Arvind Panagariya Arvind Panagariya

Two of India's great prime ministers, P.V. Narasimha Rao and Atal Bihari Vajpayee, spent better parts of their tenures replacing the Indira Gandhi-era socialist edifices with growthfriendly structures. Unfortunately, Vajpayee lost the 2004 elections to UPA with the task of placing India on the path to sustained rapid growth left incomplete. Led by Congress President Sonia Gandhi, who derived her inspiration from mother-in-law Indira Gandhi rather than husband Rajiv Gandhi, UPA switched course.

With rare exceptions, pro-market reforms came to a halt and the nation saw new socialist edifices resurface, this time around in the social sectors. Prime Minister Narendra Modi now has the unenviable task of cleaning up the mess left by UPA as well as completing the unfinished reform agenda of Vajpayee. Going by the early indications, if anyone is up to the task, it is Team Modi.

The immediate cleaning-up agenda includes ending paralysis in the executive, a task largely accomplished; restoring financial health of the Government, which would entail cutting many subsidies, hiking user charges and accelerating disinvestment; bringing stability to the banking system; streamlining incentives for both domestic and foreign investors; amending the pernicious land acquisition act of 2013; and raising coal supply to allow full capacity utilisation by power plants.

Longer-term reform agenda to accelerate and sustain high growth must include changes to myriad labour laws, further trade and foreign investment liberalisation, urban development, privatisation, addressing infrastructure bottlenecks including a return to the reforms in power sector; and overhaul of the higher education system.

Graphics by Saurabh Singh Graphics by Saurabh Singh

Finally, the Government will need to reform social expenditure schemes such as those introduced under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) of 2005, the Food Security Act of 2013 and the Right to Education Act of 2009. Being forward-looking, this article focuses on the failures of UPA that added to the woes of the new Government. But some of its key accomplishments may be noted upfront. With rare exceptions, the UPA government did not reverse the reforms introduced by its predecessors, which helped the country grow at near 8 per cent annual rate for an entire decade.

It carried forward trade liberalisation, lowering the top non-agricultural tariff rate to 10 per cent in April 2007 from 20 per cent in January 2004. It opened multibrand retail to foreign direct investment (FDI) and raised FDI caps in several sectors including single-brand retail and telecommunications. It deregulated the petroleum price and made progress in cutting the subsidy on diesel. It substantially advanced financial sector liberalisation, enacted the important pension reform and brought to life the Competition Commission. It also made impressive progress in domestic civil aviation including building world-class airports in many cities.

An important but neglected achievement of UPA has been massive construction of rural roads, which has helped raise rural incomes. Aadhaar, a programme to issue biometric identity cards to all Indians, can potentially be an important means to reduced costs in both public and private transactions requiring identification. Taking advantage of increased revenues made possible by higher growth, the UPA government gave a major boost to social sector spending. Its specific "rights" approach in areas of employment, education and food, however, suffered from serious flaws.

So what are the tasks ahead for Team Modi?

First and foremost, UPA left a largely dysfunctional and paralysed executive. The result was stuck projects worth tens of trillions of rupees that constitute the single most important cause of the drop in growth to sub-5 per cent level in the last two years.

There were three aspects of this paralysis: An environment ministry that invariably saw a conflict between growth and environment and overwhelming voted in favour of the latter, a bureaucracy terrified of taking any decisions lest it faces accusations of accepting bribes and consequent prosecution in future, and a Prime Minister's Office (PMO) unable to adjudicate across warring ministries.

Thankfully, in less than three weeks, the new Prime Minister has turned a dysfunctional executive into the most vibrant one that India has seen since the immediate post-Independence era.

Environment Minister Prakash Javadekar, who sees growth and environment as friends rather than foes, has emerged as a hero, cutting one Gordian knot after another, clearing a critical railway project that had languished for more than three decades. Reassured by the PM, the bureaucracy is enthusiastically racing ahead working almost as hard as him. And the PMO has taken direct charge of adjudication across ministries.

While an excellent beginning has thus been made, tough decisions lie ahead. The PM spoke about this in Panaji on June 14 and the first unpopular decision was taken soon after with the Government significantly hiking railway fares. A similar decision will be necessary on a larger scale to fix the finances that UPA has left in a shambles. The outgoing finance minister pegged the fiscal deficit at a low 4.1 per cent of GDP but did so by overestimating revenues and underestimating expenditures.

