India's 13th Parliamentary Elections: A Vote of Confidence?

Panel II: Economics

November 2, 1999

Panel I: Politics
Panel III: International Relations

Economics Panel Participants

Joydeep Mukherji
Associate Director, Standard & Poor's
Deepak Parekh
Chairman, Housing Development Finance Corporation, Ltd.
W. Bowman Cutter
Managing Partner, E.M. Warburg Pincus & Co., LLP.
Narayanan Vaghul
Chairman, ICICI

Phil Oldenburg: We're going to segue into the economics panel. Joydeep Mukherji is going to bring his team on board. I'm told that the...(CUT OFF)

Joydeep Mukherji: ...put a framework for the comments of the other three gentleman, Mr. Cutter, Mr. Parekh and Mr. Vaghul is to just outline some of the general economic developments in the last decade and set the framework for the next decade. My name is Joydeep Mukherji and I work for Standard & Poor's for the bond rating of the government of India. So my presentation will be somewhat biased from what I do for a living. But hopefully it will have some general interest and allow the others to make more specific comments.

If you look back at some of the trends of the last decade, they might give you a context for the next decade in India. And let me just list a bunch of factors, I won't go into any detail in those. But the most obvious fact in the last decade is that India nearly went bankrupt in 1991. And it came out of that threat, and went to the IMF, it repaid the IMF, it had a successful IMF program. India grew at over 6% over the last ten, or nine years. Which is remarkable for any country in the world and certainly remarkable by India's own standards. Industry grew at over 7%, exports grew at over 10%. The stock market boomed, if you look at the entire period from 1991 until now. Inflation has gone down from around 14% at the beginning of the decade to around 5% nowadays. Foreign exchange reserves today are over 30 billion dollars from practically zero in 1991, 92 when the crisis happened. The industrial licensing regime, which some of you are very familiar with, the license permit raj is largely gone. The number of days lost in strikes, labor disputes, lock-outs has fallen in half in the last five years. Industrial relations are better. There's a new sector which wasn't around ten years ago called software which in this year is gonna be exporting about four billion dollars and is growing about 50% per year.

The issue of corporate governance which was raised earlier this morning has now become an issue in India and we have seen Indian companies which have adopted U.S. accounting standards which have come to the NASDAQ or The New York Stock Exchange, like Mr. Vaghul's ICICI, and have adopted the disclosure standards which are the norm for U.S. and international companies. At the same time, we've seen very encouraging changes on the policy front. We know about Enron, despite all the disputes, Enron is now producing power. There's a privatization in part of the power industry. There are over twelve ports being built in India now through built operate transfer projects with private sector money. There's an airport in Kerala, Cochin International Airport which is being built through the cooperation and participation of ten thousand non-resident Indians and the state government, not by the central government of India's novel concept of developing infrastructure. We've had two budgets as was alluded to earlier, we have two budgets in the last two years which were passed after the government had fallen and political parties reassembled, passed the budgets and went back to politics, indicating the degree of insularity between economic and political policy.

And finally at the state level I'll just briefly mention the one person that you're probably most familiar with, Chandra Babu Naidu undertaking reforms in Andhra Pradesh which again wouldn't have been imaginable ten years ago. So you look at all these factors, you think the 1990s must have been a glorious decade for India. The country has turned the corner and was going to take off, it was going to be the emerging market of the future and it was actually going to achieve its potential. You would say that there's a very strong consensus in favor of economic reforms. Well there's the other side of the story that I think you're all familiar with and I'll just touch on a few of those things. During this period of record economic growth and prosperity, the public sector in India has gotten even weaker, we know about budget deficits and government debt. Just to give you a couple of numbers and I won't bore you with the numbers that I work with, the deficit of the central government and the state governments combined this year will be around 9% of GDP, which is one of the highest in the world. About 50% of all the money that the government of India receives goes out the door just to pay interest on the debt that it has accumulated over the last fifty years. So you can see the degree of flexibility in the public sector is very low and it's getting worse. And I think it's fair to say there has been a political unwillingness to tackle some of the fundamental problems in public finances in India, dealing mainly with the public sector and also with regulated entities. The biggest failure probably has been privatization. India's one of the few countries in the world to enter the 21st century without having privatized one single company, having transferred ownership and control of one single company from the public sector to the private sector. There had been minority share of sales, but never below 51%. And finally another factor I would stress is during the 1990s, there has been a great shift in labor-intensive manufacturing in Asia from the richer countries, relatively richer countries, like Taiwan, Korea, Hong Kong, to the relatively poor countries and the main beneficiary of that shift has been China and we know the statistics now about China's incredible export growth, foreign exchange reserves and the dynamism of China's coastal provinces. Well that phenomenon bypassed India for the most part, partly because India wasn't ready for it and partly because India had doubts about its appropriateness of playing with that strategy. So the result of that, if you were to just look at the negative factors, is to depress yourself and say that nothing has changed. And I think a balanced view would say the country has improved, but the public finances haven't, which means it retains some vulnerabilities, but also has as lot of strengths which are becoming clearer and clearer. And some of the other panelists here can perhaps discuss elements of the strengths and weaknesses.

So do we conclude that India has a strong consensus in favor of reforms? I would qualify that, I would say India has had a strong consensus in favor of weak reforms. And now as we enter the next decade, the question really is, will the consensus really change, will it change in favor of strong reforms and there are grounds for optimism in that regard. Let me just point out a few of the factors which we ought to look for to see whether this consensus is going to change. I think the central challenge is political, as was discussed in the first panel this morning. While all these economic factors are going on in the 1990's, the real story in India was on the social side, the social transformation of the churning that was going on and the political agenda really was looking at that. We on the outside are perhaps looking at our narrower vision of the economic situation or investments or software or what-have-you, but the country was not obsessed with these issues. So how do we know or how can we spot if there is a stronger consensus? I think I would look for privatization to see if privatization truly takes off and that means going below 51%. When you have a public sector company which finally loses its last IAS officer on its board of directors, I think you can take that as a good sign. I would look for what I would call invisible barriers to trade in investment. Many of you in this room have done business with India and you know the visible barriers have been coming down but the invisible barriers remain and sometimes are the biggest obstacle to getting something done. I would look for external liberalization, trade liberalization. I would look for banking sector reforms and we have some experts here who can speak on that. The facts are all known in the banking sector, what has to be done has been well-documented by many experts in the banking sector. The question is, will they be implemented? And I think I would look finally at the ability of the country politically to manage this economic transformation while maintaining the social harmony and that's an extraordinarily difficult task and I don't envy Indian politicians who have to do that, but given the negative factors I highlighted in the middle part of my presentation, it's a challenge that they have to face. So I would say that I'm cautiously optimistic that Indian's strong consensus in favor of weak reforms may move to a stronger consensus in favor of somewhat stronger reforms. But let me stop there and pass on the discussion to other panelists who have more direct experience with some of the factors that I just outlined. So the first person will be Mr. Bowman Cutter.

