Cracks begin to show in Modi government

Does the appearance of confusion and ineptitude within the ministry of finance threaten to unravel the business-friendly, reform-oriented economic policy agenda of Prime Minister Narendra Modi and his Bharatiya Janata Party (BJP)-led government?

As the government approaches its first anniversary in office, a number of worrying missteps and miscalculations by finance minister Arun Jaitley, or at any rate officials within his ministry, are conspiring to undercut Modi’s own efforts to jumpstart the Indian growth story.

The spectre of retrospective taxation, and of the minimum alternate tax (MAT), has earned the ire of foreign portfolio investors, who have been making their unhappiness with the tax regime known by heading, en masse, for the exits. While the overall macroeconomic scenario still remains largely sound at the moment and while some of the recent sell-off is no doubt due to global market developments —such as a resurgent oil price and the possibility, however unlikely, of an increase in US interest rates—for which blame obviously cannot be laid on the doorstep of Jaitley or his officials, it would be folly to deny the minatory impact of MAT in particular on foreign investors’ sentiment.

What is more, the fact that foreign investors are rebalancing from longer to shorter positions in the Indian market suggests that they foresee continued volatility in the short to medium term, and are waiting for a dose of good news before doubling down on India’s longer-term prospects.

Unfortunately, Jaitley’s response has, thus far, been less than fully satisfactory.

Writing an op-ed in the Financial Times to assuage the concerns of foreign investors, as he did last month, is a good start, but that ought to have been followed by decisive action to dispel the cloud of uncertainty over taxation, rather than merely to make it a little less thick. Ask any investor, and they will tell you that what they really hate is uncertainty about taxation, rather than the level of taxation itself. Yet, by referring these issues to a new committee headed by A.P. Shah, and by continuing to insist that these are “legacy” issues—rather than legitimate issues of the current government’s own making—Jaitley at once fails to own up to the follies of officials within his ministry and gives the impression of kicking the can down the road, rather than settling the matter once for all.

Alas, these are not the only recent missteps. After much fanfare following an announcement in the Union budget, Jaitley, late last month, caved in to pressure from Reserve Bank of India (RBI) governor Raghuram Rajan and deferred the government’s proposal to create a public debt management agency (PDMA), pending further consultation. The creation of the PDMA, stripping away a responsibility presently exercised by the RBI, would have brought India in line with other major economies, and eliminated a fundamental conflict of interest at the heart of the RBI’s mandate. As such, it was the lynchpin of a trinity of reforms which included the RBI’s new inflation targeting regime and the creation of a well-functioning bond market in India, which in turn would have greatly enhanced the presently creaky monetary transmission mechanism and taken a giant step towards giving India a modern financial sector.

Rajan’s resistance to the creation of the PDMA was a naked assertion of turf, pure and simple, and, in this battle of wills, it was Jaitley who blinked first, thereby weakening his credibility in the battle over the constitution of the Monetary Policy Committee (MPC) which awaits in the near future. To add to the mess, there was evident confusion within the ministry of finance itself, with minister of state Jayant Sinha giving an interview to Reuters on 28 April in which he asserted that the PDMA would go ahead, just two days before Jaitley unceremoniously dropped it. While no doubt unintended, Sinha’s out-of-turn remark conveys the unfortunate impression that the government’s own ministers are not speaking with one voice on the issue.

What’s more, for a government which, until recently, has apparently been immune from the sort of palace intrigue which hobbled the previous Congress-led government, no doubt due to the towering presence of Modi himself at the top, cracks have begun to appear. Thus, a Reuters report of 7 May cited an unnamed “source” within the BJP who asserted that Modi personally backed Rajan in his feud with Jaitley and that this is what led to the latter’s climbdown. Whether credible or not, such reports, amid a slew of hatchet jobs targeting Jaitley very directly, only serve to reinforce the impression of a finance minister who is besieged from within and facing a credibility crisis from without.

The good news is that Jaitley has ample opportunity to right the ship. This he can accomplish by ensuring that the goods and services tax (GST), if it should pass the remaining constitutional hurdles, is launched with a sensible (low) rate and few exemptions. He must also get the ball rolling on fixing public sector banks laden with bad loans, and thereby kickstart lending and the private investment cycle.

What will not work for Jaitley going forward is confusion, hesitation and backsliding on promised reforms. Incrementalism is not a synonym for inaction.

Every fortnight, In the Margins explores the intersection of economics, politics and public policy to help cast light on current affairs.

Comments are welcome at views@livemint.com. To read Vivek Dehejia’s previous columns, go to www.livemint.com/vivekdehejia--