To revive growth, the Government needs to revive infrastructurebuilding and restore the health of public sector banks. Even allowing fiscal deficit to be at the more realistic level of 4.5 per cent of GDP, financing these expenditures would require far deeper cuts in subsidies and more aggressive disinvestment than provided in the interim budget.

Subsidies on diesel, cooking gas and kerosene, which largely go to the middle class, are good candidates for elimination. Fertiliser subsidy, overwhelmingly absorbed by large farmers, must also be subject to larger cuts than in the interim budget. On the revenue front, it must hold the line on taxation and not give in to the populist temptation of raising the exemption limit on income tax. Consideration must be given to bringing urban agricultural income, which is largely a vehicle for turning black money into white, into the tax net.

The recent directive by the Securities and Exchange Board of India to minimally divest 25 per cent of the market capitalisation of all listed public sector units (PSUs) is helpful but it gives the Government three years to achieve the target. The situation demands frontloading of this divestment. The Government's target should be no less than Rs 100,000 crore in disinvestment proceeds as opposed to Rs 57,000 crore provided in the interim budget and just Rs 26,000 crore actually raised in 2013-14.

Restore the health of public sector banks

The new Government has also inherited a relatively weak banking system. Going by the official Reserve Bank of India estimates, which are perhaps underestimates, restructured plus non-performing loans summed to Rs 5.4 trillion or 9 per cent of the total outstanding loans as of March 31, 2013. Such large volume of troubled loans has serious adverse effect on credit flows and, indeed, soundness of the entire financial system. An important part of the solution to this problem is to address the root cause of the proliferation of restructured loans. In many cases, inordinate delays in environmental clearances and land acquisition and government created shortages of inputs such as coal and gas have led to large losses in the affected projects. In turn, the losses have undermined the ability of the companies sponsoring the projects to meet payments to lenders, forcing restructuring of loans. While environmental clearances have picked up, land acquisition and input supplies require reforms.

In addition, the Government will need to directly address the nonperforming and restructured loans. The key instrument here is recapitalisation of banks, which requires fiscal resources. Unfortunately, the amount allocated for this purpose in the interim budget, Rs 11,200 crore, is inadequate.

It is not clear if the Government can significantly expand this amount in view of the overall fiscal constraints. Therefore, it must resort to two other complementary instruments. It must allow public sector banks to raise equity from the market by letting the government share drop below the current statutory minimum of 51 per cent. This will require legislation but time is opportune for it.

Additionally, the Government must take the bold step of closing down some of the weakest banks and merging yet other weak banks with the healthier ones.

UPA has also bequeathed to the present Government a land-acquisition legislation that, if not amended wholesale, can derail almost all major projects announced by the President in his policy statement such as the new cities, bullet trains, highways, rural roads and industrial corridors.

Because the act also applies to all private acquisitions larger than 50 acres in urban and 100 acres in rural areas, it has the potential to stop industrialisation dead in the tracks. Lacking sufficient checks, the original, colonial-era land acquisition act had allowed state and Central governments to effectively grab privately held lands in return for a pittance. But in its zeal to correct the injustice, the UPA government went to the other extreme.

According to available calculations, land acquisition in India is now an order of magnitude more expensive than in any other country in the world, including those in North America and Europe.

Therefore, the recent announcement by the rural development minister that he plans to amend the act is a welcome move. But he must remember that minor tweaking of the act will not suffice. The legislation needs major surgery, even complete replacing of it by a new law. The revised law must focus on the compensation to be provided, leaving other matters to the states as per local conditions.



Streamline incentives for investors

Incentives for investors, both domestic and foreign, need streamlining. Tax laws in India lack predictability, with much discretion left to the tax officer in the field. The result has been what the PM called "tax terrorism" during the election campaign. There has been a proliferation of tax disputes involving both domestic and foreign companies. The Government needs to settle the cases quickly and get out of the habit of pursuing every case till the last recourse has been exhausted. Litigation is socially costly and net social return may be negative even when the Government wins a case. The Government also needs to work towards proper codification of tax laws minimising discretion. Retrospective taxation should be dropped, bringing a clean end to this sordid legacy of UPA. Finally, the Government must commit to completing the Goods and Services Tax reform within two years.