Bowman Cutter: My name's Bo Cutter and the process of both preceding the two gentlemen who are going to follow me and following the panel that we started with is a daunting one. I could have, I found as I always do when I hear particularly Jairam speak that I'd much prefer to listen to him talk about politics then talk about economics or business, so and it always seems as if we wind up talking in, when we talk about these topics, about fairly prosaic things, but let me proceed. You know the, both the involvements and the accomplishments of the two speakers that will follow me. Let me say just one point to establish bona fides. I'm a partner in the firm of Warburg Pincus, which is a private equity and venture capital firm. We have substantial investments in India in several sectors, both traditional sectors and high technology. We virtually entirely invest with entrepreneurs in our businesses, the businesses in which we invest are largely domestic-oriented businesses, we typically do not invest for export. India has been a major focus of our investment activities and I suspect, although there aren't any decent statistics, that we're the largest of the private equity or venture capital firms in India.

Our focus on India occurred for all of the traditional reasons. There is a business, an entrepreneurial tradition in India, there's a growing middle class, there's a vast English speaking population, it's a democratic society and therefore one that we're instinctively familiar with and they're real laws. And our experience while frustrating at times has all and all been good. We've had access to government when we've needed it. We've been treated by both the public sector for the courts and in terms of corporate governance with the entrepreneurs with whom we've invested. I ought to say in indirect response to a question that one, someone asked right toward the end of the last session, having been involved to some degree in the public sector and in regulation in the United States, the process of back and forth that's occurred in Indian regulation in the courts is not different in kind then that that has occurred in the deregulation process in the United States over the last twenty years in several major industries.

Let me start my presentation by underlying that I think that you have to see the selection and the changes that follow it as part of a continuum. One could not do business, certainly not our kind of business, in India in the 80's. Much of the underlying infrastructure didn't exist, some of the activities were actually illegal. And the changes, as the first speaker underlined since 1990 have been substantial. And it seems clear to me as Jairam said that after four Prime Ministers and two years, all who have committed to on-going liberalization that the changes are not going to be reversed. I like to, the last speaker of the first panels' distinction between stock variables and flow variables that even if it is as Joydeep said a qualified consensus for weak reform, it's a stock variable at this point and not a flow variable, at least in terms of how we thought.

But I think that the BJP's opportunity, having won the election in the way it has is to seize the moment and do much more than simply not reverse the progress of the last ten years. And in Jairam's terms, its opportunity is to be the party explicitly in favor of economic progress and development. India's growth this year, just to reiterate, will be again in the neighborhood of 6% with inflation in the neighborhood of 4 to 5%. It's opportunity is to establish this level as a base and move to a higher level, say a range of 7 to 9% for a substantial period. To do for a major country what Chile did throughout the '80's, for example. And such a change would make an enormous difference. It would be a doubling of living standards every eight to ten years. But what does it take to achieve this? Let me make a few comments on both the substance and the politics. India's core economic problem can be summed up with a statement and a question. India's greatest economic barrier is a profound shortage of capital. That's the statement. The question is how can the nation with one of the world's highest savings rates, twenty-five to seven percent, be capital short? And it arises, the conundrum arises from a set of interlocked problems. The remnants of the license raj, which drive Indian businessmen just as nuts as it drives foreign businessmen like myself, misallocate capital and lowers its productivity. The fiscal deficit of 8 to 10%, which is being spent not on productive and necessary public infrastructure, but on interest and subsidies and transfers, misallocated capital and lowers its productivity. The state owned sector, which is roughly 25% of GDP and for which the privatization process has not occurred and I say in parenthesis, that China's sector is about 40%, misallocates capital and lowers its productivity.

India's relative diffidence with respect to trade and investment policy misallocated capital and lowers its productivity. I could go on, but you get the theme. What these interlocked issues result in is a productivity of capital of roughly a third of that in the United States and you can think in terms of India's interlocked economic problems as a machine that takes one of the highest gross savings rates in the world and translates it into one of the lowest net effective savings rates in the world.

These aren't theoretical or conceptual problems. Every business and every investor bears them in mind with every investment and every business decision one makes. And it's that process that transfers this sort of overall, two overall and two macro views down to the facts on the ground that India, even with its quite extraordinary performance over the last decade in it suffers.

Now with a new government facing this problem, or this set of interlocking problems, one knows in advance that they're not going to be actually solved rapidly. Particularly in a democratic society. There is a loud fight with respect to every detail of every piece of these problems. But a new government can, I think, do the following and has an opportunity to set a course that has an opportunity that hasn't been there for some time. It can state an overall direction. It can publicly diagnose the problem. It can put an overall outline forward for systematic, for a systematic and consistent program of change and it can then make concrete progress across that even if in small steps and to small degrees. My own sense is that results flow fairly rapidly from the staking out of such a course because India has the great advantage of having increasingly working capital markets, markets anticipate events and businesses and investors then follow markets. India has the opportunity, as I'll conclude of making occur a virtual circle. So let me conclude just with three points. The first is you have to see the opportunities and the problems that India faces in the context of substantial change and improvement in the function of the economy over the last ten years. Anyone that tried to do business in the eighties and then slept for ten years and reawoke in the India of today would find the changes to be almost miraculous. Second, the real opportunity is not a few specific changes. We could all name a few we would like. I could name telecommunications reform and a complete revamping or blowing up of the foreign investment board process. Frank Wisner, who's not in the room today right at the moment could name insurance deregulation, all of us here could name a few of our favorites. But they're not really the point. The real opportunity for the government of India and for the BJP with it's electoral security is to take the strands of change that have occurred over the last decade, gather them together and provide a fundamental and broad roadmap for the country and the economy. And as I suggested a minute ago, there's a very real possibility that if a government were to do this and to lay out such a roadmap, that a virtual circle could be created in which the process of economic change itself could establish a different kind of momentum than it has over the last decade.

