Showing posts with label Economic policy. Show all posts
Showing posts with label Economic policy. Show all posts

Sunday, March 1, 2015

Economic Reforms in Budget 2015-16



Introduction

    The Union budget has many objectives and constraints. My basic criterion for evaluation of the budget, or any other actions of the government, is very simple. Does it help in bringing about a sustained improvement in the Welfare of the average person and of the bottom 40 per cent of the population in particular? That is, will the measures taken or announced result in higher per capita GDP and less poverty ten years from now?  As this requires better policies and institutional reforms related to sustained economic growth, employment creation and efficient welfare transfers to the 40 per cent, it boils down to an identification of policies and institutional reforms that will achieve these objectives. Institutional reforms as defined in the economics literature includes the laws, regulations and rules that define a framework of incentives under which economic agents, including government bureaucrats and ministers operate.

Macro, Fiscal, Monetary Policy

     As per the new GDP series economic growth has revived over the last two years. This has been accompanied by and partly driven by an acceleration of private consumption growth and an acceleration in growth of Gross fixed capital formation. Inflation as measured by the implicit price deflator for consumption has declined sharply. However, corporate output growth has lagged the overall recovery, partly because of global demand and excess capacity in certain tradable sectors. However, sectors like automobiles, housing and real estate linked more closely to domestic demand have also contributed to the slow recovery.

       The Govt’s commitment to Federalism was amply demonstrated by the abolition of the Planning Commission and National Planning that inherently inclines towards centralized, “one size fits all” approach to programs and projects.   The fourteenth Finance Commission (FC14) recommendation for “increasing  the share of tax devolution to 42 per cent of the divisible pool..” complimented this approach, allowing a return to the fundamental principles of Federalism outlined in the constitution.  As the FC took account of the revenues and revenue expenditures of the States in deriving the new devolution norms an equivalent amount of revenue expenditures earlier incurred in Plan schemes on State and Concurrent Subjects under the administrative control of States (Education, Health, Welfare, Poverty, Irrigation, Roads etc.) could have been eliminated from the Central Budget.  However the Central Government “has decided to continue supporting important national priorities such as agriculture, education, health, MGNREGA, and rural infrastructure including roads”. One consequence of this decision is that the time path of fiscal consolidation supported by the Finance Commission, in terms of both fiscal deficit and revenue deficit targets will be exceeded in the next two years (New targets for FD are 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18).
  Though many eminent economists support this decision to loosen fiscal policy, to stimulate demand, in my view a policy that adhered to the (earlier) fiscal targets through a greater reduction of revenue plan expenditures on State subjects, would have had a more positive effect on the economy and social welfare. This is primarily because it would have permitted a quicker easing of monetary policy in line with reduced inflation rates, giving a greater boost to demand for interest sensitive sectors like automobile, housing (consumer demand) and real estate (business).
   The budget speech indicated that Govt had signed the Monetary Policy Framework Agreement with the RBI. The agreed inflation target  of  less than  6%, will hopefully ensure an appropriate timing and phasing of monetary easing. The Govt’s intention to amend the RBI Act this year, to provide for a Monetary Policy Committee is one of the positive announcements in the budget speech.  My analysis indicates that the real repo rate is now at or close to previous peaks, and requires a reduction in the nominal rate by 1% to 2% points over the next 12 months. 

Subsidies & Expenditure

    In his budget speech the Finance Minister has proposed two new laws, which will help improve the efficiency of government expenditure and of government contracting and also reduce leakages and corruption (“malfeasance”). These include,
(1)       A procurement law and an institutional structure consistent with the UNCITRAL model.
(2)       A Public Contracts (Resolution of Disputes) Bill to streamline the institutional arrangements for resolution of such disputes
          The budget reiterated government’s welcome commitment to the “process of rationalizing subsidies” to create a “well targeted subsidy delivery” system that cuts “subsidy leakages, not subsidies themselves.”  The government also expressed its intention to bring in Mobile payments as a means of transferring subsidy benefits under the “JAM trinity.” There was however no indication of which subsidies would be rationalized after LPG, probably because it is political more appropriate to first work out a detailed implementation plan.
     The successful payment of govt scholarships through direct transfer to scholars bank accounts has encouraged Govt. to rethink how to ensure equal educational opportunity to all, irrespective of their financial situation. The budget proposal to create a “fully IT based Student Financial Aid Authority to administer and monitor Scholarship as well Educational Loan Schemes, through the Pradhan Mantri Vidya Lakshmi Karyakram, could be an important step in this direction.  However, it needs to be accompanied by two other shifts in Govts approach to Education. One, a shift from constructing and running Colleges & universities to regulating them more transparently & effectively and from Brick and Mortar Colleges to e-education that is digitally available in rural, hilly and remote areas.  
   The budget’s emphasis on social insurance for life, accident, old age health, assisted living and pensions also suggests the possibility of a new federal division of labor between the Central and State governments: The Central Government should focus on providing help to the poor & needy through insurance and other financial products that come under its purview, while the States are fully responsible for basic health, education, welfare, poverty & employment program that require an administrative set up down to the Panchayat & Nagarpalika level.  I hope the next budget will move more decisively in this direction.