Coal shortages have led to very low capacity utilisation in power plants in India. Coal supplies, over which the government has complete monopoly in India, were grossly mismanaged under the outgoing government with major corruption scandals breaking out. This needs to change. Immediately, there are both issues of increasing supplies and efficiently allocating the existing supplies across users. There are three avenues to raising supplies. First, entry needs to be given to private mining companies that would bring the latest clean coal mining technologies with them. Second, imports may be allowed liberally.

Finally, remote mines in the states of Jharkhand, Chhattisgarh and Odisha need to be linked via railway lines to the existing freight networks. As regards allocation, the coal ministry has recently initiated a number of steps to better match users and supply points but this is a work in progress.



Amend existing laws

The UPA government has left two major reform documents for the Modi Government: The Direct Taxes Code (DTC) and the Financial Sector Legislative Reforms Commission (FSLRC) report. The former proposes to supplant all existing income and wealth tax laws and the latter all financial sector laws.

The Government must carefully study the implications of implementing these laws before reaching a decision. No matter how well-intentioned and well-drafted, comprehensive legislative change can lead to huge disruption and longdrawn transition with pain inflicted on all involved including taxpayers, tax collectors, regulators, regulated entities, Central, state and local governments, and even lawyers and judges. Such comprehensive legislative changes should be the last, not first, resort. If possible, it is far less disruptive to deal with pressure points through amendments. Repairing a house while living in it is painful, remodelling it is very painful and replacing it altogether by a new structure is pain best avoided.

Shutdown Planning Commission

At the India Today Conclave in March 2014, I had said that India is now a market economy and there was now no place for planning in it. The distinction between plan and non-plan expenditures is also artificial. My recommendation was that we end this distinction and also close down the Planning Commission. The Government has already done the former and shifted what used to be "plan expenditures" to the ministries concerned. The Planning Commission is no longer a conduit for any of the central transfers to the states. This effectively ends the need for the commission and the Government should give it a final burial.

Give states greater fiscal space

The forthcoming Budget must announce the Central government's intention to give greater fiscal and legislative space to the states. There are far too many-66 at the last count-centrally sponsored schemes (CSS) in existence.

These schemes often have rigid structures that are uniform across states. But the states' needs and ability to implement them vary. While Bihar may have urgent need for the expansion of electricity, Haryana may need to focus on developing water resources. The Central government should adopt the policy of grouping the myriad schemes into a handful of broad categories such as education, health and infrastructure and allow states to shift expenditures across schemes within the broad category.

Over time, the role of CSS should be reduced with the funds given as block grants to the states to be used according to local priorities. The Central government must also give the states greater legislative space on subjects such as land and labour included in the Concurrent List of the Constitution. Central laws normally take precedence over state laws on subjects on the Concurrent List. But the Constitution empowers the Central government to grant permission to the states to amend the central laws as per local needs and conditions. In the past, such permissions have been rarely given. This must change with states allowed to have different laws in areas such as land and labour. This will lead to greater experimentation and healthy competition across states. Given the highly rigid nature of the current central land and labour laws, some minimum reform of these laws is necessary for all states and is best done through central amendments. But states can then be allowed to take the reform further as per their needs.

Accelerate and sustain growth

Once it is past the immediate tasks, the Government needs to pick up the threads of longer-term reforms where the Vajpayee government had left it.

Reform labour laws

Laws, rules and regulations relating to industrial disputes, layoffs, contract work, trade unions, strikes, provident fund, employee insurance, apprenticeship and inspection of factories need to be amended or revised to facilitate healthy growth of manufacturing in general and labour-intensive sectors such as apparel, footwear and assembly activities in particular.

Liberalise trade and foreign investment

Also important to manufacturing growth is trade and foreign investment liberalisation. India's own experience here stands out. After this liberalisation began in earnest in 1991, exports as a proportion of GDP have expanded more than threefold. Foreign investment has risen from a paltry $100 million to tens of billions of dollars.

