Economic Growth and Macro Stability: Budget 2016-17

Introduction

   Sustained fast growth of the economy requires a stable macro-economic framework,  policies that stimulate growth and institutions(including laws & rules) that support competitive self sustaining job creating business and promote employment opportunities. Though India's GDP growth rate has risen gradually to 7.6% in 2015-16 (estimated), parts of the economy are buffeted by global growth deceleration, capital market uncertainty and deflationary pressures. These have reduced nominal growth to 8.6% and put pressure on the globalised corporate sector, reducing the nominal growth rates of their sales and profits. The rural economy has been weakened by two consecutive droughts, the first such dual drought since the end 1990s.  In this note we review the budget to identify, what if anything the budget proposes to do about these issues.

Fiscal Balance

   The 2016-17 budget implicitly recognizes that a growth rate of 7.5% to 7.75% doesn't require an expansion of government expenditure or wide tax incentives, by sticking to the fiscal deficit (FD) target of 3.5% of GDP for next year. Such a panicked reaction that will haunt us for the next decade. The decision to stick to fiscal targets enhances the credibility of the government, reduces the risk of contagion from World turmoil & sudden stops in capital flows and lays the basis for a reduction in policy interest rates by the RBI. A reduction in the interest rate by 50 BPS will considerably ease the stress felt by the corporate sector by stimulating demand for consumer durables, including housing and automobiles. The proposed amendment of the RBI Act to create a Monetary Policy Committee will formalize flexible inflation targeting, enhance the credibility of the RBI and allow better Monetary-Fiscal policy balance. 

Subsidies & Investment

    When the fiscal deficit target for 2015-16 was loosened to accommodate more infrastructure investment by government. The question in our minds was whether the government would be able to shifting expenditure from consumption cum subsidies to investment. The fact that the Revenue deficit(RD) for 2015-16 is 0.3% point below the revised target suggests that it has successfully achieved an improvement in quality of government expenditures. As the revenue deficit is a rough measure of government dis-saving, this will help raise national savings and reduce dependence on foreign savings. The RD is projected to decline by only 0,2% point of GDP in 2016-17 compared to the 0.4% of GDP reduction in FD. This is partly due to wage pressures arising from pay commission report implementation, however the budget could have done much more on reform of the fertilizer, food and kerosene subsidy.  In the longer term the proposed bill to provide statutory backing to use of Aadhar for providing targeted benefits, will greatly improve the efficiency of subsidy expenditure and reduce leakages & corruption.

The adoption of Kelkar committee recommendations on Private-Public Partnership would also help in completing stalled projects and promote new PPP projects by reducing regulatory uncertainty. Among the proposals in the budget are, one a Public Utility Dispute resolution Bill, Guidelines for PPP re-negotiations if the external environment changes unpredictably and a Credit rating system for infrastructure taking account of special risks involved. 

Policy Initiatives

  There are a few notable policy initiatives in budget that will help improve the competitiveness of the economy, promote productivity and generate employment. The budget speech proposes to allow 100% FDI in food processing. Along with the previously proposed setting up of a National e-market in agricultural produce could be a game changer for agricultural marketing . For decades we have talked about the huge wastage of food because of lack of farm to market linkages and marketing. Recommendations of many weighty commissions have been received and implemented by Govt without much success. This is the only thing which has not been tried in India, though it has worked in other countries. According the FM 12 States have already amended their APMCs to allow them to join the E-marketing platform to be inaugurated in April 2016. This will set the stage for the FDI in marketing.

   The other measures announced in the budget, should tide the agriculture sector till the next monsoon, which is expected to be normal. The year following the last two consecutive droughts in the late 1980s, saw a jump of 16.7% in agriculture production. With a normal monsoon in 2016-17, we estimate an agricultural growth rate of 7% to 9%. The reform measures proposed in the last two years will help restore rural income, consumption & depleted savings.

The second significant reform is the proposed change in the Motor Vehicles Act to open up the passenger transport sector. Road transport falls in the concurrent list of the constitution but passenger transport has been declared a monopoly of the State Govts in most State. The proposed bill will allow private road transport companies to compete in States which adopt this change. This would allow a modernization of the sector, improving productivity and generating higher quality jobs.

The third significant reform proposal is a model law amending the Shops an Establishment to provide greater flexibility in operation to small establishments, subject to undiluted health & safety requirements. This will provide them with greater freedom and flexibility to compete with malls and other large establishment. This law too would require States to adopt it. The basic approach is to promote inter State competition in reforming laws and rules to promote employment.