Taxes

     FMs reiteration of the Govt’s determination to institute the GST  by April 2016, as a state-of-the-art indirect tax system, gives hope that this land mark tax reform will finally reach fruition and translate into efficiency improvements during the next two years.
    The FM also indicted to reform Corporate income taxation so as to make it competitive with other major Asian countries. Even though the effective tax rate in 2015-16 may increase marginally because of higher surcharges, a revenue neutral reduction in marginal tax rate to 25% along with a reduction in exemptions over the next 4 years , will contribute to an increase in competitiveness of modern industry & service sectors.
Reduction in the rate of income tax on royalty and fees for technical services from 25% to 10%, aligns it more closely with capital gains taxation and will strengthen voluntary compliance and reduce tax disputes.

Financial Sector

    The FM, in his budget speech proposed a number of institutional reforms that will help improve the transparency and credibility of the Indian Financial system and thus improve the flow of equity and long term debt form individual Indian investors into the formal financial system.  This in turn will help improve the efficiency of intermediation between savings and investment and thus improve the growth potential of the economy.
      The proposal to merge the Forwards Markets Commission with SEBI has been stymied by vested bureaucratic interests for decades.  A decisive PM-FM team has clearly helped in clearing this proposal to modernize the regulation of commodity forward markets and thus ensure that farmers truly benefit from forward markets in agriculture.  Enabling legislation, amending the Government Securities Act and the RBI Act is proposed in the Finance Bill, 2015
The setting up of Public Debt Management Agency (PDMA) to manage Govt’s internal & external debt has been approved by the Govt. Such an agency was first proposed in the late 1990s early 2000s to take over this function from RBI so as to remove the conflict of interest with RBIs primary one of monetary policy & financial stability. There was so much resistence in RBI that even the report had to be buried in a file. The approval of this agency is another example of this govts ability & willingness to take quick decisions.
Other institutional reforms include the establishment of a  Financial Redressal Agency grievance redressal viz all financial service providers, a Financial Data Management Centre, a Financial Sector Appellate Tribunal, and a Resolution Corporation.  An Indian Financial Code (IFC) for integrating financial laws rules and regulations is also to be introduce in Parliament for consideration.

Agriculture, Infrastructure, Industry

        The FM also announced a number of initiatives for reforming the policy frame work for Agriculture, Industry and Infrastructure, which will facilitate productive growth:
(a)    “To increase the incomes of farmers, it is imperative that we create a National agricultural market, which will have the incidental benefit of moderating price rises.  I intend this year to work with the States, in NITI, for the creation of a Unified National Agriculture Market.”
(b)    “Ports in the Public sector will be encouraged, to corporatize, and become companies under the Companies Act.” As this is needed to both attract investment as well as leverage the huge land resources lying unused with them.
(c)      “The Government also proposes to set up 5 new Ultra Mega Power Projects, each of 4000 MWs in the plug-and-play mode.  All clearances and linkages will be in place before the project is awarded by a transparent auction system.    The Government would also consider similar plug-and-play projects in other infrastructure projects such as roads, ports, rail lines, airports etc.” Thought the “plug and play approach” has been suggested before, the emphasis on “transparent auctions,” will enhance public support and credibility of such projects.
(d)    “To have a common approach and philosophy in the regulatory arrangements prevailing even within the different sectors of infrastructure.  Our Government, therefore, also proposes to introduce a regulatory reform law that will bring about a cogency of approach across various sectors of infrastructure.” This another law that has previously been stymied by inter-departmental disagreements.
(e)     “Bankruptcy law reform,  that brings about legal certainty and speed, has been identified as a key priority for improving the ease of doing business. We will bring a comprehensive Bankruptcy Code in fiscal 2015-16, that will meet global standards and provide necessary judicial capacity.  It was incredible that a New Companies Law did not address this issue properly and focused on issues peripheral to the healthy growth of modern Companies.
(f)     “Expert Committee to examine the possibility and prepare a draft legislation where the need for multiple prior permissions can be replaced with a pre-existing regulatory mechanism”
(g)     “Expert Committee for this purpose to examine the possibility and prepare a draft legislation where the need for multiple prior permissions can be replaced with a pre-existing regulatory mechanism”

