RARELY has a year ended on such an upbeat note as 2005 did. With GDP growth of 8% and more in the first half of the financial year, on top of average growth of 7.6% in the previous two years, and with the stock market’s Bombay Sensitive Index reaching the dizzy height of 9,000 points (twice as high as when the Congress government came in), India has certainly (perish the thought) been shining. Interest rates are low, bank credit has been growing at more than 30% , and housing finance even faster. While inflation has been very moderate, there is new zing in manufacturing, and agriculture has been in recovery mode because of a better monsoon, while many service sectors (like banking, hotels and travel, and of course telecom and software) have enjoyed boom times.

Inflows of both portfolio and direct foreign investment have been at record levels (a combined total of about $17 billion). So, although the trade deficit (in goods and services combined) has soared because of an unprecedented oil bill ($40 billion, up by 40% ), the foreign exchange reserves have kept getting fatter. Even fiscal reform is beginning to show results: the combined deficit of the central and state governments will probably settle this year in the region of 8% of GDP, which is better than it has been at any stage since the 1980s.

It is hard to think of any period since Independence when all the macro-economic numbers looked this good. In a flash of exuberance, the prime minister even spoke in late November of aiming for 10% annual economic growth – surely more dream than reality just now, but a reflection of the buoyancy of mood all round.

So it is odd that 2005 was also the year in which the reform debate changed in tone and focus. P. Chidambaram, reformist finance minister in the 1990s mould, when given a podium these days, focuses not on labour reforms or privatization or the building of infrastructure, but on making sure that the poor are taken care of through health and education programmes. Manmohan Singh as prime minister tends to do the same. So does Montek Singh Ahluwalia at the Planning Commission. Sure, it can be argued that the time to focus on inclusive growth and the problem sectors is precisely when everything else looks good for the fortunately placed, and in any case the Congress had promised a shift of focus to the ‘aam aadmi’. So, whether out of conviction or because of the power of political swings, the reform trinity is now giving voice to Sonia Gandhi’s concerns.

To be sure, Manmohan Singh mentioned labour reforms and the need to improve the physical infrastructure, during his November-end speech to the India meeting of the World Economic Forum. And the finance minister, addressing the same forum, talked of getting more foreign investment. But these are still mostly in the nature of promises, and what is notable is the lack of substantial progress on the ground.

 

What is new on the ground? The rural employment guarantee programme, for one, has acquired the force of law. A new education bill is before Parliament, to force private schools to admit poor students without charge, up to 25% of their total student intake each year. And while job reservation has not been mandated for the private sector, affirmative action is an idea being seriously explored by industry chambers with their members, because they recognize that if there is no voluntary action, then legal sanction will surely follow. What will also follow in the wake of that other major step, the tribal rights bill, are ambitious social safety net programmes – entailing big ticket government spending. Note that not one of these ‘aam aadmi’ issues was on anyone’s radar screen before the Congress released its election manifesto in the summer of 2004.

And what has gone on to the back-burner in the year gone by? Labour reform, despite the prime minister’s lip service to the subject. Serious disinvestment too, on a scale that will make an impact (Sunil Mittal of Bharti told a conference that the government could garner Rs 90,000 crore by just selling Bharat Sanchar Nigam without reducing the level of competition in the telecom market). Also off the radar screen is addressing the subsidies in everything from power to petroleum products and natural gas, which are essential for both rational pricing and fresh investment in these vital areas. Plus the opening up of more sectors to foreign investment: promises with regard to the insurance and retail trade sectors are yet to materialize (though the government has delivered on telecom and civil aviation). Note that what have gone on to the back-burner are market-oriented measures. What have come in are large, new government spending programmes, and extension of the reach of government into new areas that have so far been part of the private, non-government domain. So it looks like a dual speed dance: slow when it comes to reforms, a quicker beat on ‘aam aadmi’ issues.

