Time India walks the talk

RUCHIR SHARMA

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JUST like the Frenchman who remarked that the Eiffel Tower reminded him of sex, because so did everything else, in India we tend to see the hand of the politician in just about every problem that makes for the poor state of the Union. It’s our favourite sport to willfully elect our representatives on the back of an agenda set by us and then make them the scapegoats for everything that goes wrong.

Of course, attacking the political class is a common feature in democracies across the world. The average politician is generally more intelligent and successful than the average citizen, so it is human nature to run him down. But even if the more popular politician is considered of low quality by global standards then it’s a telling statement on the general populace in India, and herein lies the problem.

What ails our nation the most is the state of the economy, which foments caste and communal politics. Yet we still seem to be going around in loops figuring out some mythical ‘middle path’ towards economic development. The success of free market enterprise stares us in our face yet we seem to invariably find some lousy excuse for inaction. India doesn’t even have a serious right wing constituency, as defined by economics and not religion, which speaks for unbridled economic reforms for that would at least shift the centre of the political economy more to the right.

India badly needs a free market ideologue, with a mass base, who is willing to see the connection between economic reform and political success and rise above playing mundane caste and religious cards. Remember that good leadership is not about following opinion polls but in taking a difficult road and then getting people to follow what appears like too adventurous a path. Many countries in the world, and in a way the world itself, have been transformed by such leaders. Reagan and Thatcher changed the world and when they both started out their ideology was considered too extremist.

Similarly, in almost every developing country that went on to prosper, the reform cause was almost always championed by a single decisive leader, stretching from Carlos Memem in Argentina, Fujimori in Peru to Deng in China and even the likes of Mahathir Mohammed and Suharto in Indonesia (during their better days). The important thing here is to have a mass base leader who can communicate the benefits of the reform process to the people. This was the main problem with the Narasimha Rao regime in India where no one could communicate with the people on the reform process. Therefore, no real support was built up for the reform effort.

Now if in India it is the people who are the problem then there’s no scope for such an experiment. However, one’s still not willing to come to such a fatalistic conclusion because no leader has really tried this experiment. Even stupid people can be led in the right direction. Agreed, the odds of anyone even trying it in the foreseeable future are less than even. After all the people only get the leaders they deserve. But India at present does have some mass-base leaders, who have the potential of rising above narrow-minded politics, and one hopes against hope that one of them will try and pursue the connection between economic prosperity and political success, like many other leaders have across the world to become legendary figures.

 

 

Following on from the lead provided by Deng Xiaoping, the top Chinese leadership has truly zoned in on the connection between economic reforms and popular appeal. There are many lessons to be learnt from what’s happening in China. Probably the most important thing to note is the mindset of the top policy makers. For example, last year the Chinese People’s Political Consultative Conference (CPPCC) sponsored a gathering of leading intellectuals in the country and also invited a few foreign guests. These guests were given an audience by Chinese President, Jiang Zemin, and the details of the meeting got front page space in some of the international press because what the president had to say just left the guests awestruck.

Jiang Zemin spoke about the virtues of a capital market induced system of economic growth. He marvelled at the worldwide equity culture that Nasdaq had spawned and said he wanted to promote an entrepreneurial spirit that makes a Silicon Valley. The Chinese president said his countrymen were inherently risk-takers and stock markets are all about taking and understanding the concept of risk, which in turn lies at the heart of wealth creation. In short, Jiang Zemin stated his intent to make the Chinese economic model look a lot like the American one! Before this, it was Zhu Rongji, the Chinese premier, who was viewed as the leading champion of reforms in the country. But this discussion made it clear that the president himself was passionately committed to reforms and the signal this sends to the outside world is worth more than a few billion dollars.

 

 

China’s recent moves reveal the mindset – one driven to modernize China by making the best use of the opportunities presented by the outside world. On tricky subjects like privatization, China understands that it should first sell what is ‘buyable’ to make the process popular and this requires a mind sensitive to global market conditions – something our Indian policy makers apparently lack.

Developing capital markets is the other focus of the broad reform effort in China. In this regard, the WTO accession has helped in providing the requisite push as it binds China to rule-based norms of globalization. While China already has a serious stock market culture, the growth there has been more quantitative than qualitative in nature. China realizes, as was also apparent from Jiang Zemin’s comments above, that an effective stock market is vital with the market likely to increasingly assume the burden of intermediation away from a banking sector weighed down by non-performing loans. The market will also have to play a part in funding the social liability from restructuring the state owned enterprises (SOEs) as the government adopts the market route to clean up the SOE mess. Accordingly, the government has been announcing a series of steps to improve the functioning of the stock market.