Conclusion
   The 2015-16 budget lays out a substantial agenda of policy and institutional reform, as well as administrative and procedural improvements (not detailed above) that will help in accelerating economic growth to 8.5% and in sustaining it at that level for years to come. Some of the complementary reforms needed in land and labor laws, rules and procedures will of course be necessary to raise the employment elasticity of economic growth.
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Aversion of this article also appears in ET Blogs at http://blogs.economictimes.indiatimes.com/PolicyAnalysis/economic-reforms-in-budget-2015-16/
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Sunday, December 15, 2013

Reforms (2014-19) for Employment and Empowerment



Introduction

        What will the Indian Economy look like in 2020? The answer will depend on whether the next Prime Minister (PM) and Finance Minister (FM) understand what has gone wrong in the last 4 years.  In particular, it will depend on whether the leader of the house and PM understands the importance of putting the Indian Economy back on the path of sustained fast growth for providing productive Employment and job opportunities for all (particularly the youth). The speed with which India is put back on the fast growth track will also depend on the professional quality and credibility of the person appointed as Finance Minister.  A reversal of the governance failures and regressive tax changes during 2010-13 will help recovery in 2014-15.  Much more will need to be done to put the economy back on track of Welfare catch up with the World and sustained growth in an a weak un uncertain Global environment.

Closing Welfare Gap

The welfare of the average Indian had increased to about a third (1/3rd) of that of the average World inhabitant by 2010 and has stagnated since then. It is very important to understand that it is this gap between our per capita GDP (at PPP) and the World average, which results in our higher poverty ratios and is the main reason for the gap between our social welfare indicators and those of better-off countries(with a few exceptions). The fundamental objective of any Indian government must be to close the welfare gap of the Indian people with the rest of the World.  The next Indian government should aim to raise the per capita GDP level of India to 45% of global average by 2020. This requires a restoration of per capita growth to 6.5% (8% GDP) and a sustaining of this growth rate till 2020. This will generate economic opportunities and jobs for youth and begin to restore the welfare and dignity of the average Indian to the level of the average World inhabitant.

Setback

     During 1981 to 1991 the Indian economy grew in real terms at 2.1 per cent points above the average growth of the World economy.  The rate of growth of the Indian economy accelerated during 1992 to 2010 to 3.6 per cent points above the average growth of the World economy, because of the 1990s reforms. Since then, the real growth differential has collapsed to 1.2 per cent point.  The entire 2.4 per cent point drop in the growth differential can be attributed to domestic causes.  There are two broad reasons: One, deteriorating economic governance, including poor macro-economic management and the re-introduction of regressive rules, procedures and administrative practices (a la LPQ raj). Two, failure to introduce policy, regulatory and institutional reforms essential for sustaining  growth at the underlying growth potential of 8%.

Reviving Growth: Governance

        The next PMs top priority for his first two years in office must therefore be to restore the Indian economy to its long term growth potential of 8%+ (about 6.5% in per capita GDP terms) and to communicate the importance of this objective credibly to voters and the investment community.  An important determinant of credibility will be the Finance Minister selected by the PM to restore growth.  In a global environment marked by great uncertainty and risk, the FM must have the respect of the investor-investment community. This will ensure that the government’s program to restore growth gains immediate credibility.
   An improvement in day to day governance in terms of resolution of interdepartmental differences and speed of decision making within departments will help revive growth.  Three legislative mistakes, however, need to be corrected:
(a) Right to Education Act: Research has shown that the private non-profit sector provides education, of average quality equal to that of the public sector, at 1/3rd the cost. By requiring the NPOs to double or triple the salaries of teachers it will drive them out & do incalculable damage to the cause of education. These clauses need to be dropped.
(b) Right to Food Act: By ignoring the corruption in the PDS-FCI while expanding the provision of cereals to 2/3rd of the population, it does great dis-service to the hungry (1-3% of population) and to  wasted/ stunted/ “malnourished” children under 5 (7.5% of population).  The coverage of FSA should be scaled back to the 22% below poverty line (BPL) population and directed to eliminating hunger by seeking  them out in remote areas and identifying those hidden among the poor.  Govt. focus should be on eliminating the causes of child stunting-wasting, by improving sewage and sanitation and eliminating open defecation.[i]
(c) Land Acquisition Relief and Rehabilitation Act. The extremely laudable objective of fairness in compulsory acquisition of land has been converted into an expansive ecological and social agenda. Purely private voluntary land transactions must be removed completely from the ambit of this law and the enormous bureaucratization of rules and procedures rolled back.

