Governance is the challenge of 2014

Dr Bharat Jhunjhunwala
President Pranab Mukherjee has given a warning to the politicians that people are restive because the Government is not measuring up to their expectations. The warning holds equally for the economy. The main problems facing us here are price rise, low growth rate and falling value of the rupee. All these are a result of bad governance. Consider price rise. Government revenues are leaked away to be deposited in Swiss Banks or in buying gold. The government has to borrow more monies to cover this loss of revenue. The Reserve Bank prints more money to increase liquidity in the money market so that the Government can borrow easily. This increased supply of currency leads more notes chasing same amount of goods and, therefore, to price rise.
Our growth rate is similarly falling because the Government is allowing the revenues to be siphoned away; and using the money for buying votes through programs like loan waiver and MNREGA; instead of investing in research and improving infrastructure. The rupee is falling, similarly, because our exports are less due to high cost of production. This, in turn, is because our manufacturers have to pay hefty bribes and infrastructure is bad. Our goods are priced out of the global market. Improvement of governance will, therefore, solve the problems of price rise, growth rate and falling value of the rupee.
The recent elections have indicated that the people are moving towards BJP-AAP. Both these parties are, I believe, less corrupt. Modi has cleaned up administration in Gujarat. AAP is likely to do so in Delhi. Therefore, I am quite bullish on India. Ascendency of these parties will spontaneously solve our economic woes.
The threat lurking on the horizon comes from the happenings in the United States. Mainstream economists are generally bullish on the US economy. The growth rate in that country is picking up and unemployment is not increasing. This happy situation, however, is built upon the huge stimulus injected into the economy by the Federal Reserve Board. Recently, the Fed has started tapering the stimulus. Till last month it was buying USD 85 billion worth of bonds every month. This money was being injected into the economy till recently. Interest rates were near zero. Consumers borrowed for consumption; and businesses borrowed for investing in emerging markets like India. The Fed has now decided to reduce borrowing by USD 10 billion every month. Tapering will lead to less availability of money, a rise in the interest rates and reduced borrowing for consumption as well as overseas investment.
There are two possibilities here onwards. One possibility is that the US economy will survive tapering. Economic activity will continue to rise so that businesses can survive despite higher interest rates. They will continue to employ large numbers of workers who will continue to buy goods from China and India. The challenge before us, in this case, would be to reduce our cost of production and export more to the US. That, of course, is only possible by good governance. On the flip side, strengthening of the US economy would provide opportunity to global investors to invest in that country. Foreign investors are likely to move towards the US. That would lead to a flight of FIIs from India. We can reduce this impact if governance is improved and our companies do better in the intense competition for global capital.
The second possibility is that the US economy will crash under the burden of debt as it happened in 2008. The cost of production is likely to increase due to tapering of the stimulus. In this case there will be a scramble among global investors to pull out money from the US and invest in emerging markets like India-as happened in 2008. There was a short period of outflow followed by return of FIIs in 2009 onwards.
In this case we will stand to benefit from FII inflows. The flow of investment to India, however, will not be automatic. FIIs will assess whether Indian companies are likely to make more profits in comparison to those in, say, Mexico or Brazil. The ability of our companies to attract global capital will depend on they having low cost of production. That, in turn, will depend on good governance. On the flip side, we will face problems in exports because consumption will fall in the US. Therefore, the key to success lies in good governance irrespective of what happens to the US economy.
I am bullish on India. The combination of BJP and AAP is likely to deliver better governance which will jump start our economy.
(The author was formerly Professor of Economics at IIM Bengaluru)