After This Week's Victory, Will the Congress Government Press Ahead with Reforms?
Published: July 24, 2008 in India Knowledge@Wharton

On Tuesday, the United Progressive Alliance (UPA) led by Prime Minister Manmohan Singh won a trust vote in Parliament by a surprisingly large margin, beating out the combined opposition by 19 votes. The UPA received 275 votes while the combined opposition of the extreme Right and the extreme Left mustered 256. It wasn't as close as in 1999, when the Rightist Atal Bihari Vajpayee government lost by just one vote. But the debate -- centering in part on the government's insistence on going ahead with a nuclear deal with the U.S. --was far more acrimonious.

The crisis has been long in the making, and time was running out for both Singh and U.S. President George Bush. The latter has just a few months left in office; Singh has to call for elections to be held before May 2009.

When the Indian government took the step of approaching the International Atomic Energy Agency (IAEA) with the draft India-IAEA safeguards agreement for approval by its board of governors, the Left parties cried foul. They have been supporting the UPA from the outside. Without their backing, the government was reduced to a minority. The Left has been opposed to the nuclear deal on ideological grounds. Prakash Karat, general secretary of the Communist Party of India (Marxist) has often criticized it for being too pro-U.S. and undermining Indian sovereignty. As for the Right -- principally the Bharatiya Janata Party (BJP) led by Vajpayee and shadow PM L.K. Advani -- the nuclear deal was conceived when the BJP was in power. Consequently, its arguments against it now sound opportunistic.

Opportunism is actually the order of the day. Filling in for the Left (which has 59 members of Parliament -- MPs) is the Samajwadi Party (SP), which has 39. Other parties -- several of which have just one MP in the House -- moved into horse-trading mode. "The price of an MP is Rs25 crore ($5.8 million). No one has principles anymore," Communist Party of India (CPI) general secretary A.B. Bardhan said at a meeting to launch the Left campaign against the government. A few days later, rebel Congress MP Kuldeep Bishnoi told a rally that he had been offered $23 million for his vote.

The House descended into chaos when three BJP members took out bundles of currency notes (a total of Rs1 crore -- $234,000) and alleged they had been paid that amount as an advance to abstain from the trust vote. The total promised payoff, they claimed, was $2 million. The Speaker has ordered an investigation.

These big numbers, the mudslinging and the drama have overshadowed the more important issues. A political dimension is in play, including the forging of new equations and the emergence of a third front -- which opposes both the UPA and the BJP-led National Democratic Alliance (NDA. Led by Mayawati Kumari of the regional Bahujan Samaj Party (BSP), it promises to complicate affairs in the coming general elections.

New Highs and Lows

The man on the street may find such circus games entertaining, but he has far more serious things to worry about. Inflation, around 12%, is at a 13-year high; industrial growth at 3.8% in May is at a six-year low. On July 16, the Bombay Stock Exchange Sensitive Index (Sensex) fell to a 15-month low of 12,514, a drop of 40% over the 20,873 recorded in January 2008. The rupee has dropped to 43 to a dollar after being in the 38-39 range.

The central government's fiscal deficit is seen by many as out of control. According to rating agency Fitch, the budgeted deficit could increase from the projected 2.8% of gross domestic product (GDP) to 4.5% of GDP because of farm loan waivers, a pay hike for government servants, increased interest payments and subsidies. Add to this items that are not captured in the budget (principally bonds to finance oil subsidies), and the total deficit could cross 6.5%. Fitch has lowered its estimate of GDP growth in 2008-09 from 9% to 7.7%. It has also revised India's local currency outlook from stable to negative. Other rating agencies such as Standard & Poor's (S&P) and Moody's have been making warning noises. In fact, S&P has estimated the combined deficit of the center and the state governments at 9% to 11%.

With elections around the corner, the principal worry is inflation. Indeed, the trust vote debate didn't talk much about the nuclear deal. The key issues seem to be horse trading and inflation, with the former winning by several lengths. But the nuclear deal does matter. Strategic issues and security concerns aside, the agreement would end India's technology pariah status. The country was consigned to the doghouse after it undertook its first underground nuclear test in May 1974 at Pokhran, in northwestern India.

The nuclear deal will have a positive fallout on business, says a survey of 400 CEOs by the Associated Chambers of Commerce and Industry (ASSOCHAM). India could attract $40 billion worth of foreign direct investment (FDI) in 15 years in nuclear energy. An earlier ASSOCHAM survey in June had indicated that CEOs expected FDI for 2008-09 would fall $7 billion short of the $35 billion target, thanks to the economic and political uncertainty. For 2007-08, the commerce ministry had set its sights on $30 billion in FDI and managed to garner only $25 billion.