Reforms for Sustaining Growth

    Among the reforms that can restore growth to 8 per cent and sustain it at that level over decades are:
 (1) Macro Pivot:[ii] Scale back government consumption expenditures including subsidies and transfers, to bring Revenue and Fiscal deficits to zero in five years. This will reduce government debt, the Current account deficit and foreign indebtedness and raise the national saving rate, allowing RBI to ease monetary policy and stimulate investment and consumer durable demand without fear of increasing Non Performing Assets or inflation.
(2) Agricultural Reform: [iii]  Halt procurement price led inflation and massive overstocking of wheat and rice, repeal Agricultural Produce Marketing Act and Essential Commodities Act. Remove all restrictions on FDI in food retail.  Replace the policy of Ad hoc agricultural import-export bans by import-export tariff bands that offer transparent protection within limits. These & related reforms will reduce Indian food inflation to the much lower levels prevailing globally, and thus help control overall inflation.
(3) Infrastructure: Break up government monopoly in coal and infrastructure sectors, namely railway, ports, airports, electricity distribution and transmission (open access), convert into publicly owned Ltd companies and set up a professional independent regulatory structure to oversee free entry & benchmark competition in these sectors.  This will set of a cycle of self-sustaining infrastructure growth and productivity improvement.
 (4) Sell all Public sector units in industry and finance that are inherently competitive (steel, airlines, power/ railway equipment, hotels, machinery; banks, insurance). [iv]  Use the proceeds to reduce national debt. This will stimulate a surge in manufacturing productivity (as in 1990s).
(5) Repeal exit clauses in labor laws with existing employees grand fathered. Allow private competition in Employee State insurance (ESI), Employee Provident Fund (EPF) and other monopoly social schemes for employees.
(6) Empower the poor (including farmers) through a UID linked Multi application smart card containing all entitlements (food, education, health etc).[v]
(7) Focus Plan programs on five basic public goods & services, essential for bringing the entire country into the 21st century.[vi] (a) A quality National Road grid connecting every city and every village.  Highways/roads are the most cost effective stimulators of economic development. Roads & footpaths within cities and towns must be of quality expected of a middle income country. (b) A modern drainage, water supply & sewage system with water works, sewage treatment plants and comprehensive system for garbage disposal. In villages & habitations septic tanks and dry disposal devices would need to be implemented. Research shows that this will dramatically reduce disease and “malnutrition”. (c) Basic education (reading, writing & arithmetic) and Job skills (1/4500 recognized/certified) for every youth in this country. This will ensure that the rural & semi-urban youth are empowered to participate in a growing economy.  (d) Telecom (internet) connectivity for e-governance, public education, public health, development knowledge (agro/rural) and mobile banking to every habitation.  (e) Water & drainage Grid: Water planning, recycling, training and management for sustainable water use.
(8) Initiate fundamental political/electoral, police, judicial, legal and bureaucratic reform to address the issue of pervasive, systemic corruption and start restoring good governance.[vii]  Public safety & security is the right of all citizens as is “equality before law.” In the long term, “The rule of law” is critical to sustaining growth in a democratic open society. With good governance, we can even dream of welfare catch up with China!

Conclusion

       Such a program of reforms can sustain Indian GDP growth at over 8% (6.5% - 7% per capita growth) for the next two decades creating opportunities for youth and the emerging/new middle class, despite slower growth of World GDP and International Trade. It is not necessary to accomplish all the listed reforms within 2-3 years, though it may be opportune to take the politically sensitive steps within the first two years.  It is however essential to outline the broad direction of reforms and to take credible steps to implement them.

       A version of this article appeared in the Deccan Chronicle under the heading, "Next PM must have Ear for Reforms", ( http://www.deccanchronicle.com/131229/commentary-sunday-chronicle/article/next-pm-must-have-ear-reforms) and the Asian Age (http://www.asianage.com/cover-story/ear-reforms-next-pm-must-have-335 ) on December 29, 2013.

      A more detailed policy paper, "Reform Agenda for Growth and Welfare," Policy Paper No. 1/2014, New Delhi, January 2014 is at,  https://sites.google.com/site/drarvindvirmani/policy-papers .

[i] Virmani, Arvind, "Undernurishment of Children: Causes of Cross-country Variation," Working paper No.WsWp 4/2012, October 2012. https://sites.google.com/site/drarvindvirmani/working-papers and Virmani, Arvind, “The Sudoku of Growth, Poverty and Malnutrition: Lessons For Lagging States,” Working Paper No. 2/2007-PC, Planning Commission, July  2007. http://planningcommission.nic.in/reports/wrkpapers/rpwpf.htm .
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