It was five years ago that I made my first trip to India. The economy was buoyant, expectations of significant inward investment to develop schools, hospitals, roads and infrastructure were high.
The liberalisation of the markets in the early 1990s permitted limited foreign ownership in certain sectors of the Indian economy that had been highly regulated and protectionist. Progressively capital controls were relaxed allowing Indian business and individuals to invest overseas.
The inflow of foreign capital stimulated the economy and improvements in education supported the development of world class IT and software capabilities. India’s technology institutes are some of the best in the world and this capability, combined with outsourcing from the west, heralded a strong period of economic performance with India celebrated as a prominent member of the BRIC nations.
Manmohan Singh pronounced that 8-9% GDP growth was India’s ‘new cruising speed’.
The reforming zeal of the 90’s faded as India basked in economic success, capital controls were tinkered with, foreign investors continued to be shut out of key sectors, and as India began to believe the world investment community needed India and its growth, more than India needed FDI, protectionism came to the fore.
Vodafone’s Indian investment returns were famously attacked retrospectively, proposals for a new tax regime pricing much more value into the Indian Exchequer created uncertainty, and have recently been followed by a reversal of some of the earlier capital exchange control relaxation.
The capital control restriction limiting overseas investment by Indian’s panicked the international investment community who have quickly moved to protect holdings in India. The Rupee has seen a big sell off losing around a sixth of its value accompanied by stock market falls in the order of 25%.
The only real reformer in the current cabinet is Finance Minster Chidambaram, but he is increasingly a lone voice. With an election looming in 2014 political solutions look ever harder to come by.
What should India do?
The formula that propelled its renaissance in the 90’s after decades of stagnation should be revisited.
Get government finances in order, introduce the long awaited goods and services tax, and widen the very narrow existing tax base. Be bold and generous on capital controls and clear on the treatment of foreign investment.
Signal the long term goal is to remove exchange controls completely and stop trying to manipulate the currency market. Avoid punitive tax on investment capital and encourage job creation for the tens of millions of aspirational young Indian's who will need work.
As the economy improves remove the complex web of subsidies and distortions in market pricing that deter competition and innovation.
The world's largest democracy is in trouble, fixing it requires bold reform, the alternative is a retreat to stagnation.