evidence in a research paper published last week in tandem with its annual health check of the Indian economy.
A problem with recent discussions on policy uncertainty is that it is based on what could be dismissed as subjective grouses; there was no objective numerical measure. IMF economists have considered a new measure of policy uncertainty developed by Scott Baker and Nick Bloom of Stanford University and Steven Davis of the University of Chicago (www.policyuncertainty.com). It shows that policy uncertainty in India has risen sharply since 2011, though it has drifted down after a peak in June 2012. It is not hard to see that this is precisely the period when there was policy chaos in New Delhi even as the fiscal deficit rose. The policy uncertainty index is still uncomfortably high.
“Moreover, the current level of uncertainty exceeds its post-Lehman highs, suggesting that uncertainty is primarily driven by India’s domestic policy challenges, and not by global uncertainty such as related to changes in expectations about QE (quantitative easing) tapering,” says IMF.
It is widely accepted that India cannot meaningfully regain its economic momentum unless corporate investments are brought on track. The sort of demand stimulus that this government has preferred despite supply constraints will only add to inflationary pressures. Public investment cannot play a major role in the recovery unless there is a significant shift of public spending away from subsidies and towards asset creation. A private investment revival is thus the key.
The next government will need to focus on this challenge, and the recent IMF research suggests that one of its first tasks will be to reduce policy uncertainty that companies face. The first step would perhaps be to unclog the investment pipeline; stalled projects peaked in the middle of 2011 at around 2.5% of GDP.
The cabinet committee on investments set up by the second Manmohan Singh government has been set up precisely to deal with stalled projects; finance minister P. Chidambaram has said that 296 projects worth Rs.6.6 trillion have been cleared by this committee till January. The next Prime Minister will have to continue the good work.
Cutting through the red tape that has held back some projects is undoubtedly welcome but the more difficult task will be to encourage companies to announce fresh projects. Some of this will also be dependent on the state of corporate finances.
Indian companies are now weighed down with excess leverage that they will have to bring down in the coming years. The experience of the last business cycle shows that there can be a gap of around five years between an investment collapse and the next revival.
The great wave of corporate deleveraging and shop-floor reengineering that India saw in the last years of the previous century created conditions for the subsequent investment boom.
The upshot: Indian companies will have to battle several internal demons if they are to get back into investment mode but that in no way takes away from the core task of the next government. It will have to work hard to reduce the policy tangles it will inherit from the current regime. What the Vajpayee government did so well with the telecom regulation will have to be repeated several times over if animal spirits are to be unleashed again.
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