Narayanan Vaghul: Let me in the ten minutes allotted to me try and sum up with the present government, the new government that is in power is going to take the relevant steps and the hard decisions.

The new government is in power, is in place for the last few weeks and just at a time when the country is entering into the new millennium with tremendously greater expectations for the people of the country. If you talk to the people during election time, it is expected which candidate wins, I think the points they want is they want a better standard of living for themselves. And six points are very common, whether it's north or south or east or west. Housing, energy, that's power, water. These are health, education. These are the common things wanted by the people of India for a better standard of living. And each political party, each politician talks about improving the standards of living.

In the last two years, however, the economy slowed down and we had problems in the economy. In spite of that, we grew at about six, around five and a half to six percent, even this rate of growth was nonetheless reasonable compared to what happened during the last two years in the Asian sub-continent. In the Asian continent. And the deformed endeavor of the government of India during the last two years when the economy was really under crisis, the growth rates had come down significantly, but Indian economy, Indian industry really showed their resilience, that it was there in the system.

This 6.5%, 5.5% growth in the last two years was against price stability. We had inflation again, Bo mentioned inflation of about 4%, now this comes, I come to the other issue that India perhaps has the highest real rate of interest. And I'm no economist, but Joydeep will confirm that the broad parameters are that if the real rate of interest is more than the GDP growth of a country, there is something chronically, basically wrong in the economy. And we've had consistent years where the real interest rates are 10% and the growth is much below that. And so the real issue is how do we bring our real interest rates down? Real interest rates are extremely high, we are paying for it due to the weak financial system, we are paying for it due to the weak banking system, we are paying for it because the banking system was nationalized and the banks were asked to, were obliged to go into the rural areas, the banks were obliged to lend money to non-viable projects, banks were without proper legal foreclosure laws and without adequate legal protection.

External front, doing exceptionally well, reasonably well I would say... (INAUDIBLE) deficit for the last five, seven years, 1 to 1.5% of GDP, very normal, very acceptable level, again, this is really spurred by the non-resident Indian remittances into the country, capital flows in 1999 have been strong, reserves are about 30 billion, seven months exports, seven months imports, again proving that management has been our strength. India's strength has been proven: debt management out of the total external debt, short term debt is an extremely small portion of the total debt, the other is congressional debt, also accounts for about 40% of India's debt and debt service capacity is also coming down significantly, so on the external side, I don't see major problems.

How do we move ahead now? The key factor is growth, we must have faster growth, we must have growth, much faster growth. We cannot grow at 5 and 6%, we have to accelerate it, 8%, sustained growth of 8, 9% in the next decade is the only way India can come up. But to get to an 8% growth, you need double digit growth in the industrial sector. You need double digit growth on an annual basis in the industrial sector, which has really slowed down in the last two years. So the government has to do something to improve the industrial sector.

Why is this? Because the agricultural sector cannot be depended on on an annual basis. It's still predominantly dependent on monsoons, on performance of monsoons, so the growth of agriculture production cannot be estimated to be every year growing at a fast level. The service sector is growing, the composition of the GDP, the service sector is growing the fastest, but the service sector to grow fast again needs a buoyant manufacturing sector.

What is the biggest problem? According to me, the biggest issue is fiscal deficit. Fiscal deficit if you divide it into three ways, the central, the state, and the public sector, it's according to me, around 10%. Again, Bo mentioned 8 to 10, Jairam mentioned 8%, but I think around 10% fiscal deficit is too high. That is really the reason why the real interest rates are high.

What does this do? Private sector gets crowded out, bulk of the debt in the markets are government debt, state government debt, central government debt, public sector debt. Private sector is unable to capture the debt market, enter the debt market with large sums of money.

The government is talking about a fiscal responsibility act. And I think this is a positive step. In the two, three weeks that the new government has been in power, they've started talking about a fiscal responsibility act, which would give a definite timetable where the fiscal deficit will come down to acceptable levels, they're talking about two to three percent of GDP, one has to wait and see how they manage to achieve it. It also talks about a better range of debt to GDP ratio and it gives a time frame of three to four years. We have to see what the act is, how credible is it, is it going to be enforced, how is it going to be enforced?
Do you think fiscal deficit is going to be a difficult job? The two or three possibilities of controlling expenditure, raising revenue, are the two main ways, main methods by which you can reduce your fiscal deficit or contain your fiscal deficit. Again, we heard the earlier speakers say expenditure control is very difficult since out of the entire revenue receipts of the government, 50% is interest payments. Over and above that, you have the wage bill, which is high, you have the subsidies, very little is left for developmental purposes. Again this year we have the added pressure on defense expenditure, there will be pressure of the government within the government to increase the defense allocation due to the Kargil war. So reducing expenditure or containing expenditure is going to be a very, very difficult task, particularly because contractual obligations are already there. Your wage bill, your interest payment, your subsidies for food. So there is not much scope according to me to contain your expenditure, thereby reducing the deficit.

Let's look at the raising of revenues. Raising of revenues is possible two ways, better tax compliance. I think better tax compliance is what the government is talking about. Today as you are aware, only 1.2% of India's population pays income tax and we must improve, there must be tax simplification, there must be better compliance and that is one way where we can increase the revenue of the government.

You can also think about introducing value added tax at the central and state levels and rationalization of tax, which has started in the last three or four years. There has certainly been simplification of tax rates, there has been rationalization of taxation, bought, excise and customs.