 

The effects of these changes in government focus have not been felt so far. Despite semi-paralysis on reform, the momentum created by the reform steps taken since 1991, good macro-economic management, a better monsoon and a favourable world economic environment have given the economy enormous momentum. The business picture, as a corollary, is almost rosy. Company profit and sales figures continue to reflect rapid expansion at rates of 20% and more, and now fresh investment has kicked in – both in previously unfashionable as well as cutting-edge sectors. At least three companies have announced mega-steel projects varying in size from six million tonnes to 12 million tonnes. Sugar could be another bonanza industry, now that the European Union has agreed to open up its market somewhat. Fresh investment in textile capacity has also begun to kick in. All three sectors have important linkages, backward and forward – so the spread effects are substantial. At the other end of the spectrum, new age businesses like handset (by LG, Nokia and Motorola) and chip manufacture (by NRIs in partnership with AMD) are being established in the country. Previously dull sectors like civil aviation have seen near-explosive growth (24% in international traffic), and getting a hotel room in any of the metros has become as difficult as finding a parking slot for a plane at any airport. As a sign of the times, hotel restaurants are full of blue suits once again.

 

In the first decade of the new century, therefore, India will do dramatically better than what was postulated in Goldman Sachs’ BRICs report. For although it forecast that India will be one of the three largest economies in the world by mid-century, it credited India with no more than 6.1% GDP growth in the second half of this decade. Though it should be obvious that long range forecasts can be completely wide of the mark, and that a lot of hard work and tough decisions are required for growth to accelerate to the new goal of 10% and then be sustained, there is no doubt that the ‘India story’ has been bought by international business like never before. One result is the clear ratcheting up of India in the list of priority markets for more and more large global firms, whose chief executives and entire boards come visiting in such numbers that the domestic press has almost ceased to take note even when the chiefs of such giants as IBM and HSBC come calling.

The economy at large has ignored the United Progressive Alliance’s slow-down on reforms even more comprehensively. A year-and-a-half ago, when the Left made its first noises about economic policy after the UPA government assumed office, the stock market tanked. The index fell by more than 10% before stabilizing. To be sure, share prices fell in many countries at the same time, so there were other forces at work; but there could be little doubt that the Left’s comments on subjects like disinvestment played an important part in unsettling investors.

Eighteen months later, everything that the Left said they would do, they have done. They have virtually stopped significant disinvestment in its tracks; and they have prevented the opening up of key sectors to foreign investment. They have also prevented pension reform and proper petroleum pricing. Under relentless pressure, the government has not addressed issues like labour market reform, while the new electricity policy has got nowhere because of the Left’s opposition to tackling the problem of subsidized power. The subsidy raj therefore continues to run unbridled, even as new spending schemes have been launched that will cost much more than the value they are likely to deliver.

 

In short, the worst fears that had been aroused by the Left’s initial declarations of May 2004 have come true and the expectations of what the UPA government can do by way of economic reform have reached minimalist proportions. The problem is not just the Left, of course. Outside of the reformist (and largely ineffective) trio that has been trying to steer the reform process forward, there is almost no one in the Congress who seriously wants pro-market reforms. Most politicians in all the major parties would be more comfortable with the soft socialism of times past – reflecting a near unanimity against the tough set of ‘Second Generation’ reforms that the small minority is keen on. So even if the Congress in its present avatar were to be able to shake off the Left and still survive in government, it is far from clear that the country would get more reform.

But with the economy booming, the mood today is dramatically different from the mild panic that set in, in May 2004. So no one is worrying overmuch about the Congress’ and the United Progressive Aliance’s populist policy thrusts. Equally, since the new laws and programmes are yet to take real effect, there isn’t yet much flowing by way of tangible benefits for the under-privileged. And yet, isn’t there legitimacy to the focus on the ‘aam aadmi’? For it is easy to get misled by the stories about the growing market power and reach of the middle class, when the fact is that this is still a tiny minority. The National Council of Applied Economic Research does an annual survey of households, and this tells us that barely 10% of households have life insurance cover – traditionally the first form of savings for anyone with a reliable income flow and with dependants. And medical insurance is available for barely 1% of all households.

 

There is worse to come. Only 2% of households use credit cards. Even that basic item in a middle class household, the refrigerator, exists in only a sixth of all households in the country (probably because barely 40% of rural households have a domestic electric connection!). The only items of truly mass consumption remain daily consumables like cooking oil and washing and toilet soaps, followed some way behind by shampoos. Among consumer durables, the ones used most often are not the stuff of contemporary middle class legend, and are either electric fans or bicycles. The first category sells about 37 million each year, the second about 25 million. In other words, what appears a normal lifestyle to the average city youngster working in an office, is completely abnormal for the majority, in both towns and cities.

From this, it is a short leap to yielding to C.K. Prahalad’s thesis, that your ‘fortune lies at the bottom of the pyramid’; in other words, the vast majority in India can only afford really low-cost goods and services. Certainly, the evidence of the mobile phone industry and of cable TV bears this out; both expect their customers to pay no more than a few hundred rupees every month.

