Like in the United States, where the Republican Party talks the language of maximum freedom, minimum government and frugal budgets but ends up overseeing an expansion of the government and the fiscal deficit, the Congress party in India has repeatedly presided over expanding fiscal deficits, rampant and persistently high inflation, external deficits and banking crises.

It has been left to the relatively short-lived non-Congress governments to come in, stem the rot and repair the economy. The National Democratic Alliance (NDA) government under Atal Bihari Vajpayee did that from 1998 to 2004 and the history repeated itself under the BJP-led government from 2014 to 2019.

Therefore, it is important that, whichever party or alliance that comes to office in May 2019, the hard-won macroeconomic stability is not squandered away as the United Progressive Alliance (UPA) government did rather spectacularly from 2004 until 2014. India needs a sound macroeconomic strategy not just for the next five years but for the next two decades. Homilies and platitudes do not make for macroeconomic strategy. What needs to be done is understood but how it can be done is less clear.

Reforming Factor Markets — Capital — Banking Reforms

Since 1991, in fits and starts, India has liberalised its product markets, financial markets and the external sector. But, Indian governments have faced greater political economy challenges in reforming its factor markets. Of the three factor markets — land, labour and capital — the last one was substantially better reformed than the first two. In fact, reform of the market for capital, the factor, got a major boost with the enactment of the Insolvency and Bankruptcy Code (IBC).

As Arvind Subramanian, the former chief economic adviser to the government of India put it, India had capitalism without exit and, in particular, the BJP government faced the challenge of dealing with “stigmatised capitalism” in the wake of the crisis of bad and non-performing assets in the banking system. IBC has dealt with both these challenges — capitalism without exit and stigmatised capitalism. But, there is still the unfinished task of reforming the banking system, which is an important cog in the wheel of provision of capital for the economy.

Admittedly, the dilemma of solving the problem of bad assets in the banking system might, without appearing to bail out the wilful and not-so-wilful corporate defaulters, be one of the reasons for the present government’s delayed recognition of the problem and its scale.

It is also possible to argue that it simply did not do the homework early enough to anticipate how the problem would develop nor did it understand the deflationary consequences of some of the reforms it undertook and the consequent adverse impact on the already-fragile balance sheets of Indian banks, majority of whom are under majority-owned by the government. But, it is never too late. The stress in bank assets is still real and big and is festering and the crisis still presents an opportunity for the government to reform the banking system.

In 1969, privately-owned commercial banks came under government ownership for reasons of economic development and financial inclusion. In the first two decades, these two objectives were met mostly rather than unmet. Post-1991, as the opportunities for rent-extortion shrunk in a liberalised economic environment and as government finances came under increased scrutiny, the banking sector became a proxy financier of government’s budget priorities and, in the process, it facilitated both rent-seeking and patronage.

That is why since 1991, nationalised banks have had a far more mixed record of contributing to economic development. In fact, they have been more of a burden on the economy than a boon.

Long-term infrastructure financing by commercial banks who did not raise money for the long-term have resulted in asset-liability and cash-flow mismatch. In the liberalised financial and banking environment, India had shuttered its development of finance institutions. It was a case of misapplication or thoughtless application of Western model of financial and banking sector, ill-suited to India’s development context.

Ownership need not be a hurdle for efficiency and profitability but it ends up being one. The government needs to be a far-sighted owner. In other words, the priorities of politicians elected to govern should be distinguished from the priorities of governance. It is easier said than done.

The only way to ensure that is to deliberately empower the regulator in such a way that the regulatory playing field between privately-owned and government-owned banks is levelled. That is, India’s banking regulator, the Reserve Bank of India (RBI), must have full regulatory authority over all banks, regardless of ownership.

The government, as an owner, can be in banks’ boards of directors but the regulator need not be. Further, the regulator should have the right to approve and to direct removal of key personnel of government-owned banks as it has over majority non-government owned banks.

There may be a case for reviving development finance institutions with long-term financing options backed, perhaps, by government guarantees such that they could fund infrastructure projects with long gestation periods and uncertain cashflows.

Such government guarantees must be explicitly recognised in the budget calculations such that the fiscal obligations of the government are fairly and accurately represented while, at the same time, it imparts a higher degree of accountability both on such long-term lenders and borrowers.

Further, as mentioned earlier, India has failed more often than succeeded in distinguishing between political and governance priorities. A case in point is the waiver of agricultural loans, which has become an accepted political promise, notwithstanding its disastrous consequences for the lenders coupled with dubious or even non-existent benefits for the borrowers.

The frequency with which agricultural loan waivers are deemed necessary is an indication that the problems run deeper. Fragmented land holdings render farming unviable to begin with. Irrigation does not extend to all farm land and, as the chief of NABARD argued recently in an op-ed, the extension of agricultural credit is skewed and unbalanced. More importantly, the government of India itself has conceded that farms less than 4 hectares are very unlikely to be viable. The solutions to the perennial problems of the farm sector are not easy to find. However, three things come to mind.

Priorities For The Farm Sector

Farmers need to be freed to sell their produce wherever, to whomsoever and at whatever price the market is willing to pay. Frequent imports to clamp down prices of farm produce (think onions and tomatoes) is anti-farmer. Urban consumers should be allowed to rein in consumption of products that are dearer or switch to other vegetables. Indeed, concerns over inflation in urban consumption goods and inflation targeting in a developing country smack of urban bias in policymaking.

Empowering farmers means alienating powerful middlemen. The new government needs to be prepared to expend political capital on that. Therefore, the earlier in the term it is pursued, the better are the chances of success.

Farmers need a working, effective and timely crop insurance. The BJP-led government had initiated a sensible crop insurance policy. But, the implementation has been in the hands of state governments, some of whom had not paid the premiums on time rendering the initiative futile.

The third intervention will allow for easier and even automatic land-use conversion. Digitisation of farm ownership and easier land-use conversion policies are substantial deterrent to corruption and bribes at lower levels of bureaucracy. This initiative too rests with state governments and the next Union government must encourage friendly and like-minded states to pursue this initiative and consider rewarding states that do so.

Access To Working Capital For Small Businesses

More important, perhaps, than addressing regional imbalances in the extension of agricultural credit is the issue of access to working capital by micro, small and medium enterprises (MSMEs). The BJP-led government has pursued this unheralded but important reform by giving teeth to the recently formed Receivables Exchange of India.

In 2017, the government mandated all central public sector enterprises to participate in the Receivables Exchange of India, which enables MSMEs to factor their claims on big buyers of their goods in the exchange and receive payment from banks. Banks, in turn, will collect the monies due from big companies on the due date.