Financial Sector

FM reiterated his intention to carry forward the financial reforms, such as Bankruptcy law (for non-financial companies) and proposed some new initiatives for financial firms and banks. The most significant long term reform was a Financial Firms Resolution bill. A number of changes were also announced regarding FDI in and taxation of Asset Reconstruction Companies (ARCs), DRTs, and Public Sector Banks which will expedite solution of the bad debt problem.

Conclusion

    There are were a number of small changes in the personal income tax, corporate tax, customs and excise duties. Some of these will help simplify the tax system while others will complicate the tax system. The net effect is a bit difficult to determine at this point. The budget also carried forward the effort to improve the system of tax administration and dispute resolution based on the recommendations of two tax administration reform committees. But the proof of the pudding in bureaucracy is always in the eating. Overall, the fiscal consolidation and reforms highlighted above make this good budget.
    I expect GDP growth to accelerate by about 0.2% points from the growth rate for 2015-16, and to be much better distributed across sectors & segments of the economy. In particular, rural economy will do much better,  with normal economy, I project an agricultural growth rate of 7% to 9%, based on past performance after two consecutive drought in late 1980s. The corporate sector is also likely to revive with a better mix of monetary-fiscal policy and improvement in the quality of the fisc with a shift from consumption-subsidies to infrastructure investment.
 

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 A version of this article appeared in the Indian Express of March 3rd, 2016, under the banne, "Race To The Top," at http://indianexpress.com/article/opinion/columns/union-budget-2016-race-to-the-top/ .

National Reform Agenda: Post Modi 1 year Update

Introduction

My January 2014 paper titled “National Reform Agenda for Growth and Welfare” proposed a reform agenda for the five years of the Government that would be formed after the General Election in May 2014.[i]  At that time, a number of pre-election Pols predicted that the BJP-NDA could be the largest party-coalition in the Lok Sabha, there was far from consensus on how far they would be from a majority. Thus the paper can be taken as an objective assessment, given the data and information available till that time, on what needed to be done. 

    A recent paper, titled “National Reform Agenda: Year One of Modi Government,” by the author, Evaluates the actions taken on the issues reaised and suggestions made in the January 2014 paper.[ii] There were three main sections in the Agenda(January 2014)[iii]: The Broad Objectives and aims, Reviving Growth by correcting the mistakes made in the previous four years, with particular reference to Governance, and Economic & Institutional reforms for putting growth on a sustained fast growth path. The paper, uses the same format and headings as in the earlier note, and considers each of the 15-16 sets of issues and suggestions. In each case the action taken by the Modi government is listed and commented on, followed by further suggestions. The first broad suggestion and the conclusions are reproduced here to give a flavor of the paper:

Objective: Closing Welfare Gap

Issue: Welfare Gap It is the gap between our per capita GDP (at PPP) and the World average, which (along with corrupt governance systems) results in our having higher poverty ratios and worse social welfare indicators than those of better off countries. The fundamental objective of any Indian government must be to close the welfare gap of the Indian people with the rest of the World.  This will require a restoration of per capita growth to 6.5% (~ 8% GDP growth) and policies to sustain this growth rate.  If we can sustain such growth for two and a half decades, Indian welfare levels will equal the rest of the world by 2040.

Action Taken: This government seems to understand the critical link between economic growth, employment generation and public welfare. This is reflected in the change in focus from “poverty alleviation” to “poverty elimination” and economic & technological development and employment creation as the principle instrument for achieving it. Another indicator is that it has adopted, as its principle foreign policy objective, the need to close the economic and technological gap with the rest of the World.

        The other issues and suggestions range from reform of laws passed in the last few years, to Governance and corruption issues and Policy and Institutional reforms to put economic growth on a sustained low inflation fast growth path. (for details see policy paper).

Conclusion

 The January 2014 paper suggested that, “It is not necessary to accomplish all the listed reforms within three years, though it may be opportune to take the politically sensitive steps within the first few years.  It is however essential to outline the broad direction of reforms and to take credible steps to implement them.”

