India: Delhi Dreams

In May, when India's left-leaning United Progressive Alliance shocked the nation by defeating the long-entrenched Bharatiya Janata Party, millions of rural poor who had backed the UPA coalition rejoiced. Investors, however, panicked, fearing that costly social programs would supplant the more conservative BJP's market-based reforms. The Bombay Stock Exchange dropped by more than 20 percent in four days.

UPA leader Sonia Gandhi, an Italian-born member of India's revered political family, moved quickly to quell investors' anxieties. Sidestepping a crisis, she abjured the prime minister's post and turned that job over to Manmohan Singh, a trusted former Finance minister. A champion of economic liberalization in the early 1990s, Singh in turn appointed market reformer Palaniappan Chidambaram as Finance minister. In a previous stint in that post, from 1996 to 1998, Chidambaram had overcome leftist protests and cut corporate, capital gains and customs taxes. As of late August, the Bombay market, buoyed by the appointments of Singh and Chidambaram, had risen almost 20 percent from its May 13 low.

Now Singh and Chidambaram, who have been dubbed the "Dream Team" by the press, must deliver. Gandhi's party, the Indian National Congress, leader of the UPA coalition, has promised a "New Deal" for the 650 million indigent Indians who live in the countryside and haven't benefited from India's economic surge; half earn less than $1 a day. At the same time, Chidambaram, 59, who holds a law degree from the University of Madras and an MBA from Harvard Business School, must attract foreign investment to create jobs by demonstrating that India will overhaul its antiquated, protectionist economy. Yet the UPA's 18-party electoral base opposes most reforms, including any weakening of India's strict labor laws and the privatization of state enterprises. The Congress Party opposes selling majority control of state companies.

Nevertheless, Chidambaram insists that the government needs to carry out privatizations to raise funds. In October the National Thermal Power Corp., India's biggest electric utility, is expected to haul in $1 billion by selling a 10.25 percent stake.

"Expectations are always too high when the Congress Party assumes office," Chidambaram sighs during an interview in his sparsely furnished office in New Delhi (see box). "Expectations are high because Dr. Manmohan Singh is prime minister and I happen to be sitting in this chair."

Maybe so, but Chidambaram's own ambitions are not modest. The Finance minister intends to reduce steep indirect levies on corporations, such as import duties and state sales taxes. Comparable taxes in China are barely a fifth as high. Chidambaram also is bracing to take on India's notorious bureaucracy. It takes 88 days to set up a business, compared with eight in Singapore. The Finance minister has proposed an investment commission, to be headed by an eminent businessperson or other nonbureaucrat, to facilitate foreign and domestic companies' efforts to go into business in India.

To revitalize the country's dilapidated, Raj-era infrastructure, Chidambaram must first reform a tax structure that is even more decrepit. Despite a population of more than 1 billion and the world's 11th-biggest economy, India has only 34 million tax filers -- only half of whom actually pay any taxes. The country's tax haul amounts to just 9.6 percent of its GDP.

Some observers suggest that grumbling from the left is mainly just noise, noting that even Communist strongholds like West Bengal and Kerala welcome foreign investment. But as he addresses economic shortcomings, the Finance minister must be careful to placate the UPA's more leftist coalition partners.

K.R.G. Nair, an honorary professor at New Delhi's Centre for Policy Research, paints this picture: "There will be turf wars between Congress and the Communists, but at a national level they will remain good though somewhat strange bedfellows. And they are not quite such strange bedfellows as they look, because they have a common enemy in the BJP, and the Communists don't want to be out of government again so soon."

As for the BJP, party leader L.K. Advani has cautioned the government "not to misread the people's fractured mandate as a decisive mandate." He noted in May that the Congress Party holds only seven more seats in the lower house than the BJP. The close vote, said Advani, showed that Indians expect Singh's government "to follow the path of maximum consensus, not only within the ruling alliance but also with the opposition."

Nonetheless, the government is following its own path. Chidambaram's June budget proposed raising limits on foreign investment in civil aviation, insurance and telecommunications. It was well received by investors. But leftists in the UPA, supported by the BJP, are vowing to derail the hike in the cap on foreign investment in Indian insurance companies -- the only proposal that requires new legislation. Their main fear is more competition leading to job losses.

"Chidambaram's hands are tied, his feet are tied, everything is tied," says Bibek Debroy, a director of the Rajiv Gandhi Institute for Contemporary Studies in New Delhi. "He believes in the market, but he's constrained on all sides."

Debt is one constraint. Fitch Ratings notes that India's budget deficit of $56 billion, or 10 percent of GDP, is "more than triple the 'BB' median." Interest consumes 51 percent of the budget. Thankfully for New Delhi, the debt is owned chiefly by domestic investors, who tend to be more patient than foreign ones; otherwise, India could face a Latin American­style financial crisis, says a development economist.

