Protectionism no solution

T.N. NINAN

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THE new year that has just begun will mark the 10th anniversary of the start of serious economic reform. China at the same landmark (1988) was already a booming economy, ratcheting up a sustained annual growth rate of 9 per cent. Prime Minister Vajpayee has now set his sights on a similar target for India. But while the political spirit is willing, the business flesh is weak.

Indeed, the mood in business circles at the end of the old year was one of doubt and worry, if not downright pessimism. The business confidence surveys by the National Council of Applied Economic Research (NCAER) showed a drop in optimism through successive quarters. The Confederation of Indian Industryís (CII) periodic business outlook surveys reflected the same picture. And, of course, the statistics on non-oil imports, on customs and excise revenues collection, and on industrial production, all showed an unmistakeable loss of momentum by the middle of the calendar year, as did non-food commercial bank fund flows to business a little later.

It didnít help that the monsoon had been less than perfect, that Gujarat and Rajasthan would face severe drought problems next summer as a consequence, and that the yearís harvest would not yield much by way of agricultural growth. Naturally, everyone quickly downgraded growth forecasts for GDP.

The stock market reflected this all-round pessimism, especially after the dotcom bubble burst in April or shortly thereafter. If one looks beyond the yo-yo movements of the share index, the stark fact is that the price-earning ratios of the majority of listed companies are below 10. Indeed, the only companies that seemed to enjoy a modicum of investor confidence were those engaged in software, consumer softs and pharmaceuticals. But even in consumer softs, the giant in the field (Hindustan Lever) saw its sustained out-performance become a thing of the past as sales became flat and the companyís share price got hammered as a consequence.

If the investing community was signalling a lack of confidence in the future of most of Indian manufacturing, the manufacturers themselves were saying the same thing. The cry this time was China; that imports from China were swamping India, that there was large-scale dumping going on because the price of finished goods was much less than that of the raw materials used, and so on.

 

 

Reports surfaced in the newspapers of Chinese bicycles, electric fans, batteries, calculators and much else selling at between 30 and 60 per cent of domestic prices. Indeed, at a meeting with businessmen which the finance minister had called in order to discuss the loss of economic momentum, a secretary to the government resorted to the dramatic gimmick of fishing a Chinese pencil battery from his pocket and holding it up for all to see. He got everyoneís attention with the announcement that the battery was available in the Indian market at less than a third of the price of its Indian rivals.

It took a while for economists to fish out the trade statistics, and put a macro-economic perspective to the undeniable fact of Chinese imports having begun in a more serious way than was the case till now. And the numbers gave no cause for alarm. Yes, imports from China had gone up, but by less than Indiaís exports to China. So the trade balance happens to be in Indiaís favour. Besides, imports from China were only a tiny fraction of the countryís total imports. Then, consumers began discovering that the life of a Chinese battery was much less than that of an Indian alternative, so there was a quality issue as well (in the case of at least some Chinese products).

Farmers meanwhile faced their own problems, because of a downturn in the commodity price cycle in sectors like rubber and edible oils. So they joined the growing chorus for protection from imported competition. The government responded with a series of swadeshi measures. Customs duties were jacked up sharply for rubber and palm oil, among other agricultural products. Duty levels were tweaked for some industrial products as well, and a series of non-tariff barriers were sought to be put in place: the imposition of local standards on imported products, stipulations on which ports importers had to use, and so on. Some of these were legitimate, and in fact have been mandated by Indian law for some time, but the governmentís intention clearly was to try and slow down imports by putting bureaucratic hurdles in place. India has also become far more active in imposing anti-dumping duties on imported items.

 

 

It isnít clear that these measures will have the desired results. But businessmen justified their call for protection by pointing to the several cost and other disadvantages of locating manufacturing operations in India. In many states, for instance, electricity costs upwards of Rs 6 per unit for industry, which is nearly twice as high as it should be and is a result of extreme cross-subsidisation, since farmers get their power either free or at hefty subsidies. Similarly, railway freight rates are much too high, because the railways use these to subsidise passenger fares. Trucking is expensive too, since the poor road conditions, octroi charges and delays at check posts raise dramatically the cost of moving goods.

Equally, Indian port charges are high, and ship turnaround takes five times as long as it does in many East Asian ports. By one yardstick, nearly 90 per cent of Indian port and dock workers are surplus, as are one-third of the 1.5 million railway employees. The result of all this is that shipping rates from East Asia to Europe are lower than they are from even western Indian ports to Europe. Then, of course, there is the lack of operational flexibility imposed on business by the rigid labour laws, not one of which has been changed in any way so far.