 

The NCAER projections till the end of the decade do show that for almost any category of product the market will double in terms of annual sales. That’s because the size of the middle class will grow sharply in the coming years. But even conceding this, the NCAER projections are that, in 2009-10, the middle class will still be an island in a larger ocean of non-consuming classes: one in seven house-holds will have an annual income exceeding Rs 2 lakh. So, does Sonia Gandhi have a point? Or is the issue not one of desirable ends, but of questionable means?

The debate between the reformers and the populists on means, i.e. the appropriate strategy to follow, was fiercest on the employment bill, and it raged for more than a year. Those in favour argued that it was essential to address the problem of unemployment (especially since the statistics showed that the reform years had not expanded employment), and to directly tackle the problem of widespread poverty by providing income to poor families. Those against argued that such programmes had led to widespread leakages in the past – to bogus muster rolls, to under-payment, and to the failure to create lasting assets on the ground – with much of the leakage benefiting members of the political class. In short, it would be one gigantic boondoggle. The reformers in the government saw the dangers and tried first to delay and then to limit the scope of the programme, but failed because of Sonia Gandhi’s clear preferences.

 

In the end, we have a programme that could cost Rs 40,000 crore annually (about 1% of GDP), if not more: 100 days of work for each person in the programme, at Rs 100 per day, will cost Rs 10,000. If one member in every one of India’s 40 million families (20% of the total) that are officially below the poverty line enjoys the full benefit of the programme, the annual cost becomes Rs 40,000 crore. If you assume widespread leakages and fake muster rolls, as in the past, (remember that the number of BPL ration cards exceeds the official numbers of the poor) that figure could be much bigger.

Sonia Gandhi’s answer to the critics, as that of Jean Dreze and Aruna Roy (the two social activists who powered the employment guarantee law), is the Right to Information law, which is the second important piece of legislation to find its way into the statute books during the year. Roy has used such a law to good effect in Rajasthan to arrest corruption, misdirection and malfeasance in government programmes, though whether the results are state-wide can be questioned. Also, it is one thing to have a determined and accomplished activist achieve results in one state, and another to assume that such activism can be comparably effective in a programme covering 40 million workers across all the states in the country. Anyway, the new law is in place (to the chagrin of almost every bureaucrat in the country), and the spending has started and we will have to see what effect the first has on the second.

At this stage of the proceedings, it does seem simplistic to believe that the government spending 1% of GDP is all it takes to abolish age-old poverty in the land. More than simplicity, it could be reflective of a blindness to the dangers of programme miscarriage. But then, M.G. Ramachandran’s mid-day meal programme in Tamil Nadu, when launched in the 1980s, seemed similarly simplistic in its thinking and approach; yet it achieved dramatic results in terms of improving literacy in the state in less than a decade (children came to school for the meal, and picked up some education as well), and reducing the birth rate (more children survived for longer, so parents had fewer babies). So, who is to tell what the theory of unintended consequences might throw up in the fullness of time?

 

Meanwhile, consider the rate at which things improve in Indian society. The Planning Commission’s numbers on the percentage of people below the poverty line, showed a drop from 35.4% in 1993 to 25.4% in 2000 – a nine percentage point drop in seven years, or roughly 1.3 percentage points annually. Then take the literacy rate, which improved from 52% in 1991 to 65% in 2001 – once again, at the rate of 1.3% of the population every year. Move to life expectancy, and we see that it improved by 0.7 years annually, moving from 58 in 1991 to 65 a decade later – which actually works out to about 1.2% per annum on the base. In short, the average rate at which the key social indicators improve in the country works out to be slightly more than one percentage point each year.

This congruence just above the 1% number extends further. For India’s human development index (put together by the UN Development Programme) has gone up by 0.323 points, from 0.254 to 0.577, in the 30 years to 2000, which makes it an annual improvement of almost 1.1% of the potential maximum on the index. Turn to the UNDP’s Gender Development Index, and we see India’s rating move up from 0.250 to 0.563 between 1970 and 2000, which too makes it an annual improvement of fractionally more than 1% of the potential maximum.