The nuclear deal is expected to open the floodgates of business between the two countries. Tentative alliances have already been struck between big Indian business houses and their U.S. counterparts -- and not in the nuclear arena alone. In defense, procurement by India is expected to top $70 billion in the next five years. There are other spin-offs in areas such as space.

"The nuclear deal is good for Indian business and industry for two reasons," says Rajesh Chakrabarti, professor of finance at the Hyderabad-based Indian School of Business (ISB). "First, in the long run, it will help ensure adequacy of power supply. Ultimately, our other sources of generating power are going to dry up and the nuclear way will be the only way to go for India. Secondly, because of the nuclear deal, there will be further trust and interaction between India and the U.S. This will have a positive impact on Indian businesses."

"The nuclear deal will be good for the future of the country," industrialist Adi Godrej told business channel CNBC-TV18. "And I think some of the reforms agenda could be executed before the [general] election. I think that will build confidence. I also feel that one of the major negatives -- high inflation -- will probably be contained by March."

"Inflation will be controlled," Prime Minister Singh told newsmen even as the debate was on. "It is something we are very concerned with." And within the House, finance minister P. Chidambaram, speaking in defense of the trust motion, rattled off statistics to show how great a job the government had done.

It has, if one goes by the number of social and economic programs announced. Major questions have arisen, however, on whether they have been implemented properly. It is also true that this government -- with reformers Singh and Chidambaram in its ranks -- has not made much progress on the liberalization front. Some political observers lay the blame for this on the Left, a conglomeration of several parties. A government beholden to it for support -- threats of withdrawing have been commonplace -- has had to fall in line.

Speeding up Unfinished Reform

Is this a golden opportunity? Will the next few months see a big-burst reforms agenda? Industry seems to hope so. The recent ASSOCHAM survey said 72% of 400 CEOs polled expected the government to speed up unfinished reforms in the pension, insurance and civil aviation sectors. There was some optimism on labor reforms, too.

Delhi-based economic daily Business Standard quotes government sources as saying that Singh will "expedite action on implementing the long-awaited reforms in the banking, insurance and pension sectors." Writing in the same paper, Jamal Mecklai, CEO of Mecklai Financial, a leading foreign exchange risk management consultancy, says: "Having tasted the champagne bubbles of victory, we can be sure that [Singh] will forge ahead with the large slate of reforms that were held up."

Not everybody is uncorking the bubbly, however. "If you look at the different constituents of the UPA and even within the Congress, there is very little consensus on reforms," says Paranjoy Guha Thakurta, an independent political commentator, who until recently was founder-director of the New Delhi-based School of Convergence. "Like apple pie and motherhood, reform sounds very nice, but people are more concerned with inflation and food prices."

Adds New Delhi-based political commentator and former journalist Sumit Mitra: "The chances of a government rushing with reforms in the final year in office are generally bleak. They are particularly so in India at the moment, with a procession of state-level elections ahead. Besides, the Leftists, usually regarded as the biggest obstacle to reform, are not the only ones skilled at putting the clock backward. The Samajwadi Party, which now promises to fill the vacuum created by the Left, has quoted its price already."

"I doubt if we will see any quick-fire reforms," says Chakrabarti of ISB. "There is too little time until the next elections and they will be reluctant to take a gamble and start any controversies. Major reforms usually happen with a government which has a long enough mandate and not one in the last year of office."

What are the reforms that may get through without too much trouble? The sectors are:

* Insurance: This is one area where the MNCs are eagerly anticipating change. Nearly a decade has gone by since Parliament passed the Insurance Regulatory and Development Authority Act in 1999. Private sector players in the industry have finally begun making money. There is currently a cap of 26% on FDI in this sector. Chidambaram had earlier proposed that this be increased to 49% but had to back off because of opposition from the Left. He may now able to get this done.

* Banking: The government currently has 50% plus stakes in the public sector banks. The proposal is to allow dilution. Also, shareholders in these banks are allowed 10% voting rights regardless of their actual equity holding. This could change, allowing more mergers & acquisitions (M&A). FDI in banking is capped at 10%; this could be raised to 26%.

* Pensions: The Pension Fund Regulatory Authority Bill will be passed and a pension regulator appointed. This is the first step in the creation of new pension funds, which will compete with the monopoly Employees Provident Fund Organization (EPFO). However, the government is likely to keep the EPFO out of the ambit of the proposed changes. In time, however, it will have to compete in the marketplace as the Life Insurance Corporation is doing with the joint venture insurance companies.