 

 

Taken together, according to an assessment by the Federation of Indian Chambers of Commerce and Industry (FICCI), Indian manufacturers suffer a cost disadvantage of about 17 per cent, compared to manufacturers in other countries. And (which is the point of outlining the whole issue), it focuses attention directly on the fact that, nearly a decade after economic reforms began, so many key areas in the Indian economy still remain unreformed and inefficient.

Much the same thing can be said about agriculture, which faces a new kind of crisis because the wheat and rice mountain has now become as big as 45 million tonnes, while the sugar mountain is nearly 15 million tonnes. India now has as much of sugar as it should have of wheat! And neither can be exported without incurring huge losses, either because product quality is not acceptable (India does not produce what the rest of the world recognises as refined sugar) or because Indiaís costs are far too high.

One reason why those costs are so high became clear through the kharif harvesting season, when farmers in one state after another agitated for a relaxation of the quality norms for public procurement. Under the pressure of state governments ruled by parties that are part of the ruling coalition in New Delhi, the Centre eventually gave in. So, the grim fact was that a decade after reforms began, India remains a high-cost economy.

Looked at another way, these problems are reflected in the various international rankings that now come out every year. There is the competitiveness ranking, the ranking on corruption, the ranking on the basis of the human development index, and so on. And it is instructive that in virtually every such international ranking, India shows up in the bottom quarter of countries. There is no getting away from the fact that this is a severely under-performing system.

 

 

At one level, the solutions to these problems are not profoundly difficult. If the system as a whole is 17 per cent more inefficient than, say, the countries in East Asia, a 17 per cent import duty should be able to act as an effective neutraliser in terms of providing a level playing field in the domestic market. In point of fact, the average customs duty level in India remains among the highest in the world, and currently is in excess of 25 per cent; there is even talk of raising the peak duty rate yet again. There will be a few products where the protection level is lower, but not many, and not by much.

Exports present a trickier problem, because the only way to provide a system-wide corrective to a cost disadvantage (so that you donít have to pick and choose individual manufacturer-beneficiaries) is to push down the external value of the rupee till it reflects the cost disadvantages of operating out of India. The problem of course is that, since the rupeeís value is no longer determined by the RBI and is a result of market forces, no such solution can be introduced by fiat. However, the RBI certainly has enough influence in a thin market to push the rupee down, if it really wants to. The political problem of course is that no finance minister wants to face the flak for downgrading the currency, since the strength of the currency is still seen by many as reflecting the strength of the system.

In point of fact, if the rupee could be pushed down from Rs 46.75 against the dollar, to about Rs 54 (and admittedly, this would not be easy), importers would not need the extra duty protection, while exporters would have got their price advantage. One suspects that the 17% cost disadvantage figure put out by FICCI is an exaggeration. Most exporters and domestic players would be perfectly happy if the rupee dropped to 50 against the dollar (which would provide a correction of less than 7 per cent). This isnít the easiest thing to achieve, but equally, it isnít impossible either.

 

 

One suspects, though, that even if this were done, you would still have exporters and domestic players complaining about the lack of a level playing field. And with todayís standard excuses for failure having run out, the real issues would start surfacing. First on the list would be the lack of economies of scale, which would include the continuing problem of whole sectors of industrial activity being reserved for small-scale industry. In point of fact, this only excludes large domestic players, it does not exclude the large international players, because as part of the deal with the US under the aegis of the World Trade Organisation, the last policy restrictions on imports have to go by the coming April.

In anticipation of imported competition, the government has recently dereserved garments, as part of a textile policy package, but hundreds of other sectors remain reserved. But equally, the scale issue goes well beyond the issue of reservations, because most Indian manufacturing operations remain cottage enterprises when viewed from a global platform. Thailand has sugar factories on a scale that no one is able to dream of in India. Chinaís TV companies dwarf Indian set manufacturers. Koreaís Posco is vastly bigger than any Indian steel mill.

 

 

Second would come the issue of quality, allied to which is the issue of access to current technology and effective marketing and branding. While Indian manufacturers are shy of discussing these issues, the fact remains that a great deal of very shoddy material gets pushed into the Indian market. Many Indian steel producers still turn out uneven quality. Indian trucks are not as contemporary as they could be. Many Indian companies still use highly polluting technologies, or technology that requires excessive material inputs (thereby raising costs), or have work practices that do not achieve maximum productivity. All of these affect competitiveness, and solutions lie with the manufacturers, not the government.