Chidambaram does have some wiggle room for pushing reforms, thanks to India's robust economy. It grew 8.2 percent in the fiscal year through March and is expected to expand a further 6.5 percent through this coming March. The Finance minister aims to hit 7 to 8 percent annual growth over his five-year term, though many consider that optimistic. Led by booming software and information technology businesses, services are driving growth: The sector's exports spurted more than 30 percent last year. One fortuitous by-product: India's foreign exchange reserves are $110 billion, almost three times what they were three years ago.

In urban areas like Bombay and New Delhi, life has been especially good. And nationwide GDP per capita increased from $1,800 in 1999 to $2,900 in 2003, and there has been a significant drop in overall poverty rates, even in rural areas.

It's not surprising that the BJP stood for reelection on its "India Shining" slogan. But what the party forgot is that the plight of the indigent in the countryside, though it may have improved some, is still miserable. One quarter lack clean water. The rural poverty rate was more than 30 percent in 2000 and was not far behind that in urban areas.

India's worsening unemployment rate -- despite a steadily rising GDP -- is frightening. Government projections show that even if the economy grows 6.5 percent annually through fiscal 2007, unemployment that year will be 11 percent of the workforce, or 45.6 million people. This reflects the flood of Indians reaching working age each year. At the end of 2002, 35 million Indians were without jobs, for 9.2 percent unemployment. Complicating matters: 44 percent of workers are illiterate, and 23 percent have only primary schooling.

"Getting people jobs outside agriculture is where the system has repeatedly failed," says Subir Gokarn, chief economist with domestic ratings agency Crisil in New Delhi. In a June speech at Stanford University, International Monetary Fund first deputy managing director Anne Krueger admonished those favoring a gradualist approach to reform in India. "Economic success is not a secret recipe known only to a few," she pointed out, noting that Singh's 1991 trade and finance reforms had improved private sector efficiency. "Bigger steps, taken more boldly, would bring correspondingly greater rewards," declared Krueger. "The solution is more-rapid growth -- not a switch of emphasis toward more redistribution. Poverty reduction is best achieved through making the cake bigger, not by trying to cut it up in a different way."

Chidambaram may be India's best baker of a big cake. He is strong-willed -- some say arrogant -- and believes utterly in his program and himself. "He's an old hand -- he has been in the job before and knows the reality," says Ashok Lahiri, chief economic adviser in the Finance Ministry.

Yet the Finance minister may have an Achilles' heel: his dealings with the UPA's leftists. His abrasive manner could hamper negotiations, say critics. But as he would remind them, in the 1960s he was "a trade union leader and a committed socialist." He says that wide travel and reading taught him the limitations of that ideology. "The other model, an open, competitive-economy model, has worked in more than 100 countries, and therefore it will work in India," Chidambaram says bluntly.

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Chidambaram to investors: 'India is a happening place'

Palaniappan Chidambaram enjoys chess. His hobby may come in handy as India's once-and-current Finance minister maneuvers to accomplish his goals while checkmating his leftist opponents, including those within his own coaliton.

The veteran politician and economic policymaker must find a way to sustain India's run of prosperity, push much-needed reform of its antiquated economic system and -- most critical -- create jobs for hundreds of millions of impoverished rural Indians who haven't participated in the country's boom.

To complicate matters, Prime Minister Manmohan Singh's left-leaning coalition government was elected with a mandate to help the poor. Chidambaram, 59, will need the support of socialist politicians, many of whom oppose such reforms as privatization and tax cuts.

Chidambaram is ready for spirited debate with his more left-wing colleagues. As he tells Institutional Investor, "I'm going to try to convince them, as I'm sure they will try to convince me, and we will reach agreement."

The new Finance minister spoke about his plans with II Hong Kong Bureau Chief Kevin Hamlin last month at his New Delhi office.

Institutional Investor: What are your priorities for the next six to 12 months?

Chidambaram: We are refashioning the priorities of the government and focusing on issues relating to governance. That translates to a focus on rural agriculture and manufacturing and on employment. The reasons are obvious: The bulk of our people are in rural areas and dependent on agriculture. Manufacturing is the heart of industry, and as long as manufacturing keeps ticking at a healthy growth rate, the industrial sector also would move at a healthy rate. And of course, the whole purpose is to ensure that there is gainful employment. Parts of the country are always affected by drought or some calamity, so we also have to provide a food-for-work program for the very poor. My responsibility is to ensure that tax revenues as projected are collected, allocated and spent in accordance with these priorities.

Is the new investment commission you propose setting up a key part of your plans to improve the environment for manufacturing investment?

The investment environment is very favorable. The flows in the current year -- the calendar year and the first three months of the current fiscal year -- are significantly higher than the corresponding period of the previous calendar year or fiscal year. The investment commission is intended to give a further stimulus to investment. The commission will be pro-active and outgoing, aggressively wooing investors in India and abroad. The idea is to seek meetings with boards of directors of major corporations or business officers, spending two or three hours with them, making a presentation on opportunities in India and inviting them to India. And in the Indian context, sitting with boards of directors and asking them what their investment plans are and helping them fashion the plans in a manner that will quicken the pace of investment.

We have figures that show investment intentions that are very large. And investment announcements are about 60 percent of investment intentions. But actual projects under implementation are only about 50 percent of the announcements. So if I can close the gap between intentions and implementations, we will have made quicker progress.