Privatization, let me turn to privatization. Again, Joydeep mentioned, not a single company has been sold in the last six, seven years when you started talking about privatization. We are going about the privatization through the wrong way. The end of the year, the end of the financial year is coming closed, oh, we have to have a deficit of ten thousand clause, we have to meet this ten thousand clause by selling government assets, let's do something in a hurry. It is not planned, it is not properly implemented and it is a knee jerk reaction, it is done in the last two months of the year and it is disastrous. It has not worked in the last two years, again, it's been done in the last three months of the financial year and last year in fact it was done in the last month, twelve month, by cross holdings. One company, one public sector company bought shares of another public sector company and the government sold itself and from one pocket they got money to the other pocket. So I think this is the crux of reduction of fiscal deficit. We have to push privatization and I personally feel there is no other option this government has but to do privatization on a massive scale. The few statements that the finance minister has made in the last few weeks has been that he has no other option but to look at selling off assets and selling off assets in a large manner. I won't be surprised if even a company like Maruti where the government holds 50%, this year, in 1999, I mean in the year 2000, government will divest it's 50% holding in Maruti. It is one of the big petro chemical companies, it is on the block and it's trying to sell, but they still want to retain that 25% interest in it. But I think as time goes on, they will be forced to sell assets because there's no other way to reduce your fiscal deficit. You cannot keep on increasing revenue and there is no way you can reduce expenditure. Again, infrastructure sector, it's not policy, stable policies is what we need. We can talk about the power sector or the telecom sector, but we do not have proper, stable policy at the moment.

And unless, again, Bo mentioned our biggest problem is we are capital scarce company, we want foreign technology, we want foreign capital, we have large markets. But unless we have stable policies, unless we have stable government, unless we have the right policies, we will not attract foreign direct investment.
Capital inflows into the country, again, we talked briefly last night, the three and a half billion dollars that India gets by way of foreign direct investment, it's not too large, but it is much more than what we were getting a few years ago. Again, the foreign institutional investment and the investment like what Bo mentioned from private equity has increased significantly in the last couple of years, and I expect private equity to be the main force of foreign direct investment in the years to come.

One word about oil exploration. I think on oil exploration, India is totally dependent on crude, about 60% of oil investments are imported, and we need to put more stress on oil exploration and encourage foreign companies to come in a massive way with foreign capital. We don't have the technology and we don't have the capital for oil exploration. And with oil prices at $23, now at $22, it is really hurting the balance of payment.

Now all these initiatives, I'm sure are necessary and again, to sum up, we can talk about it later in the Q&A, but easy decisions have been taken by the government in the past, hard decisions have been shoved under the carpet. I think the crux of this government, the test of this government is to see whether they have the capability to take the hard decisions in order to bring down the fiscal deficit and increase the capital flows. Thank you.

Deepak Parekh: Thank you. In the interest in economy of time, let me start by making a few specific points. Number one, I'm going to take it as given that we have grown quite a lot in the past decade. I don't want to dispute that point at all. And I don't think that I need to show facts for proving this point that we have achieved quite impressively during this decade. Point number two, as both Jairam mentioned and Joydeep also said, that a political consensus is emerging across the broad spectrum of political framework in favor of three forms. Successive Prime Minster's trying to prove that they are better off than his predecessor. I think we need to give a word of caution in this political consensus. I used to call it a Mafa syndrome, in the Indian politics, mistaking articulation for achievement.

I think you can really look at the words that are spoken in saying that they represent their real intentions or real achievements of the people. When you come to the political consensus, there's quite a lot of people talking in terms of integration of the global economy, privatization, spreading of the reform. But at the same time, I believe that most of them are getting committed very strongly their philosophy of gradualism that was introduced by Narasimha Rao, who said that in India and in a democratic country, I think the reform process will have to be slow. These people are not appreciating the tremendous change that has been brought about during the last couple of years in the global environment in which time has started acquiring different meaning altogether. And then thanks to the communications revolution, today what used to be one year, it's now three months. And you don't have all the time in the world to bring about changes in the political framework, in the economic framework. Like it can take about three years to pass an insurance regulation and say that at the end of three years, we have allowed ourselves 26% foreign investment and all of us should pat ourselves on the back on this, a very impressive achievement. I don't think that is possible under the present circumstances. I think time is running out very fast for the Indian government. And still I don't think the realization has grown in the Indian government, that these dynamic changes in the environment impose a different set of obligations on us. I think the third point I would like to make is, I don't think the political system is not seized of the fact that there are going to be bottle necks to the reform, coming not from their intentions, not from their policies, not from their pronouncements, but I think they're going to come from the various interest groups that they're occupying, the vantage positions in the Indian economy.

Unless the political system wants to double up compensating mechanisms for dealing with these various interest groups, I don't think we will be able to go ahead with the reform. Ultimately there will be what do you call the limits in so far as the economy growth is concerned. These limits to economic growth are going to be imposed, not because there is a political unwillingness to do that but because there are natural obstacles to the whole process of reform, coming from the various interest groups. I even know what the interest groups are. For example, you can talk of a privatization program, unless you are able to deal with the interest group of the employees and the employee. You cannot talk about globalization of the Indian industry unless you are able to deal effectively with the interest group of the domestic industry and their fears and apprehensions on global integration. Third, you cannot deal with this whole process of economic reform unless a very vast amount of poor people are to be in a position to appreciate, are to be given compensation for the perceived benefits of the higher income group. I think that despite it is an income that gets developed, as a result of this economic reform process, we'll have to be effectively managed with the political system.

So the third point that I'm making and I'll answer it if any of you have got questions in respect of that, how exactly this compensating mechanism will have to be doubled up. I think that's the third point that will have to be revealed.

The fourth point that I think that in regard to the various, very correctly all the previous speakers are identified, the core issues that are going to dominate the next decade, the core issues have been very clear and listed out. Has one, unless we make forward movement in respect of, fiscal deficit, we are not going to go anywhere. I think fiscal defect is not going to disappear. Fiscal deficit is not going to go away. Fiscal deficit is not like something which can come down on it's own. I think it has to be brought down. Now the only way in which it has to be brought down in a country where, well we got into your debt trap. Where the more and more borrowings are going to create more and more interest burden and it will not be possible for us to handle this deficit in the normal fashion. Fiscal deficits cannot be brought about with the Finance Minister saying I want to bring them about, there has to be a positive action. And privatization has been very clearly identified as a means by which you can play down the fiscal deficit. But the problem is that we are not while we're talking in terms of this factor that lead to the macro economic stability and the factors that lead to the economical process. We are not going to the root of the issue.