 

 

Admittedly, India is ahead on some of these fronts with, believe it or not, much better corporate governance norms than China and a more institutionalized market. But what is important here is the rate of change. China is coming out firing from all ends and is reflecting a mindset willing to drive through meaningful change with the top leadership fully committed to reforms. It has learnt from the mistakes made in the earlier boom period of the mid-nineties and has therefore shifted focus more towards the quality of growth rather than the quantity of growth.

Of course, when comparisons are made between India and China the standard response from the Indian side is that India is a democracy and it is a lot harder to get things done here. Maybe that is an important difference but what’s crucial is to see the stark contrast in the mindsets of the top officials. The Chinese leadership shows a very high level of sensitivity to global economic and market developments. Jiang Zemin and Zhu Rongji, the two top ranking officials, are the ones leading the reform campaign and openly embracing the American economic model even as they probably continue to despise some of the American cultural values. For much of the political and intellectual class in India it would be sacrilege to even acknowledge the fact that we are in the golden age of capitalism and a market-oriented system is all that works. Sure the government here continues to liberalize at the margin but it’s more like reform by compulsion and stealth rather than passion and aggression.

 

 

China launched in the second half of 1999, what will probably be the world’s biggest asset sales programme in the coming decade to help finance economic restructuring. As an important part of the opening up programme, attracting foreign investment has an irreplaceable status in economic development of China. It raised US$ 20 bn in the international stock market in 2000, a record for any developing country in a year. This compares with US$ 5 bn for other regional countries combined. International investors are rewarding China with huge amounts of money for committing to reforms by joining the WTO. China is the world’s second largest receiver of FDI, with a total of US$ 306 bn worth of investment over the past two decades, representing about 10% of the world’s total FDI.

China is on the verge of a paradigm shift due to strong reforms. The longevity of the current bullish sentiment towards China will critically hinge on China’s progress in reforms. Asset sales and listings have clearly become the official policy since the Fourth Plenum of the Central Committee in September 1999. Asset sales will not only help reduce state control, but also raise sufficient financial resources to facilitate restructuring, such as improving the social security system, centralizing the pension fund system, taking over social welfare functions from state owned enterprises (SOEs), reducing the gearing of SOEs, replacing outdated machinery and helping develop the western and inland areas.

MNCs merge well in the economic landscape in China as it knows that it must give a considerable portion of the upside from its development to MNCs. China is a big country and its development carries significant strategic implications. If MNCs don’t benefit a great deal from China’s growth, the international community will not be friendly to China’s development process. Foreign invested enterprises (FIEs) play a very important role in the development of China’s economy. Increase of industrial output of FIEs was higher than the national average in 1999. The percentage of FIE industrial output increased from 19.1% in 1998 to 20.6% in 1999. Tax income from FIE, one of the fast growing tax income sources, increased 33.8%, comprising almost 16% of the total tax income.

 

 

Total import and export amount of FIE reached US$ 17.5 bn, which is 48.4% of total foreign trade. Over 160,000 FIEs have started operations in China and around 20 million people and 10% of China’s non agricultural personnel are employed by FIEs as at the end of 1999. Among the major nations of the world, China stands alone in the progress it has made in having closed the income gap in the 20th century. According to the IMF, at the beginning of the century China was ensconced in the lower quartile of the global income distribution; by the end of the century it has ascended to the ‘centre-high quartile’. This is ample testament to the benefits of an extraordinary era of structural reform that occurred in the final two decades of the century.

China is a newcomer in the technology market, but it has the potential to become a giant and Indian software experts do cite China as a possible competitor in the software services area. In a few years, with cost, skill and foreign investment advantages, and the upcoming WTO entry, China could become a global centre for hi-tech production. China is likely to become not only the world’s largest market but also a major exporter of many tech products. In another 10 years it could overtake Singapore, Taiwan and Malaysia, possibly even Japan.