 

What is interesting is that this 1% figure seems to hold fairly steady, irrespective of whether the economy is growing rapidly or slowly, whether it was the stagnant decade of the 1970s, or the more rapid period of the 1980s and 1990s. In that sense, the rate of progress in Indian society seems to be independent of the rate of progress in the economy – which then begs some obvious questions. Indeed, there has been some controversy about whether the rate of decline in poverty numbers slowed down or accelerated during the reform years. If one steers the middle ground in the argument, the conclusion is that the reforms made no difference at all. So while we may no longer have the Hindu rate of economic growth, perhaps we still have a Hindu rate of social change and poverty reduction.

What this tells us is that India’s (or, a slightly different proposition, the majority of Indians’) place in the sun will not be attained in the next five or even 10 years. Because while economic growth may have broken out of the 5.5-6.0% level that has prevailed now for nearly a quarter-century, and crossed the 7% barrier, the ‘tiger economies’ usually had better social indices when they took off with eight plus per cent economic growth. In other words, India needs to focus on its social indices (and of course its physical infrastructure) if the new economic momentum is to be maintained and then ratcheted up. Among many other things, you need healthy, literate workers if productivity is to improve.

 

The other point to note is that future improvements in the key social indices will depend fundamentally on improving the state of affairs in India’s most backward states of Bihar, Orissa, Jharkhand and the like. This is not impossible: Madhya Pradesh (including what is now Chattisgarh) showed fairly dramatic improvements in literacy in the last census. It boils down then to improving the quality of governance. Though the Prime Minister has tried to focus on the issue, the UPA government seems to have done little on this front while opening the door to more spending by malfunctioning governments.

At the conceptual level, the reformers would argue that the UPA policy thrust is misplaced because inequality levels in India are not out of line with global reality, when you compare the consumption levels of the top 20% of the population with the bottom 20%, or use some of the other standard tools for measuring inequality. China, certainly, is now widely reckoned to be much more unequal than India, but has fewer poor people because it has had faster growth for a quarter century. And as the Nobel laureate economist Simon Kuznets showed long ago, inequalities tend to increase in economies as they begin the process of development, and then level off or decline. So even if there is some increase in inequality as national income rises, this is what should be expected and indeed treated as normal. If that is the case, then the focus of policy should be on the growth- and productivity-related issues, on the ground that rapid growth will generate enough opportunity and upward mobility for the majority.

But that is precisely the argument that has not been bought by either Sonia Gandhi or the Left. And so, the promise of guaranteed employment has become law. The right to information too has just become law. And the right to education will soon become law, as will the tribal land rights bill. These are all big ticket issues, promising major benefits to millions. So whatever one may say about the UPA government’s report card on economic reform, its rapid record on legislation for social and economic empowerment is perhaps unmatched. If what follows now are country-wide pension schemes and other social security measures, then Sonia Gandhi will have made history, for this is her agenda. Such a record would even invite comparison with the Narasimha Rao government’s initial blitz on economic reform in 1991-93, and Indira Gandhi’s statist legislation in her 1969-71 phase: nationalization of banks, general insurance, coal mining and much else.

 

As those comparisons make clear, the question is whether this is the history we want. Those in favour argue that these are enactments meant to remove blots on the contemporary India story, and an economy growing at 7% a year can certainly afford such programmes. The nay-sayers argue that the fiscal deficit is already bloated, and in any case nothing can justify spending money if much of it will go waste – as they say it will. Those in favour counter that the right to information will provide a safeguard against that. The arguments are now familiar in the employment guarantee case, while the debate on education has barely begun – and could get just as fractious. It might be useful, therefore, to set the stage.

If you believe the government’s statistics, all children in the 6-11 age group have been enrolled in primary schools for at least the last three years (it was only 81% in 1990-91). And 72% of those in the 11-14 age group are enrolled in middle school (up sharply from 42% in 1990-91). At that rate of progress, we should have complete enrolment in middle school too, in another decade. That may be slower than the goals set for Sarva Shiksha Abhiyan (universal middle school enrolment by 2010), but a milestone nevertheless. The problem, of course, is with the statistics. For, if the drop-out rate in primary schools is 43%, how can middle school enrolment be 72%? In fact, the Abhiyan goal of universal primary school enrolment by 2007 (a goal already reached two years ago!) suggests that the government doesn’t believe its own statistics.