The problem in India has been that privatization has always been seen as a process by which we can bring down a fiscal deficit whereby government can generate revenues. I think that mindset is ridiculous. Privatization is there for generating revenues by admitting the fiscal defect. But more importantly, privatization is for making India more competitive in the global economic environment. You cannot have a huge public sector which is inefficient. Why don't we talk about that? The problem in the country has been we talk in terms of Mr. Joydeep Mukherjee talked of bringing down to 51%. That is gone. Ten years back we would've talked about 50, below 51%. Today we have to talk in terms of the government getting out of the whole thing. I think government has other priorities. Unless the government is able to realize that there is other priorities to tackle and this is not going to be one of the priorities, we should not be talking in terms of 51%, or IS officer not being there. I can tell you it doesn't make a difference to the government whether they're' holding us 20% or 30%, IS officers, so long as they are dead, they will be there and there is not getting away from it. I think my organization is an example of that. I don't think that, I have two officers in the board and I have only about 20% of holding control with the government so that is not the point. The government has to get out of it lock, stock and barrel. That means that we have to redefine the whole goals of the privatization as (INAUDIBLE).

The second point is in respect of infrastructure. Infrastructure is not an issue of policy. Interest activity is not an issue of foreign investment. All those things can be taken care of it, in fact, it has been taken care of. Infrastructure the root issue is one of pricing. So long as when you're shifting from providing a social service to a commercial utility, you have to think in terms of shipping so far as your present policy is concerned. That creates it's own bottleneck. Unless you're able to resolve the pricing policy, it will not be possible for you to solve this infrastructure problem.

And third major problem that really comes up is none of this reform process will have sustainability unless we tackle the root cause of the whole thing, namely we create a fundamental foundation structure which can sustain an economic reform process. We are not devoting anything to the social sector, namely the process of primary education, a process of health, the process of hygiene. I think all these things are equally important in a different process. Unless the government is able to reorder its priorities, to things in the industry and moving to the social sector and thinking in terms of promoting education and health, I don't think it will be possible for us to sustain the economic reform process. So to my mind, I think the agenda for the next syndicate is very clear. The agenda for the next decade is we have to bring about clear political consensus, not the type of articulated political consensus, but the political consensus in which there is a basic commitment of all the political process, political parties for the type of reform that we will have to really go into consistent with the changes that have taken place in the global environment.

Secondly, we need to double up mechanisms for the purpose of dealing with the various interest groups that could provide a block. In fact when I was talking London, when I was saying the economic reforms in India are reversible, one economist, I think a really cynical economist said, so is a car stuck in the mud. I think that is also irreversible. Well I don't think that speaks well of the Indian economy. We need to deal with these various interest groups.

And the third is we need to develop powerful institutional mechanisms, whether it is in the financial sector or in the political legal system, or in respect of the judicial system which can cope with this whole economic changes that are taking place in the development.

And fourth, we need to deal with the fundamental problems of privatization, fiscal deficit and social sector, not in the periphery, but going into the root of the problem and trying to take care of the root of the problem. Unless we do all these things, it will not be possible for us to move forward. On this note, I will stop but then we'll be able to respond to the questions.

Joydeep Mukherji: Thank you Mr. Vaghul. Now we go to the question and answer section. As before, please raise your hand, identify as a courtesy to the speakers who you are and if it's directed to a specific speaker, please say so otherwise I'll just ask the panel who is to respond to that question.

Male Voice: …but despite all the policies you are inclined, I think the country has lagged behind in attracting foreign direct investment. Particularly compared to China, which is massive in flock and the second, since I'm standing, I'll also ask a question to Deepak, Deepak your speech today reminded me of your excellent chairman speech at the annual report of infrastructure leasing about four years ago, if I recall correctly. Probably you're the only one, (INAUDIBLE) who has come forward so strongly to the communication medium annual report to tell the government of India what has been done. I don't see that kind of consensus. You wanted the private sector business community to influence a drastic change on the part of the government of India to make things happen in the way Mr. Vaghul explained. Would you like to comment on that?

Deepak Parekh: In fact, you see that what we try to do, use the annual report as a medium to convey to the government not what has done, but what needs to be done. And I think number of institutions, particularly where there is no vested interest which Mr. Vaghul mentioned and where we have nothing to lose, we've been very frank and open of what needs to be done by the government, but I don't think anyone reads it also. That's the problem. And all the issues, particularly on opening up the Indian industry to competition, there is so much of vested interest within even privatization, there's vested interest, particularly, the Indian entrepreneurs do not want big multi-nationals to come and acquire Indian government company because that will bring more technology, that will bring more capital, it will hurt the Indian industry. So vested group which is there in every industry and every business decision and in every government decision on privatization, what Mr. Vaghul mentioned about Western India is really the key how to tackle it. You see in public sector, again, what one should say is that when you want firm to invest in your company, they look at ROE. And what is the return on equity and how are you going to enhance shareholder value? Today the bulk of public investments and public sector. And the public sector investments are earning negatively to the rate of return. You know that the return government is getting negative. And again the faster we get out of it the better. And it will improve the efficiency, but what about labor? Is the government willing to retrench the labor? No one has talked about it. So there are difficult decisions which have not yet been taken by the government and many, many of them which will have to be tackled by the present government. Because they're going to be in power for a reasonable period of time, three to five years at least and they cannot sort of wait for the fall in the government, which we've seen in the last two, three years.

Surika Adia: I know that industry in India in general is very unionized, highly unionized place and maybe Mr. Vaghul and Mr. Parekh can answer, what would effective union workers be on all this privatization, you've been talking about how we should privatize, but the unions generally have been against any change if you will and do you foresee that as a major negative impact on privatization, or...?