  The government has taken action in virtually all the areas suggested by the paper. Thus we can say that it has taken credible steps to implement the suggested reforms. There are undoubtedly a few areas in which action has not been initiated, but this is to be expected from any government. Good progress has been made in a majority of areas, with one exception. The performance on income tax reform issues has been dis-appointing.  Government has, however shown responsiveness by responding quickly to widespread protests on what were seen to be backward steps.

   Inflation has declined sharply from 11% in Oct-Dec, 2013 to 5.3% in Jan-Mar 2015 (CPI2012). Both food (weight 0.39) and Core (weight 0.54) have contributed to this decline, with food inflation down from 14.7% to 6.4% and core inflation from 8.7% to 4.5%. CPI Fuel (weight 0.68) inflation has actually risen from 1.6% to 2.3% because of lags in pass through.

  Economic Growth has accelerated by 0.4% to 0.6% in 2014-5 relative to 2013-14: 0.4% in the case of GDP which approximates what was earlier called GDPMP and by 0.6% in terms of Gross Value Added(GVA) which approximates what was earlier called GDPFC. This is a little lower than what the author had projected, based on the old GDP series.[iv] However, the decline in Inflation is much greater than any analyst (including the author) had forecast. Thus inflation as measured by the Private consumption deflator has declined from 8.5% in 2013-4 to 4.6% in 2014-15 and inflation as per the CPI2012 base has declined from 9.5% to 6.3%. The global factors that have aided the fall in inflation are the same ones that have slowed the recovery of World GDP and World demand for tradable goods and services and thus contributed to the slower recovery of the Globalized part of the Indian Corporate sector.  Thus to the extent that success in inflation control can be attributed to global developments, the same developments also resulted in slower recovery of GDP growth. 

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[i] Virmani, Arvind, “National Reform Agenda for Growth and Welfare,” Policy Paper No WsPP 1/2014. https://sites.google.com/site/drarvindvirmani/policy-papers   

[ii] Arvind Virmani, “National Reform Agenda: Year One of Modi Government,” Policy Paper No. WsPP 5/2015: https://sites.google.com/site/drarvindvirmani/policy-papers

[iii] Virmani(2014) op cit FN 1.

[iv] We had projected an increase of growth rate of GDPFC of 1% +/- 0.25 ie between 0.75% & 1.25%. Thus the actual increase in GVA is a little below this range.

NITI AYOG

Introduction

     The “Yojna Aayog” or “Planning Commission” has been replaced by the “National Institution for Transforming India” or “NITI” for short.  From “Yojana” to “Niti” what is the difference?  First and foremost a sharp break from Soviet inspired National Development (Five Year) Plans to “Niti”, that is “Policy” and Institutional change for ‘transforming India’.  Para three of the cabinet resolution states that, we “require institutional reforms in governance and dynamic policy shifts that can seed and nurture large-scale change.”

Policy And Institutions

“Development” is one of those words that everyone thinks they understand but means many different things to different people. It covers a multitude of possibilities as well as a multitude of ideological sins and special agendas. The cabinet resolution constituting the Niti Aayog approvingly quotes Mahatma Gandhi “Constant development is the law of life, and a man who always tries to maintain his dogmas in order to appear consistent drives himself into a false position”. The Planning Commission took its first tentative steps towards “policy” 28 years ago, by creating a post of Advisor Development Policy. There was so much resistance, that the Advisor (yours truly) had to be designated Advisor-Development Policy Research.” Despite decades of effort, policy solutions always played second fiddle to increasing Plan allocations and expenditures without any ‘social benefit-cost analysis’ or ‘Macro-economic models’ to back the decisions.[i]

   Three other points in the introductory part of the Cabinet resolution setting up Niti Aayog are noteworthy: First is the assertion that “our aspirations have soared and today we seek elimination, rather than alleviation, of poverty” The second is the important role given to governance in achieving desirable social outcomes:  “The people of India have great expectations for progress and improvement in governance, through their participation. They require institutional reforms in governance and dynamic policy shifts that can seed and nurture large-scale change (para 3).” Subsequently there is an indication of how the institutional reforms in governance can be brought about: “Government and governance have to be conducted in an environment of total transparency – using technology to reduce opacity and thereby, the potential for misadventures in governing(para 6 g).”

   An EPW (2002) paper had raised the issue of corruption & governance and to bring policy-institutional reform into the development debate, to no avail.[ii] A debate on Poverty elimination, as against alleviation, was sought to be initiated in 2005-06 through a Planning Commission paper, but was stymied.[iii] It is therefore very encouraging that this is an important part of the mandate of the Niti Aayog.