 

Against this backdrop, the education bill asks among other things that all schools (including government ones) be handed over to school management committees comprising primarily parents. It also asks all schools (including private ones – both those that take government aid and those that don’t) to reserve 25% of their seats for underprivileged neighbourhood children, who must be educated free of charge in their mother-tongue. These are doubtless meant to make under-performing government schools accountable to those with the greatest stake in education (i.e. parents), as also to break down walls of private privilege, for equality of opportunity is what every liberal society must deliver. The implicit assumption also is that private schools are better managed than government ones. That is only partly true when one looks at the statistics on children passing school board exams. The pass percentage of private schools is twice as good as for government schools, but then Kendriya Vidyalayas and Navodaya Vidyalayas do just as well, if not better. And since the drop-out rate is negligible in states like Kerala and Tamil Nadu, other states can learn from them.

Rajiv Gandhi had one answer to the problem: start Navodaya Vidyalayas to give poor children the education that the rich ones get. Sonia Gandhi, typically, has a more ambitious goal that reaches into the enclaves of the privileged: get poor children into the private schools. The debate will be: whose is the better idea?

 

Meanwhile, the equally lively debate on investment – who should do it, in which sectors, and how – has focused on key policy choices. Should it be in the Indian or foreign sector? And then, public or private? Those who might be called reformers would prefer a greater role for the private sector, both domestic and foreign. The Left, now the swing player for the UPA government, would want a ‘strong public sector’ and indeed primacy for it where possible.

This debate on rival approaches would benefit if it is grounded in hard facts. Investment is a question of cash; the question must therefore be, who has the cash to invest? If it is the public sector, then it can go ahead and invest as much as it wants. And if national savings are not enough for getting the growth rates that we want, then foreign investment must come in. We may have our preferences, but at the end of the day growth happens when investment happens.

Framed in this way, the facts are that the public sector accounted for as much as 20% of the total savings generated in the economy half a century ago, when the public sector thrust began. That figure remained more or less steady till 1980, when it was still above 18% of the total. Then began the great decline: to 5% in 1990, and now to minus 10%. So, if there is virtually no public sector investment taking place today, it is because the public sector has no savings, and therefore no money to invest – except what it can borrow. And most governments are already so indebted that their ability to borrow more is constrained. In sharp contrast, the contribution to national savings by the private corporate sector has gone up from 10% of the total to about 16% – close to the level of public savings before 1980. So the private corporate sector is ready and able to play a larger role. The bulk of savings of course continues to be accounted for by the household sector.

As long as the public sector remains as impecunious as it is now, it simply cannot take the leadership role in any capital-intensive sector. Indira Gandhi probably saw the problem coming when she nationalized the largest banks; indeed it was argued then that, after nationalization, the country could even get by without any income tax because the government would have so much of bank money to spend! Such crazy notions have long been forgotten (bank money belongs to depositors, not the government), but the question remains: if the Left and the UPA want an increase in the public sector’s role, where is the money?

 

One answer has been to marry the public sector with the stock market, so that private resources flow into public sector companies, while the government retains control (which suits the ministers and bureaucrats). Hence also the Left’s willingness to go along with 49% private investment in the non-navratnas. But the real solution would come from addressing the huge fiscal deficit: about 8% of GDP this year, if you take both the Centre and the states. The Left would argue that the problem can be licked by getting more tax resources, and there is some scope here – as the Kelkar reports have shown (but not by raising tax rates, because all that causes is evasion). There is also correction to expenditure – by lowering interest rates on government borrowings (which the Left has opposed because it won’t allow the provident fund rates to drop), and by cutting subsidies (which too the Left opposes). Finally, there is the business of getting better returns on the money that has already been invested in public sector companies. Outside of the oil sector (which still enjoys monopoly profits) and perhaps telecom, these returns are pitiful.

 

It would seem therefore that it is the reformers who are addressing the right issues: reform the public sector and if you can’t, sell it and stop the bleeding; cut subsidies and borrowing rates; improve tax policies and facilitate compliance; cut the deficit. All these would make the government/public sector more financially capable of spending more on health and education (which the UPA wants) and investing in key sectors, because the government would then have money to spare. But the way the Left wants it played, exactly the opposite will result. Which wouldn’t matter if the Left would allow private investors (Indian and foreign) to take up the slack.

On balance, it is hard to ignore the conclusion that the Indian economy would do much better, and everyone in the country would benefit, if the UPA government would focus more on (and deliver more on) market-oriented reforms. And the Sonia Gandhi brand of poverty reduction programmes would achieve better results if the governance and leakage issues were simultaneously tackled. As it happens, in an economy growing at 7.5%, both sides can have their cake and eat it too!