Commentary: India's Reform: So Far, More Peril Than Promise

Wherever he goes these days, Indian Prime Minister Atal Bihari Vajpayee proclaims the promise of a strong Indian economy. That's what he told the U.S. Congress on his recent trip to America. That's what he tells foreign leaders who travel to India to witness the high-tech miracle in Bangalore. And that's what Vajpayee told investors at a conference in New Delhi on Nov. 27. Steady and strong growth, pledged Vajpayee. Count on it.

The trouble is, no one is counting on such a performance from India--at least no one involved in the markets. The rupee is trading at record lows against the dollar, despite big foreign reserves of $35 billion. The budget deficit is stuck at 10% of gross domestic product. Foreign investment has dropped to about $2 billion a year. Inflation has more than doubled in the past year, and the stock market has lost almost half its value.

This is starting to look like a country in crisis, not one poised for a thrilling economic expansion. "Fat foreign exchange reserves are giving a false sense of comfort. The situation is critical now," says Subir Gokarn, chief economist of the National Center for Applied Economic Research in New Delhi. True, the economy should grow about 6% this year. But the feeling is that a few more scary events--another bad monsoon, a new swoon in the market--and confidence and investment could evaporate.

The sense of foreboding is especially great as India approaches the 10th anniversary of the start of reforms. In 1991, the ruling Congress Party, threatened with a balance-of-payments crunch, started the painful task of deregulating industry and stripping special interests of their privileges. The result was brisker growth and the flowering of the software industry.

DANGER. But the reforms have proceeded in a halting manner, and never produced the 8%-plus annual growth rates India really needs to relieve grinding poverty. Now, India is in an especially dangerous state: Enough reforms have gone through to inflict enormous pain on ordinary Indians. But not enough reform has occurred to give businesses and workers the flexibility and speed they need to make it.

Just look at what's happening in trade. India has lowered tariffs sufficiently to let cheap imports come in and compete for consumers' hard-earned rupees against locally made goods. The result has been a host of bargains for shoppers, but devastation for local factories. Since last year, China has been dumping goods from toys to chemicals into the Indian market at 60% of local prices. Small businesses are being decimated. In Navi Mumbai, an industrial suburb of Bombay, 1,000 factories have shut down.

In theory, the flood of cheap imports will force local businesses to restructure and get more efficient. But these businesses are hobbled by high costs--and no reform laws have been passed to lower them. "We are hampered by tough labor laws and high water and power bills," says Dinesh Parikh, chairman of the Navi Mumbai chapter of the Indian Merchants Chamber.

The big, bitter pill is labor reform. Laying off workers is all but impossible. That puts off foreign investment and leaves Indian industry hamstrung when it comes to serious restructuring. "Our economic policies have been a long road to nowhere," says Surjit Bhalla, manager of the $1 million Oxus Fund in New Delhi.

Industry is manacled by other archaic laws. Sanjay Bulchandani can't even count all the hours he spent trying to figure out the taxes his family window-making business owes. "The excise tax is so complex and arcane," he says, "that you need a PhD to understand it. The process adds 5% to your costs and wastes time." Multiply such expenses by all the thousands of small businesses that face them, and the capital lost is huge.

To be fair, the Indian government has recently awakened to the immediate dangers: It is trying to stem the flood of cheap imports. But fundamental labor reform or a simplified tax code? No such breakthroughs are on the horizon.

Meanwhile, agricultural and industrial growth are decelerating sharply. A few quarters like this, and India slides into recession. "We're sitting ducks," says R. Ravimohan, chief executive of Crisil, India's top rating agency. India still has great promise. But now it's the perils that loom larger.