It is true that the last four years of depressed demand have forced many companies to address these issues in the pursuit of sheer survival, so that companies like Tisco have bench-marked themselves globally on cost and taken the hard decisions. But a great many others have not. When this is coupled with the traditional weakness of Indian businesses, in the area of marketing and branding, the prospect of competition can be pretty daunting. Which explains the cry for protection, for some way to keep out imports. The underlying lack of confidence is reflected in the poor stock market valuation of Indian manufacturing companies.

But protection is no solution, unless it were to go to the absurd lengths of the past, lengths that are now not permitted under the new trading rules. For instance, domestic industries that use high-cost Indian rubber as raw material will have to face competition from foreign rivals who donít. The solution is not higher duty levels for downstream products as well, but improving the productivity standards on Indian rubber plantations so that they can match Malaysian costs. If Indian fertiliser units that use naphtha as their feedstock produce urea at fully twice the cost of imported fertiliser, no solution is possible to the downstream problem of a burgeoning fertiliser subsidy, other than to phase out the use of naphtha as quickly as possible. And this could mean shutting down a great many plants.

 

 

The point is that Indiaís manufacturing sector has enormous work that it has to take on, if it is to get efficient. Equally, Indiaís business infrastructure has to be licked into shape if the systemís overall competitiveness is not to continue suffering. And policy changes are required across a very broad spectrum to facilitate these changes. Crucially, the principle of asking people to pay for the goods or services they consume, has to gain much wider acceptance than it does now. If the state canít do it because of political pressures, more and more of economic activity has to be left to private parties, so that pricing decisions get de-politicised.

For instance, if the post office raises its parcel rates, it becomes a matter for Parliament debate; but if a private courier company decides to up its rates, everyone accepts that as routine commercial decision-making. Railway freight rates need Parliament approval for some reason, while trucking rates donít. If the department of telecommunications were to raise its charges, there could well be a political uproar, but the private telephone companies raise and lower charges all the time, and no one notices. The legacy of the 1960s and 1970s, from which India has been trying to escape, is the pervasive influence of politics on routine economic decision-making. Markets have gained much greater acceptance as an idea, but still very partially.

 

 

If in doubt, look at the continuing opposition to privatisation (not least from within the government, and indeed the cabinet itself) as an obvious example of this. The Congress opposed at the stage of its introduction, a bill in the winter session which seeks to lower the government share-holding in the public sector banks. Bank employees have gone on protest strike, not once but twice within the space of a month. And ministers, bureaucrats and a great many others continue to be unhappy about the prospect of privatising a dozen government owned companies.

But consider the fact that ICICI Bank, which is not more than five years old, has in the space of this short time created greater value for investors than the combined value of the three largest and much older nationalised banks that are quoted on the stock market. HDFC Bank has done the same. Tomorrow, one or two insurance companies will repeat the feat against LIC and GIC. Yet, the latent hold of the Nehruvian mindset is such that these facts donít seem to provide justification in many minds for welcoming more private sector activity. Or, perhaps, it is simply a matter of preserving patronage, nothing more.

To return to the original point, all of this only underscores how little the economic reforms have actually achieved so far, and how much more remains to be done. And we havenít even looked at huge problems facing the economy, like the level of non-performing assets in the term-lending financial institutions and the banks, which continues to be much higher than is officially declared, thereby raising the cost of finance to all borrowers. Like trade, where the margins continue to be so high because of inefficient trading structures, which raise costs for consumers. And yet, the retail revolution, in terms of a quality experience for shoppers, has only just begun to happen.

Then there is energy: Oil exploration has remained mostly a public sector monopoly, with predictable results. Indiaís oil production has been static for two decades, while oil consumption has trebled. Now, with oil prices having trebled in the space of two years, Indiaís oil import bill has trebled too, and we are sending out an extra 3 per cent of GDP for the same oil that we were importing two years ago. The impact on prices, external balances and economic growth are all obvious, and if prices donít fall further in the near future, the oil crisis still has the potential to derail the economy Ė for the third time in three decades. If anyone were to harp on a swadeshi mantra, it should be in energy.

 

 

In the light of all this, the talk of achieving 9 per cent annual GDP growth is so much moonshine. If the last decade achieved a little over 6.5 per cent annual GDP growth (if you start counting the decade from 1991, instead of 1990), it is certainly possible to hope for 7 per cent growth in the coming decade. And it is a fair bet that if 7 per cent growth is in fact achieved, India will remain among the top five or six fastest growing economies in the world. But when one looks at all the unrealised potential, at all the changes that can be made in order to accelerate growth further, it is easy to understand the pessimism, frustration and even anger that prevails in what is after all an economy that is doing pretty well for itself.

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