Narayanan Vaghul: In fact it will be, I'm not really convinced after a good deal of study that unless you are in a position to double-up compensating mechanisms you will not be able to go anywhere. Compensating mechanism insofar as the labor is concerned, you need to come out at the social safety net program insofar as retrenched labor is concerned. The unions will object, if I am a union leader, I will also object if any typical public sector company is engaging 8,000 employees.

For us to be globally competitive in the public sector you need no more than a thousand people. So the issue is what happens to 7,000 people. Unless you are in a position to come out of this specific plan for taking care of the 7,000 people, how can you push throughout the privatization program? I was once given an assignment for doing the work for Holla Gomez, the operating agency to study the economic feasibility of goldmines. We came out with the conclusion that the cost of exacting gold in India is twice the price of the gold. So I think by the economic logic, you are to close down the goldmine. And so we presented the report to the government and we had a meeting in which the cabinet presided, I was called in for discussion. The cabinet secretary asked a very specific question, Mr. Vaghul so excellent a prodigy a bank is prepared, but can you tell me, how do you close down a township? They call it a township. I mean it supported the whole lot of the population. Unless you are in a position to answer these points, for us it is futile to talk in terms of privatization. It is not like we've got a social safety net, we are in a position to take care of it. To us the discussions will not have to shift to handling the interest groups simultaneously with the progress of the economic reform. And time is not on our side and we can't waste saying that unless all the interest groups are satisfied, we should go ahead. We have the two outward mechanisms and for your information this last Sunday a group of us really met, some very imminent professors like Dishan Polipo, Sichin Prekalad and a few others came and we are adressed to this specific issue please let us not tell the government what to do. Because the government knows what to do. Let us tell the government how to do it. Let us say, shifting to how to do it. Because politically there is a problem with dealing with the 7,000 entrenched employees, how are they going to deal with that? Unless we find an onset, I don't think we have a right to tell the government privatize, privatize, privatize. That won't work in India.

Amardeep Assar: I'm from the City University in New York. Mr. Vaghul, you basically answered one of the questions I was going to ask, that is the shift from what to do to how to do that is moving from strategic pronouncement to actual implementation. So another question. To anyone on the panel. India has prided itself, rightly so, on its ability to do software in relation to world markets and so on. But most of other India's exports and so on still tend to be commodity based. Is there any kind of emerging direction that India needs to be globally competitive in other sectors in industry other than the commodities?

Joydeep Mukherji: Of course it needs to be globally competitive. But perhaps it needs to be so more because that will increase the productivity and the growth rate of the Indian economy itself rather than because of the export income to be gained. I think one of the, both the facts of life and the advantages for India is that it's an immense nation. It's not going to grow at the kind of rate that all of us talked about through an export-led growth strategy. It's going to grow through a focus on its own major domestic markets. And the great advantage in my view of foreign money, of a more open kind of international economic policy is the impetus the competition gives. This is true even with respect to capital. I represent foreign capital but I'm well aware that this is never going to be the solution to India's problems that if you, in a nation of this scale which at the moment, just to put a little number on it, is receiving about the amount of foreign direct investment that Paraguay receives, the growth of foreign investment direct portfolio is simply not going to be the answer.

May I make one brief digression? That while my own time in government convinced me that doing things is more important in the long run than saying things. It is extremely important at certain strategic moments for governments to say things. And I think that one of the problems that the reform process in India has been what was called the philosophy of gradualism which also has, which also in my view characterizes the way in which it is discussed. And it has seemed to me increasingly that after a decade of gradual impressive reform that it is time for the government to take the process with both hands and say what it intends to do. Then the steps begin to define themselves. Then, India is not going be able to find specific answers for the specific interest groups of every specific problem. There has to be a commitment to an overall direction which typifies what a government and a party are going to do before I think any of these solutions are capable of being found.

Deepak Parekh: If I can just add, in fact I'm a little concerned that this government, the new government is threatening to have a new ministry for information technology. You heard Joydeep mention in his opening remarks that the software exports have grown 50% consistently on an annual basis for the last six years. Now government in its over-enthusiasm to help the IT set to grow even faster is thinking of a special IT sector, a minister for IT and a department for IT. IT sector has grown without a minister and without an IT department very well for the last five, six years. And we hope this doesn't slow down and they bring more roadblocks to the IT sector. But complementing the IT sector, what we see in the last six months to a year really is the service exports, the back-office. The amount of exports that India can earn by having not only software development but back office, like bank reconciliation and medical claims and follow-up of credit card errors and all kinds of administrative work and even call centers, you see a tremendous growth of call centers outside Bombay, Delhi and Cennai and these are mainly from American banks and American insurance companies and other large corporations, service industries like airlines. This area is going to grow significantly. Now on the traditional exports of India, you know that the Indian government even today gives an incentive if you export and this is really, this is the main reason why multi-national companies are exporting non-core goods, they're buying goods in the market and exporting just to bring the tax rate down. So you can't force that because the local markets are so huge and you know it is really not very viable or profitable to export commodity goods and you will get new areas like service export, you will get new areas like software which is in the last few years.

Narayanan Vaghul: Now I'm going to answer a specific question I clearly foresee during the next three years they ship from commodity exports to manufacture exports. And that is going to be driven by two factors. One, I think very interesting, maybe I'm anticipating what is going to be told at the next session, or maybe I may be wrong in this. I am very happy that in the last fifty years, for the first time we seem to be enjoying a type of relationship with the United States that most of us really desired. In a sense that we are finding that part of our economic problems also stemmed from the fact that we were not able to establish a meaningful relationship with the richest country in the world. And that has changed and I see, whether we like it or not, there is going to be a very substantial US enrollment in India economy during the next three years. That means that we will be following the example of the East Asia where there will be a greater shift towards manufactured exports driven largely by the foreign direct investment. I think that is the answer to your question. But having said that, I want to say the second point or so. For this to be sustainable, we need to do a lot of things. For example, I believe that over the last fifty years, we have emerged as masters in handling second-hand technology. And we need to shift our mind-set from handling second-hand technology to generating first-hand technology. That means unless we are able to invest in equal amount in our own organic research and development, that way we are able to contribute something to the knowledge creation to the domestic industry, we will not be able to achieve sustainable growth in respect of this manufactured exports. We have seen in the recent Asian crises any economy which depended on this foreign direct investment for export growth is extremely vulnerable because of the external forces. So I don't think that India should suffer the same fate. So I do expect a gradual process of (INAUDIBLE).