Unfortunately, trade liberalisation came to a halt after 2007-08 and must be revived. Likewise, the caps on foreign investment must be lifted. The reciprocity argument recently made by Indian industry against 100 per cent foreign investment in defence is disingenuous: Are we willing to accept with the United States and Europe reciprocity in setting tariffs in auto industry, textiles and clothing and above all, agriculture? We must adopt the policy that best serves the national interest rather than indulge misleading arguments by a self-interested industry.

Promote urban development

Manufacturing revolution goes hand-in-hand with urbanisation. This means not just building new cities, which have received the bulk of the attention recently, but even more importantly, improving living in the existing cities. Lowrent housing and rapid transit system are essential to arresting the growth of slums. These need to be complemented by the provision of reliable electricity, water, sanitation and waste management.

The Central government has limited jurisdiction in this area but it can play the role of a catalyst and motivator.

Privatise PSUs

Yet another step towards a manufacturing revolution is privatisation of PSUs engaged in this activity. Research by economist Nandini Gupta for the Columbia Program on Indian Economic Policies shows that according to all relevant indicators, the performance of PSUs privatised by the first NDA government has been markedly superior to that of units that the then-government had selected for privatisation but did not actually privatise. While the Government raises revenues through sales of manufacturing enterprises, it would also promote economic efficiency and help expand manufacturing faster. Turning to other PSUs, Coal India Limited must be broken up into three or four independent PSUs that would compete against each other. The break-up can also eliminate the management diseconomies currently afflicting the gigantic company. The eventual goal should be to privatise one or more of these smaller companies. Related, the railways should be broken up into four or five independent corporations as well with each corporation allowed to run passenger and freight trains on the tracks owned by the others.



Reform power distribution companies

In the electricity sector, transmission lines need to be modernised and expanded. Distribution companies, which are the key link between sellers (generation companies) and buyers (industry, households and farmers) of electricity, need to be financially strengthened.

If they are bankrupt, generation companies have no buyers and the distribution company has no electricity to sell to consumers. Ensuring solvency of the distribution companies requires ensuring that state governments insisting on giving electricity subsidies foot the bill out of the state budget.

Governance improvements within the distribution companies require them to be run by independent professionals who are in turn held responsible for their health. Promotion of public-private partnerships and outright privatisation in distribution offer further avenues to improved governance. End to the cross-subsidy from industry to households and farmers, a reform in progress under the first NDA government but abandoned by UPA, would eliminate an important distortion working against the industry.



Build highways

The Government must also return to accelerated highway construction. From 4,760 km per year during 1997-2002, the pace of construction dropped to 1,790 km during the decade of 2002-2012. A revival has been underway during the last two years. This momentum must be maintained and accelerated.





Finally, India faces a major challenge along both quality and quantity dimensions in higher education. For a country that began building westernstyle universities in 1857, India has the relatively low gross enrolment ratio (GER) of 18-19 per cent in higher education.

Quality-wise, none of the Indian universities gets listed on any rankings of top 100 universities worldwide. China, which had entirely decimated its higher education system during the Cultural Revolution in the 1960s, is now well ahead of India in terms of GER as well as university rankings. Higher education is perhaps the only sector in India that has seen no reform whatsoever.

The monopoly and stranglehold of the University Grants Commission (UGC) and its various councils remain intact. The Government needs to free up the institutions to design their curriculums, award their degrees, charge the tuition fees, and pay salaries necessary to attract good teachers. There should be no need for legislation or the approval of UGC to create a new university. The Government should define a set of norms under which universities can be launched.

UGC and its councils should be replaced by a light regulation. After all, management institutions have flourished without the UGC oversight.





The focus of the UPA government during the last decade has been on the expansion and initiation of social programmes. Unfortunately, the rights approach it adopted placed the government rather than the people at the centre of these programmes. The programmes effectively give the government the rights to provide employment, education and subsidised food while the citizen remains at its mercy. Despite very few rural households getting their full 100 days worth of promised employment, the consumer receiving subsidised food only at the pleasure of the owner of public distribution shops and many children still remaining out of school while true education in government schools remains a pipe dream, not a single government official has been prosecuted in the court of law. So what do these rights really mean?

