Investments can be revived by improving long term-growth prospects. For this, reforms are needed on three fronts: creating a framework for sustained low and stable inflation, setting public finances on a sustainable path by tax and expenditure reform, and creating the legal and regulatory framework for a well-functioning market economy.
First, the government must ensure a low and stable inflation rate through fiscal consolidation, establishing a monetary policy framework, and creating a competitive national market for food. Initiation of reforms on these fronts will reduce inflation uncertainty and restore a stable business environment. Further lower inflationary expectations would increase domestic household financial saving and make resources available for investment.
Second, public finances need to be put on a sustainable path. India needs sharp fiscal correction, a new Fiscal Responsibility and Budget Management (FRBM) Act with teeth, better accounting practices, greater transparency and improved budgetary management. Improvements on both tax and expenditure are needed to obtain high quality fiscal adjustment. The tax regime must be simple, predictable and stable. This requires a single-rate goods and services tax (GST), fewer exemptions in direct taxes, and a transformation of tax administration. Government expenditure reform involves three elements: shifting subsidy programmes away from price subsidies to income support, a change in the focus of government spending towards provision of public goods, and a focus on outcomes through an improvement in systems of accountability. A focus on health and education outcomes, rather than inputs and expenditure must be a priority. Improvements in credit ratings, lower inflation, lower cost of capital, and greater business confidence that would ensue will yield short-term benefits in response to long-term initiatives.
Third, the government faces the task of putting in place the legal foundations of a well-functioning market economy for India. This must be a carefully executed project as it involves legislative, regulatory, and administrative changes. It involves both removing existing restrictions where there is no market failure and building state capacity to allow businesses to operate in a stable environment. This will help improve the ease of doing business. While product markets have seen reform in India, there is a pressing need to reform factor markets such as those for land, labour and capital. Reforming the financial sector would involve reducing financial repression through which the state usurps a large share of household financial savings, financial sector regulatory reform and changing the laws and regulations governing the flow of foreign capital into India.
Reforming the food market is a huge challenge. Restrictions on farmers to buy, sell and store their produce to customers across the country and the world imposed by Indian laws enacted in the 1950s and 60s have not been removed, even though restrictions on industry were removed long ago. Restoring economic freedom of farmers and allowing them to be part of a competitive national market is essential for controlling food inflation. There is a huge opportunity today for Indian agriculture to be transformed through creation of markets as well as state intervention in public goods such as rural infrastructure and training as well as setting up modern regulatory frameworks for warehousing and commodity futures. Rationalisation of subsidies on inputs such as fertilizer and food is essential. Government needs to eventually move towards income support for farmers and poor households, so that market forces are able to respond to changes in consumption and technology.