Background
After we had successfully tackled the effects of the global financial
crisis in 2009 (and before I retired from GOI[1])
the general euphoria led me to warn about four potential dangers:
(1) Sustaining growth would be a challenge heightened by global slowdown & disruptions.[2] Dormant policy reforms needed to be activated.[3]
(2) A higher fiscal deficit saved us from growth collapse in 2008-9 and ensured faster recovery in 2009, but was politically addictive. It must be brought back to the sustainable level reached in 2007-8 as soon as growth was restored(as it was in 2009-10).[4]
(3) Food inflation was becoming more entrenched because of faster growth in income (demand), rising supply chain constraints & costs and traditionally slow productivity growth. Agriculture the only unreformed sector needed de-control of external & internal trade & land market.[5]
(4) Capital flow volatility, with surges and sudden stops, had to be tackled by un-conventional policy means.[6] One had to counter capital inflow surges and exchange rate appreciation, but allow exchange rate depreciation on outflow.
There is no public information to show that the ruling party, government ministers, bureaucrats or economists took any of this seriously till late 2012. Since then appreciation and action have lagged the pace of economic deterioration, so that options that may have been available earlier have been closing one by one till the government and RBI appear to be boxed into a corner.[7]
(1) Sustaining growth would be a challenge heightened by global slowdown & disruptions.[2] Dormant policy reforms needed to be activated.[3]
(2) A higher fiscal deficit saved us from growth collapse in 2008-9 and ensured faster recovery in 2009, but was politically addictive. It must be brought back to the sustainable level reached in 2007-8 as soon as growth was restored(as it was in 2009-10).[4]
(3) Food inflation was becoming more entrenched because of faster growth in income (demand), rising supply chain constraints & costs and traditionally slow productivity growth. Agriculture the only unreformed sector needed de-control of external & internal trade & land market.[5]
(4) Capital flow volatility, with surges and sudden stops, had to be tackled by un-conventional policy means.[6] One had to counter capital inflow surges and exchange rate appreciation, but allow exchange rate depreciation on outflow.
There is no public information to show that the ruling party, government ministers, bureaucrats or economists took any of this seriously till late 2012. Since then appreciation and action have lagged the pace of economic deterioration, so that options that may have been available earlier have been closing one by one till the government and RBI appear to be boxed into a corner.[7]
Policy Action
What can the government (and RBI) do at
this late stage when one mini-crisis after another seems to be hitting the economy. What
we need is an updated version of the Expenditure Reduction-Expenditure Switching
cum Policy/Structural Reform Strategy successful employed in 1991.[8]
This involves the following:
(1) A
sharp reduction in government consumption, subsidies and transfers, to bring
down the Revenue and Fiscal deficits. Could be accompanied by a modest push to
accelerate productive government investment in bottleneck areas.
(2) A
sharp loosening of monetary policy, particularly through a reduction in
medium-long term rates. An interest rate
twist would be ideal, with very short term interest held steady or increased,
even though it is not sustainable for long.
(3) A
market led depreciation of the rupee to a stable level. Though a successful interest rate twist would
dampen volatility, it is not clear whether it is still feasible or sustainable for
much longer.
(4) A
major political and governmental decision, followed by an active push, to
dismantle the Government coal monopoly, Central government monopolies in
infrastructure sectors like Railways, Ports, Airports and States' monopoly in
electricity distribution (Open Access as per 2003 electricity act). A major political thrust on investment
enhancing (as against vote enhancing) legislation. The public is not convinced that the ruling
party has made a credible effort to do so (and that the blame, therefore lies
with the opposition party).
(5) A
full correction of legal and administrative missteps taken by the revenue
department in the last 5 years. Instead
of waiting endlessly for GST it may still be worth introducing a proper central
VAT (CENVAT) including services.[9]
(6) Introduction
of simple, transparent procedures for auctioning of mineral exploration and
production rights as also for land under the control of the central government
and in States under its control. Setting up of a professional, independent environmental
protection agency, and transfer of regulatory functions to it.
(7) A
comprehensive liberalization of the agriculture sector, with decontrol (permanent
QR removal) of imports, exports, internal trade and land markets (leasing in
and out of land; regulated sale-purchase
of land in non-tribal areas). A pre-announced system of variable import and
export duties on major crops would be devised within 3 months to balance
interests of farmers & consumers. Rural
Fertiliser, Electricity and Kerosene subsidies to be replaced by Adhar based
cash transfers to all rural residents (excluding census towns and income tax
payees). FDI to be not just allowed but encouraged in all Agricultural based
activities such as retail of agricultural-food products, Agri-rural banking,
insurance (including crop, weather).
Further to
restore confidence in government and its weakened credibility:-
(8) Acceptance
of (and action on), Election reforms
to remove criminals from politics (including fast track courts), State funding
of elections and auditing of accounts under ages of Election commission, Police reforms including a new police
act to break the criminal-police-politician nexus, legal and judicial reforms to improve respect for law (increase fear
of the law in potential law breakers and remove fear in innocents).
If the Macro-Pivot (steps 1-3) and some policy reforms (steps 4-7) are not carried out, and conventional monetary policy continues, rising interest rates will trigger a further reduction in the growth rate (from the latest govt. forecast of 6%) and decline in stock market while CPI inflation persists and rupee depreciation continues (despite higher interest rates).
A version of this article, titled "Cut Expenditure, Boost Investment" appeared on the editorial page of the Times of India on Friday, 30th August, 2013. http://timesofindia.indiatimes.com/home/opinion/edit-page/Cut-spending-boost-investment/articleshow/22144597.cms .
[1] As Chief Economic
Advisor in Ministry of Finance.
[2] The Sudoku of
India’s Growth, BS Books, New Delhi, 2009. www.business-standard.com/books.
[3] A menu of reforms
was suggested in the 2008-09 Economic survey in 5 separate boxes covering
different areas.
[4] The economic survey,
2008-09, Box on Macro reforms, suggested targeting 0 fiscal deficit by end
2010s.
[5] Economic Survey
2007-08 and mid-year review.
[6] Virmani, Arvind “Macro-economic
management of the Indian Economy: Capital flows, interest rates and inflation,”
Macroeconomics and Finance in Emerging Market Economies,Vol. 2, No. 2,
September 2009, pp 189-214.
[7] Notes at http://dravirmani.blogspot.in/p/macro.html,
starting from latest on top.
[8] India: Crises
Reform and Growth, Economic and Political Weekly, Volume XXXII, No. 32, August
9-15, 1997, pp. 2064-2068.
[9] Central Value
Added Tax: CENVAT, Economic and Political Weekly, Vol. XXXVI No. 8, February
24-March 2, 2001, pp. 630-632.
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