* Privatization: Singh and Chidambaram advocate a 10% divestment in several public sector units (PSUs). The two leading candidates for public issues are Oil India Ltd. (OIL) and NHPC. Others on the list include Rashtriya Ispat Nigam, Manganese Ore (India), Nuclear Power Corporation, Railtel and Telecommunications Consultants India. The sale of 10% in OIL and NHPC could take place as early as September or October of this year.

* Telecom: The FDI cap may be raised from the current 74% to 100%. This was one of the issues that got in the way of the Bharti deal with MTN of South Africa.

* Atomic energy: Foreign entry may be allowed. Today, even the Indian private sector is barred from this strategic sector.

If all these changes take place, a flood of foreign money could flow into India. The country could actually meet the FDI target of $35 billion set by the commerce ministry. The key question, as Mitra points out, is whether the Samajwadi Party will play ball. One school of thought is that with the margin of victory at 19 votes rather than the one or two votes expected initially, the party may not carry so much clout. The reality will be apparent soon. One has only to look at how the UPA government placates the party.

The entry of the Samajwadi Party in a supporting role has introduced a new dimension into Indian politics -- the lobbying by, and influence of, the corporate world. Amar Singh, general secretary of the party, is close to Anil Ambani, the younger Ambani scion and chief of the Anil Dhirubhai Ambani Group. As is well known, he is feuding with his elder brother Mukesh, who controls the Reliance Industries group.

Amar Singh has been making various proposals to the government but insists that there is no quid pro quo for his party's support. Yet people have taken the list of demands -- made in letters and in personal meetings with Congress leaders -- very seriously. Mukesh Ambani, in fact, met the PM to present his side of the picture. This immediately attracted the ire of the Left. "The Prime Minister's office (PMO) should not become the conciliation office for warring corporates, however desperate the ruling party may be to retain power," the Communist Party of India Marxist (CPM) politburo said in a statement. "Corporate houses are openly in the fray to lobby their interests in the run-up to the confidence vote," the CPM added. The PMO issued a statement denying that the PM was involved in any mediation effort.

What has Amar Singh asked for that has ruffled so many feathers? First, he wants a windfall tax on oil company profits. This will affect Reliance and, to a lesser extent, the Essar group. Second, he wants the export-oriented unit status given to Reliance's Jamnagar refinery scrapped. This will force the company to sell petrol in the domestic market. The result: a huge loss as the public sector refineries get a subsidy which the private sector is not entitled to. (Reliance and Essar have practically closed down their petrol retail chains because there is no way they can make money.) Third, he made various suggestions about spectrum allocation. (Anil Ambani's Reliance Communications is one of the largest players in telecom space.)

"For all practical purposes, these letters could have been written by Anil Ambani himself. And Amar Singh is also very open about his friendship with Ambani," says Guha Thakurta. "There has always been corporate involvement in politics. Everybody knew it, but they didn't talk about it. It was in a wink-wink, nod-nod fashion. Today, thanks to Amar Singh, it is all out in the open. But I like it."

"I consider the increasing openness about the business-politics relationship to be a positive development," adds Chakrabarti of ISB. "Business has always played a strong role in Indian politics. But because of the very strong bias towards Nehruvian socialism, [businessmen] were never very publicly involved. Now, because of liberalization, there is a change in mindset. Business is no longer a dirty word. It is more acceptable and is present more publicly and transparently in politics.

"Even before independence, several businessmen like Jamnalal Bajaj and G.D. Birla were financial backers of Mahatma Gandhi," he says. "While no one questions their patriotism, they must have benefited by way of boycotts of foreign products etc. With Nehruvian socialism, big business had to take a backseat because it was not considered to be politically correct. Even in the Indira Gandhi era, business was viewed as some kind of semi-illegitimate activity and there was no political acceptance of the business class.

"But, like in every democracy, political parties in India, too, always took money from business houses. But it has always been in black money. The influence of business on policymaking has been huge in the past."

Chakrabarti cites a concern in some quarters that "because of the massive and disproportionate wealth that has accumulated in the hands of a few people, India may go the Russia way, where you have a few oligarchs who practically own the entire system. I personally don't see this as a threat. I feel that India is too large a market and it is difficult for a group of people to hijack the political process."

Business is one more element that has been added to the mix. And the number of such elements may be getting too much to handle. As the trust vote with all its allegations of buying MPs shows, you need to woo too many people simply to survive.

"In the future, India has to choose between political incohesiveness and economic growth," says Sumit Mitra. "If it continues to make too many concessions to too many regional and caste groups, or parties wedded to ideologies that are long past their sell-by dates, there is little chance of the country joining the super league of global economies in the foreseeable future. Its politics needs to be reformed before its economy."