India’s rentier state

It is undoubtedly good news for the finance minister and his team. Investors across the world have become more sensitive to weak public finances since the Greek crisis. The 13th Finance Commission headed by Vijay Kelkar has already set a clear road map to bring down the fiscal deficit and public debt in India. Pranab Mukherjee also indicated in his February budget speech that fiscal correction is essential to maintain economic stability.

But there are two problems as well. First, the government should not be depending on one-time bonanzas such as revenues from spectrum auctions to put its finances in order, because politicians would then have little incentive to curb wasteful spending or plug tax loopholes. There will always be lottery winnings to balance the books.

Rental income from natural resources and asset sales should ideally be ring-fenced, and used for specific purposes such as paying off public debt, funding infrastructure or any such measure that will improve the competitiveness of the Indian economy. The hard work of bringing down the fiscal deficit and eliminating the revenue deficit should be done through higher tax revenues and lower public spending. The National Investment Fund that was launched to channel privatization proceeds into productive uses has been given a quiet burial.

The other problem is that the government will have an incentive to maintain permanent shortage in the natural resources it controls, be it in the air (telecom bandwidth) or under the earth (metals and ores), so that rents can be high. It is the old monopolist game: restrict supply to get high prices.

The bandwidth war is an interesting example. There is little doubt that many of the problems in the sector can be laid at the door of telecom minister A. Raja, who has done immense harm over the past six years. However, that is not all.

Here’s how the Financial Times’ Lex column caustically put it: “India’s guide to reducing a budget deficit: allow a dozen or so mobile phone operators to compete in your country, block market consolidation and repeatedly postpone the release of third generation spectrum, and then as competition descends into a price war, auction off far fewer spectrum chunks than potential bidders. Finally, watch as 3G spectrum prices go through the roof." This could be a useful case study for game theorists to examine.

Another telling example is oil and gas. The rich KG D6 gas field being operated by Reliance Industries has been the epicentre of the prolonged legal battle between the two Ambani brothers, so less attention has been paid to its ability to transform our public finances. The gas fields are expected to yield the Indian government royalties and profit petroleum around $28 billion over their life, according to independent estimates by investment banks. And there will undoubtedly be more such resource revenues from mines and hydrocarbon reserves.

India does not suffer from the infamous resource curse, a malady that strikes many nations that are rich in natural resources. Huge tax and other revenues from these gifts of nature leave governments with very little incentive to nourish the private sector or make an economy competitive. Money from resources can be thrown at the people to keep them in line.

India by no stretch of imagination resembles an Iraq or an Iran. However, we could be headed to a milder version of the malady, where revenues from privatizations and natural resources help the government hide deeper economic imbalances. The government will then have reason to design policy with a view to revenue maximization rather than welfare. We saw this in a different context in some recent privatizations, where retail investors stayed away because the government was out to get the best price rather than encourage wide ownership of public sector companies.

Hong Kong is an unusual example of a country that maintains a key natural resource in permanent short supply and then conducts lucrative auctions to maximize government revenues. That resource is land. Despite its well-deserved reputation as a free-market haven, the island city has a land market controlled by a government monopolist. So it is not only repressive regimes such as the oil-rich states that behave in this manner.

There are strong reasons why the government should leave the telecom sector to private companies, continue to aggressively sell shares in public sector units and offer mining rights to the highest bidder. The money should be used to build infrastructure or repay public debt rather than balance the government’s books. A strong dependence on monopolistic rents may not be such a good thing in the long term.

In short, the Indian state should not behave like a rentier.

Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at cafeeconomics@livemint.com

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