Right to employment and food

If the resources devoted to these programmes are to effectively serve the interests of the citizens, these programmes and associated laws must be reoriented. The employment guarantee and subsidised food must be replaced by a choice to the bottom 50 per cent of the households between these programmes on the one hand and Rs 10,000 per year in transfers on the other.

This will truly empower the households. Those who opt for the cash transfer will get to decide how they want to spend money and it will also leave them free to sell their labour for additional wage income in the marketplace.

A time limit of, say, 10 years should also be introduced on the benefits. In a growing economy, households must be incentivised to lift themselves out of poverty after receiving benefits for a specified number of years.

Right to Education

As for elementary education, successive governments have failed to discipline the recalcitrant teachers who overwhelmingly remain absent from classrooms with high frequency and shirk their teaching duties even when in the classroom.

With the Right to Education Act of 2009 now guaranteeing children automatic promotions and no board examinations permitted at any stage, the pressure on them to perform duties has declined yet further. It is unfair to the children to keep insisting that we can fix the system through this or that reform when no one is willing to bite the bullet and allow the firing of teachers who fail to perform their duties. The only solution fair to the children is to give them vouchers of the amount spent on them in government schools and let their parents send them to the school of their choice.

Once government schools realise that they no longer have the children from poor families as their captive clients, they will feel the heat to shape up.

Deliver health

As growth is restored and rising revenues begin to flow back into the coffers, the Government will need to begin making serious commitments to the health sector. First, past governments have neglected public health services, concentrating on the provision of medical services instead. But today, the returns are the highest to beefing up public health services such as sanitation, solid waste management and vaccination.

Neighbourhoods are often filled with swamps, drains are clogged, toilet facilities are lacking and the sense of personal hygiene is missing. The Government can play a crucial role in alleviating these problems.

Second, human resources consisting of doctors, nurses, health workers, pharmacists, lab technicians and midwives are sorely lacking. The Human Resource Development Ministry badly needs to reform the medical education system, delegating full power to the states to begin and expand institutions in their area rather than be held to ransom by the hugely corrupt Medical Council of India and related central bodies.

Third and last, as in elementary education, the government has done rather poorly in the provision of medical services. Despite 50 years worth of effort to create sub-centres, primary health centres, community health centres, dispensaries and hospitals, private providers are responsible for 80 per cent of outpatient and 55 per cent of inpatient healthcare in both rural and urban areas.

The government needs to recognise its failure rather than keep insisting that it can do better. It should equip people with financial resources to choose their own providers for outpatient care and insurance for inpatient care. Public medical providers and institutions should then compete with their private counterparts on an equal footing.



Don't scrap Aadhaar

A final thought concerns the Aadhaar. This is perhaps the single most important and beneficial programme that UPA 2 had initiated. The new Government is well within its rights to tweak, repackage and rename it. But abandoning it in favour of a whole new programme will be a crime. With half of the population already covered, let us complete the programme so that the variety of government and private programmes can benefit from it. The citizenship concerns are legitimate but there has to be a way to address them without throwing away four years worth of progress and a substantial volume of financial resources into the ocean.

Courage under fire

It has taken India 30 years to send a Prime Minister to New Delhi with an absolute majority for his party in the Lower House and for his alliance in the two Houses combined. Whereas the opportunity 30 years ago arose on the back of a sympathy wave, the present one is a vote of confidence by people in a single man: Narendra Modi. Despite good intentions to launch India into the twenty-first century, an inexperienced Rajiv Gandhi squandered the opportunity. India can ill-afford to let that history repeat itself. The Prime Minister will need all the courage at his disposal to deliver the bold reforms necessary to fulfil his campaign promises and, indeed, the nation's destiny.

With the savings rate at 30 per cent of GDP, a young population predicted to get younger still in the years to come and a highly motivated entrepreneurial class, the only missing ingredients in a high-growth recipe in India are good governance, robust infrastructure and a set of market-friendly policies. The Chinese experience shows that with the Prime Minister adding these ingredients to the package in the forthcoming years, India can count on growing at 10 per cent per year or higher for the next two decades. Such growth would, in turn, raise India's GDP from $1.8 trillion in 2012-13 to more than $8 trillion and percapita income to more than $5,000 by 2030.

That, in turn, would make abject poverty history and India a genuine player in the global economy.