 

 

China is the region’s superpower. Like no other country it understands how to move with the times. In the face of all the fuss over human rights violations, the brutal handling of dissidents at the 1995 UN women’s conference and the recent spy plane incident with the US, it still bagged the 2008 Olympics because of its economic might. The mantra – be laser focused on becoming an economic superpower and everything else follows

It’s equally important to choose our enemies with care as drive often emanates from negativity. South Korea may be in conflict with North Korea but the former aspires to be more like Japan. Probably nothing would benefit us more than viewing China as the nation to beat. The unfortunate fact is that while India had once almost come to be spoken of in the same breath as China, especially when India was the hot emerging market in the early and mid-nineties, of late the gap between the two has widened. Another two decades of a similar growth profile, which looks entirely plausible, and the Chinese economy will be as big as the US economy is today.

China has matched high growth rates with zero inflation over the past few years. It emerged unscathed from the East Asian crisis, in fact helped stem the rot by not succumbing to the beggar-thy-neighbour devaluation round.

 

 

In the month of June alone China added more mobile phone connections than the composite total of India’s cellular lines. Economists estimate that FDI flows and export growth have accounted for more than half the growth in China’s GDP since 1981. Around 50 per cent of China’s exporters are either foreigners or partly foreign owned. Xenophobia is not a word well-known in China. Foreign managers are eagerly sought. The central bank of China was last heard scouting for a foreigner to be deputy head of its central bank as part of an effort to internationalize the financial structure.

Heads of public sector units spend quality time on roadshows meeting fund managers. Their compensation is linked to the company’s stock price. Managers of these enterprises are allowed to fire workers freely by paying them three years compensation and 20 million such workers have been fired over the past three years. All of this does lead to dislocation issues and the government is working on strengthening a social safety net.

Anyway, when overall growth is running at eight per cent, social problems are dealt with more easily as that kind of growth generates enough alternative employment opportunities. Sure, extended periods of economic growth create its own set of problems.

Regarding India’s downgrade by S&P and Moody’s, such agencies just don’t have the same sort of stand-alone impact they used to because of structural shifts in the nature of cross-border capital flows. For one, research shows that last year, for the first time in recorded history, cross-border equity flows were greater than inter-country bond flows. The increased equitization of global capital markets reduces the importance of sovereign ratings, which are more relevant for international bond investors. Equity markets discount information efficiently and do not wait for formal pronouncements. India too has been relying more on equity related flows and, somewhat contrary to popular opinion, such flows tend to be more sophisticated and sticky.

 

 

In the East Asian crisis, inter-bank transfers led the capital outflow. Banking crises and over-leveraged financial systems have been at the heart of most emerging market crises and India’s external debt profile doesn’t concern too many investors at current levels. Still, while it’s easy to downplay the significance of the rating changes, it’s hard to argue with the tone of the broad message to the government – don’t just stand there, do something. India finds itself in a bizarre situation where most analysts and key policy makers alike agree on what needs to be done and yet the rate of change is excruciatingly slow. The rating agencies in a way did what many folks in India have already done – throw in the towel on serious reform.

The equity market’s indifference was really on account of it being ahead of the curve and not necessarily out of disagreement. Stocks had already priced in a lot of negative news-flow by being beaten down to pulp well before the rating agencies announced changes. More worryingly those same equity investors, who showed great faith in the market through the vicious downturn, are now beginning to tire and portfolio inflows are slowing. The irony is that many of the portfolio investors, who were earlier liberal with India in pumping in capital, find themselves dragged into the controversies surrounding the financial system. The view out of the key global financial centres, from New York to Hong Kong, is that equity markets across the world have been ravaged by the TMT meltdown so why is only India kicking up such a fuss.

 

 

Policy makers would do better by focusing on the more fundamental reasons for the market’s relative under-performance. Much has been said about how India always fights back when it has its back to the wall. Instead, in the absence of a mega crisis and just sclerosis, there’s a lot of scape-goating and witch-hunting going on and no one out there seems to have the ability to draw a line and get on with the business of governing. The rating agencies, through their narrow debt related focus, have highlighted a part of the malaise. Unfortunately, the problems are much more complex than those cited.

It anyway requires a special effort to keep the economy on course in the face of the strong global head-winds, which are only increasing in intensity with the global economy fast slipping into its first synchronized downturn since 1974. Investors’ risk-tolerance levels typically tend to be very low in this kind of an environment and ratings agencies too know it’s better then to err on the cautious side.

India should take a message from all these developments, ranging from the Chinese economic success to the rating downgrades, and get laser focused on the reform process. The global environment is difficult and it is in times like these that the character of a nation is tested. India has done well in the past when it had its back to the wall. Let us hope that the few believers in the reform process India has draw upon the Chinese model as a way out of the current problem.

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