A Confederation of Indian Industry and McKinsey & Co. study shows that Chinese manufactured products are on average 28 to 33 percent cheaper than those made in India and that indirect taxes are a big part of the reason. What can be done?

I don't agree with the conclusion that manufacturing in India is more expensive than manufacturing in China. Perhaps China has a comparative advantage in some areas, but surely India has a comparative advantage in many others. Why would Toyota set up seven plants in India to manufacture everything from automotive parts to transmission systems to full motor vehicles? Having said that, I agree that we must improve the competitiveness of our manufacturing sector. This means lower cost of capital, this means better technology, this means better-trained technical and operative people, this means better management practices, this means adopting new systems to keep down costs. Today in the manufacturing industry, at least half a dozen sectors are as competitive as anywhere in the world. They include automobiles, pharmaceuticals, machine tools, light engineering goods and leather. They are as competitive as China or even better. In the course of time, textiles will be added to this list.

Will you reduce taxes?

We will have to put together a package of tax reforms. On the direct taxes side, we want to move to a central value-added tax; at the state level we want to have a value-added tax. At a state level we've set the deadline as April 1, 2005. At the central level it will take two or three years to go to one central rate. The second stage is to integrate taxes on services and on goods. We also hope to bring down customs duties progressively. We want to bring them down to Asean [Association of Southeast Asian Nations] levels. Very few people in India pay income tax. There are 34 million tax filers, but only one half pay income tax. We need to widen that and improve tax compliance.

You are widely known as an aggressive, strong-willed man, but because of that some experts wonder if you are the right person to persuade leftist factions in your coalition government of the benefits of foreign investment. Are you?

I'll be happy if somebody can take on the job of persuading the left. But at the moment it is my job, and I'm doing my best to persuade the left. They are my friends; I've worked with them before. I was a Finance minister in a government from 1996 to 1998 in which they had two ministers, so the Communist Party members have been my colleagues. I'm going to try to convince them, as I'm sure they will try to convince me, and we will reach agreement.

You are already having problems persuading leftists to raise the caps on foreign investment in the insurance sector. You also proposed raising limits in civil aviation and telecommunications. Can you persuade the left?

These problems are of different kinds. As far as telecom is concerned, the left acknowledges that we are only making transparent what is already here in a nontransparent manner. As far as civil aviation is concerned, the left acknowledges that raising it from 40 percent to 49 percent is no big deal. The most important of the three is insurance. That requires a legislative change, and therefore it is more difficult to negotiate. I don't think the whole equation between the government and the left can be reduced to this one point.

International Monetary Fund first deputy managing director Anne Krueger recently said regarding reforms in India that "bigger steps, taken more boldly, would bring correspondingly greater rewards." What's your view?

It's easy to write a prescription. The key is to implement it in the context of India. We are a democratic country, we have an elected Parliament, and there's a mandate from the people, which is complex. It has ushered in a coalition government, and I cannot ignore that mandate or ignore the realities of a coalition. A number of things are certainly desirable, but one must always look at what is feasible. However, that will only decide the pace of reform; it will not alter the direction of reform. Let's keep the two clear.

Your government says it won't privatize profit-making public entities. What's the logic of that?

That depends on the definition of profit-making. We've defined profit-making as meaning the ability to make profits on a sustained basis in an open, competitive market economy. Those companies will not be privatized.

Aren't those the companies you should be using to raise funds?

We said that we'd raise money but that we would always keep 51 percent. There's no bar to raising money. NTPC [National Thermal Power Corp.] is going to the market to raise money. [NTPC plans a $1 billion IPO in October to sell a 10.25 percent stake through underwriters Enam Financial Consultants, ICICI Securities and Kotak Mahindra Capital Co.]

India badly needs more funds to help pay down its huge deficit. The IMF's economic counselor and head of research, Raghuram Rajan, has recently said that "the fiscal deficit will come back to haunt India."

We are conscious of that. That is why we made the Fiscal Responsibility and Budget Management Act operative. The earlier government merely passed the act, but we made it applicable to restrain ourselves and to send a clear message to the rest of the world that we are committed to fiscal discipline.

Critics say your budget proposal to double rural credit in three years is a recipe for more bad loans.

The recovery rate of agricultural loans is as good as if not slightly better than the recovery rate of loans in industry and for loans given to self-help groups [cooperatives, typically in rural villages, that pool members' savings to pay for a local project]. The recovery rate is 98 percent. The critics don't look at figures and speak with an urban bias. We are not interfering with price, nor with the selection of borrower. We are simply saying, Make credit available to anyone who satisfies the criteria.

What is your message to foreign investors?

India is a happening place. India can absorb huge quantities of investment; India's human resources are outstanding. If we can combine technology and capital with our human resources, India will grow, and it is in the interest of the world for India to grow. The abolition of poverty in India will mean the reduction of the poor worldwide, because the bulk of the poor in the world live in India and Africa. So if the development goals of India are achieved, it is good for the world.