There will be also another contributing forces. I talked about the compensating mechanism. The compensating mechanism for agriculture, in a sense that agriculture today is thriving on it's subsidies. Fertilizers subsidy, power subsidy and (INAUDIBLE) subsidy, all these things will have to be given up during the next three years and for that it is necessary for us to compensate the agriculture by giving them access to the global markets. I mean, unless in seven, eight years they think agriculture prices in India are low compared to the global crises, so agriculturists you compensated like this you withdraw the subsidies, giving them access to the global market and in that process, what is going to happen is there is going to be a step up in the commodity exports. So the next two, three years, we are going to see this phenomenon of the whole economy getting churned, driven partly by the foreign direct investment, driven partly by the forces that get generated in agriculture so there will be a process of readjustment. Our hope is that during this process, we'll be able to also set the forces which could, give the economy a degree of sustainability which could really capture on this moment that is being built up over the next three years.

Rajiv Chaudhry: I have two questions. One was, and they're both directed at Depak and Narayanan. One question is about what you can see reading the tea leaves in terms of appointments that the Prime Minister's making in the key financial and industrial economy portfolios. If there's anything that you can read that could be construed to be somewhat different, a break from the past, he's talked about second generation reforms and the president's speech, the phrase e-commerce was used, I was ecstatic that the president was talking about e-commerce, but do you see any follow through in terms of appointments and the second question is, you talked about privatization as one way of breaking the fiscal defect. Could we by-pass that whole issue, the points that you raised and the difficulty with privatization by massive flow of foreign direct investment in the order of ten, twenty billion dollars a year over the next several years, if it were to happen? Could you obviate the need for the fiscal deficit to be bridged for the economy to grow?

Narayanan Vaghul: I will answer the second question, possibly the first question, but Deepak will be the (INAUDIBLE) I don't think you can link this to. Privatization is not a process, I am now convinced, privatization is not the process only of bridging the fiscal defect. Privatization is a process of imparting strength to the economy. We have nearly 30 to 35% of the Indian economy operating at sub-optimal efficiency. I don't think this can go on. You can't call yourself an economic party, can't call yourself a strong economy if 30 to 35% of the economy is operating at sub-optimal efficiency. So we need to set things right in that part of the sector. I mean it incidentally contributes to your fiscal deficit reduction is an entirely different issue. But I won't call that as a primary one. It is an important one, but an important one is setting things right. And that is not going to be linked to among the foreign direct investment that is going to come in. Foreign direct investment that is coming in is not going to go towards the fiscal defect also. In a sense, foreign direct investment is essentially a process by which we are enabled to have a much larger (INAUDIBLE). In a sense we are able to import more so because we are able to balance it by a capital flow. I think that is all it is going to do. I believe that foreign direct investment is going to come to India and this foreign direct investment is going to result in the export growth as it has happened in East Asia; the economic environment has become very, very facilitating, our relationships are being built up in the right direction. All these things are going to sell the economy well during the next three to five years. But some of us we have to look beyond the next three to five years. Say what is going to happen beyond the next three to five years, that is where I think it is important for us to set our house in order and one of the weaknesses in our houses in public sector. That has to be set right.

Deepak Parekh: Just to take your first question, I think the first indication of that new government was to retain the old Finance Minister. I think that was a very positive sign. And they were a vested interest again, after the election results and there was a lot of speculation whether who's gonna be the next finance Minster. But Prime Minister Vajpayee retaining Mr Yashwan Sinha. I think itself gave the right signal that he means business and Mr. Sinha has been talking even while he was in transition between elections that what he will do if he's reappointed, so I think that itself, the other appointments really haven't taken place, but most of the key ministries, that Prime Minister Vajpayee has retained, like we have the same Power Minister and the same Defense Minister and the same, so there has been some continued team maintained by the Prime Minister. In spite of forces from the coalition party, bureaucrats, I don't think major shift has taken place. The finance ministry, which is really the critical ministry, the shift took place, or the change took place much before the election results were out, so it did take place earlier, so I think we have a good team in the finance ministry.

Male Voice: I'll just add one comment to the question, first of all, India's not going to get increases in foreign, of foreign investment of that scale, but they will increase and what India can do is use the increases to help develop the rate of growth in the true private sector that will then give the cushion to begin to carry out a two program of privatization. I've agreed with the point, I do agree with the point that Mr. Vaghul has made that the problem of labor and the issue of labor becomes an overwhelming one in the process of privatization, it was one in the United States. And that while you can't develop in my view specific programs, you can create a context in which the employment market is a far better one. But you should understand, I guess everyone here does that the whole process of creating a much larger flow of international investment implies a fundamentally different international economic policy, because as Mr. Vaghul also said, it implies a current account defect. And it implies a decision to run an economy that looks an awful lot like the way big economies developed in the 19th century, which is a current account deficit and capital influence.

Male Voice: I was wondering whether you would be prepared to offer some how-to and what-to advice to state government leaders in this atmosphere and particularly thinking about, maybe think in your mind Chandra Babu Naidu, various state leaders that have proved to at least certain level of competence in the government. What kinds of specific policies do you think are both necessary and politically possible at the state level to reduce fiscal defect.

