But ongoing efforts by the government will be key to reviving private investment and sustaining medium-term growth. Specifically, economic policymakers must address the long-standing problem of over-indebted firms and under-capitalised public-sector banks – the so-called “twin-balance-sheet problem.”
To that end, many distressed companies have been forced to clean up their balance sheets under a new bankruptcy code that was adopted in December 2016, and more companies are likely to follow suit this year. Meanwhile, the government has also announced a large recapitalisation package (about 1.2% of GDP) to shore up public-sector banks, so that they can write down their stressed assets.
As these reforms take hold, Indian firms should finally be able to resume spending, and banks will once again be able to lend to the critical but currently indebted infrastructure and manufacturing sectors. India’s economic reforms have taken a long time to implement. But if they continue to be a success, they will provide valuable lessons for future leaders about the proper role of the private sector not just in India, but around the world.
In India, the private sector – and capitalism generally – evokes feelings of deep ambivalence. This is for good reason, given that India’s private sector still bears the stigma of having been midwifed under the pre-1990s “License Raj” – an era remembered for its red tape and corruption. To this day, some of India’s legendary entrepreneurs are believed to have built an empire simply by mastering the minutiae of India’s tariff and tax codes, and then manipulating them brazenly to their advantage.
Some of the private sector’s stigma was cleansed by the boom in information and communications technology that started in the 1990s. The ICT sector had developed by virtue of its distance from, rather than proximity to, government. Indian ICT firms adopted exemplary governance standards, were listed on international stock exchanges, and thrived in the global marketplace. And, by extension, they improved the standing of Indian capital.
But after that era of good capitalism, the stigma returned. During the infrastructure boom of the mid-to-late 2000s, public resources were captured under a “Rent Raj,” which put terrestrial rents (land and environmental permits), sub-terrestrial rents (coal), and even ethereal rents (spectrum) up for grabs. Moreover, the infrastructure investments of this period were funded by reckless and imprudent lending by public-sector banks, which often funnelled resources to high-risk, politically connected borrowers.
As a result, the Indian public concluded that majority equity holders (“promoters”) had little skin in the game, and that “limited liability” really meant no liability at all. And now that rapid technological change is threatening the ICT sector’s business model – providing low-cost programming services to foreign clients – even India’s “cleanest” capitalist industry is confronting governance challenges.
More broadly, one could say that India has moved from “crony socialism” to “stigmatised capitalism.” And under stigmatised capitalism, the prevailing zeitgeist has hobbled policymakers’ efforts to address the legacy of the twin-balance-sheet problem, which, in turn, has constrained growth.
Indeed, the mere thought that major shareholders’ debts would be forgiven at taxpayers’ expense has created political paralysis for years. After all, why should ordinary people bear the burden of fat cats who are laughing all the way to the bank?
Seen against this background, it is easier to understand why India’s economic reforms have taken so long to adopt, and why they have been so difficult to implement. At the same time that the government has had to resolve the twin-balance-sheet problem, it has had to ensure that promoters cannot regain access to their assets, driving up fiscal costs.
India’s early-stage experience with capitalism has lessons that other countries should heed in an age of rising tech giants. The Indian model, whereby public-sector-banks lent to private firms, proved so toxic and difficult to replace that public-sector bank ownership itself has lost much of its traditional socialist appeal. The irony is that after a long and bruising experience with crony capitalism, the best thing for India now might be more capitalism, starting in the financial sector.
This commentary is based on the just-released Economic Survey of India.
Arvind Subramanian is chief economic adviser to the Government of India.
Copyright: Project Syndicate, 2018.