Deepak Parekh: Well if I can just say a couple of points on this. Today the action is really in the states. There is enormous decentralization taking place and the states are really the focal points of growth and development. And one sees that the more the progress of state, the more money goes in, not only for an investment, even domestic investment. And even if you take the World Bank program or the ADB program, it is specific, large sums of money are directed to a state for why did they do certain things. And every month, every two months, they have to achieve something, whether it's reduction of agricultural subsidy or it's increase in tariffs on increase in power aids or forming a regulatory authority for the state power board or de-capitalizing the SE state electricity board, number of conditions. And that works reasonably well. Large chunks of money are directed toward the state with conditionalities. ADB has adopted a couple of states, World Bank has taken three states, and I thin in the last couple of years, this has worked. And even the private sector investment to these states where there is, for instance, Maharashtra is no longer the pride of India. Maharashtra used to get the maximum investment, both domestic and foreign but it now has lost down to number third or fourth position, Andhra and Tamil Nadu have overtaken these two. Because of better policies, because of more incentives, because of open policies and transparency. So I think that the states that are more progressive, the states that are more open. Chandra Babu Naidu, in spite of his, he was the prohibition policy which increased his coffers. He increased power tariffs in Andra twice and he was reelected again. We heard in the morning that he was re-elected because he sort of aligned himself with the BJP, but even then he was re-elected with a larger majority. But he had the courage to increase tariffs for power tariffs twice in one year, thereby improving the financial condition of those elected city board.

Narayanan Vaghul: In answer to your question, ultimately I think two names that you mentioned, Chandra Babu Naida and Singh, are setting up new benchmarks for the other people. In fact, there is a competition that is going on in the states. And what is going to drive this competition, I used to hear a story from Segia Parla that there was a frog in a well and that frog wanted to get out and all the time it was saying it was not possible for the frog to jump out of the well and it was asking everybody, can you not pick me up and put me outside of the well. And one day a kind person came along and said, okay, I'll help you but you have to wait for about half an hour. I've got some work to do and finish it and come back and take you out. When he came out, he found that the frog had already jumped out of the well. How did he manage this feat, for forty years he was saving this and he could not come out, how did he manage this? I saw a big black snake in the well. So what is necessary for the states to reduce the fiscal deficit is for the government to make it clear to the state there will be no bail-out program for the state. I think that is the critical aspect of the whole thing. Most of the states are under the impression that they can get India luxury of the deficits and all the time they can look for the center for the purpose of bailing out. And I think I see this happening. I recently, three days back I was in the state, I didn't want to mention that, the chief minister was saying that he was not honoring some of the guarantees with the state government as given to us. And when we were asking and we were telling that we had a meeting with the Governer, just because of the matter of the Finance Minister and Finance Minister said that the money is going to be deducted from the grants that are going to be given to the state and passed on to the banking system. I think the chief minister realized that it was serious enough. And so he has to balance the budget in any case. So ultimately I think what was not possible during all these years by a variety of means is going to be possible by the appearance of the big black snake in the well. I think that is the hope I have, that things are turning around in the country. That is the way it was going to work. I mean what happened in 1991? In 1991, why did we turn around? You can give credit to a lot of people for the turnaround of the economy, but again that was a big black snake of the default. I think that frightened us to no end and returned. And I think we see the same process that is happening now.

Male Voice: We have time for I think two questions. First Miss Mantha and then this gentlemen.

(INAUDIBLE)

Male Voice: ...quick questions. Reforms for the common man. There has been an increase of diesel prices by 40% and trade increase by about 30%. Now, whether the price increase should be gradual or should be no doubt there were no increases earlier on for many years. I think there will be some inflationary trends and for the common person, he would perceive that the reforms are not really good for him and why did he put these parties, the alliances to power. The second was the rate at which we are growing, we would be larger than China within fifteen years, eighteen years, so forth. And the emphasis or the allocation on monies, more moneys in the reform process for family planning. Taking into account the per capital increase in the income of the individual.

Narayanan Vaghul: Obviously our shop is still reeling under the influence of J.R.D. Tata when he talks of family planning. I think it used to be a pet passion for them. Don't worry, I think India's population problem is going to be under control. It is not because of any family planning initiative, but the operation of the natural forces. I think India's going to reach a replacement level and I'm not making it a glib statement, I am working in the population area. We don't have the latest statistics. We are loosely talking in terms of the billions Indian already been born. I have a feeling that in most of the southern states, the population growth has reached the replacement level. So that is not an issue. In any case, we have seen during the last fifty years, you cannot attack the problem of population by concentrating on family planning. You are to concentrate on infant mortality, you have to concentrate on, primarily literacy. I think these hold the key. As I told you earlier, when you look at the problem, you are to attack the root of the problem. The root of the problem we are attacking the specifics of the problem by concentrating on family planning. We should have attacked the problem of infant mortality and we should attack the problem of female literacy in order to deal with the population problem, that we failed to do.

And insofar as the past question is concerned, we have to double up that social safety net for the board person. Board person will have to be seen as an integral part of the reform process. I don't want to get into philosophy of the whole matter. One of our greatest failures during the last decade has been our failure to mobilize the people for the reform process. We are trying to mobilize the intellectual community and the media and the political groups and the industry groups but the larger public, we have not been able to give them a picture of what reform means and what it means to the daily life. Unless we are able to do that, we won't be able to make much headway.

Male Voice: Can I just interrupt, let's squeeze in one more question, we're about to run over time, if you could make it very brief, sir and keep the answers brief also.

Male Voice: My name is Staples. My question also had to do with the social sector as referred to by Mr. Vaghul. A discussion like this fifteen, twenty years ago would've been about the poverty levels, the literacy rates and things like that. Today this has been mostly absent, although the panels have been excellent. What is going to happen with this new BJP/Coalition government both at the national level and the very state levels in regard to putting more money into primary education, female literacy, family planning, health and things like this.
Narayanan Vaghul: I believe it is going to happen. I think there's one area where, I had a discussion recently that 6% allocation for primary education is going to be a reality. The allocation to the primary education is going to be stepped up a rate of 1% every year. I believe that the government is very determined about it. I would see, I would like to see and I hope to see a lot of changes in the social sector during the next five years. The realization is that it dawned on the government that unless you get the social sector right, you cannot do things right. I think this is going to be a reality.

Male Voice: Well I think we have to draw this session to a close. Obviously there are more questions and the panelists are more than prepared to answer them, so you can grab them for the next few minutes outside. The next session is supposed to begin in five minutes. So as before, you can go out there, refresh yourself and please come back within five minutes. And thank you very much.

Panel I: Politics
Panel III: International Relations