Third, is the recognition of a changed reality of economy, society and Government functioning and its implications: “India needs an administration paradigm in which the government is an “enabler” rather than a “provider of first and last resort”. The role of the government as a “player” in the industrial and service sectors has to be reduced. Instead, government has to focus on enabling legislation, policy making and regulation (para 6a)” Many old style development planners refused to accept these changes ( even if they paid lip service to it), though this issue was raised first in 1990s & subsequently in the 2000s.[iv] A recognition of this reality by the Union cabinet provides a sound basis for closing the technology gap between India and Advanced countries, that is correlated with the large income gap between us. The reference to the role of Urbanization (para 6g) as an aid to technological catch-up, suggests an understanding of the links between technology gaps and per capita income gaps. This further links to Welfare gaps through the statement, “Equality of opportunity goes hand in hand with an inclusiveness agenda(para 8c).” The open discussion of the global environment and its two way interaction with India, also displays a degree of self-confidence vis-à-vis foreign countries (para 6c) that bodes well for building a competitive fast growing economy.

Niti Aayog

So what is the specific role of Niti Aayog in this changed environment: Its primary/central role is to, “Serve as a Think Tank for the Government”.. “to give “strategic and technical advice across the spectrum of key elements of policy. This includes matters of national and international import on the economic front, dissemination of best practices from within the country as well as from other nations, the infusion of new policy ideas and specific issue-based support.” (para 11). Several of us have argued for a long time, without much success, that the Old Planning Commission should evolve into a “Think Tank” with a primary emphasis on policy and institutions, rather than on expenditure programs and projects. By its bold move to abolish the Yojna Aayog and set up the Niti Aayog the new Government has set the stage for a wholesale transformation in this direction. Given the absence of any formal social benefit-cost analysis of programs and projects and the limited capacity for appraisal of outcomes, one had also suggested to the Deputy Chairman a decade ago that the Planning Commission develop a data base of best practices to guide future decisions.  It is hoped that a full fledged division will be set up in the Niti Aayog to translate this into reality, with all such information digitally accessible to experts and policy makers.

   Some of the specific objectives of the Niti Aayog are, at the level of generality of the Cabinet note, not significantly different from those of the Planning Commission or other organs of Government. However, the following objectives suggest a greater priority and emphasis on the issues mentioned in them: 

  1)    To design strategic and long term policy and programme frameworks and initiatives, and monitor their progress and their efficacy. The lessons learnt through monitoring and feedback will be used for making innovative improvements, including necessary mid-course corrections

   2)    To provide advice and encourage partnerships between key stakeholders and national and international like minded Think Tanks, as well as educational and policy research institutions

   3)    To create a knowledge, innovation and entrepreneurial support system through a collaborative community of national and international experts, practitioners and other partners

   4)    To maintain a state-of-the-art Resource Centre, be a repository of research on good governance and best practices in sustainable and equitable development as well as help their dissemination to stake-holders

   5)    To focus on technology up gradation and capacity building for implementation of programs and initiatives

      In the first of these, the emphasis on “lessons learnt” is very important. Experience confirms a great reluctance to modify or junk programs when they don’t work. Vested build up and become so strong that it becomes impossible to overcome them.

 In the second the emphasis on interaction with international think tanks and Indian educational and policy research institutions, though expected from a ‘Think Tank for the government,’ would be a departure for Indian bureaucracy.

In the third, the emphasis on support systems, rather than funds/subsidies is an important departure.

    The fourth reinforces what was said earlier about good governance and best practices and suggests that improvement in governance will be seriously pursued to improve delivery of government social & welfare programs.

In the fifth the recognition of weak capacity and need for “capacity building” for implementation is critical to success of all new initiatives and many failed/failing old ones. For instance Urban development won’t work properly, unless we train hundreds of Urban planners. Similarly, setting up of traditional “Bric and Mortar” educational institutions (as against e-learning/education) will be quite ineffective unless we have scores of highly trained professors.

Conclusion

   The abolition of the Yojana Aayog and its replacement by the Niti Aayog, by the new government, is a bold and long overdue initiative.[v]  It will help change the emphasis from Projects and programs to Policy and institutions, from expenditure inputs to real outcomes through better governance and from political disputation over Incremental allocations to new challenges and opportunities in a global environment. The discussion of India in a global context also reminds one of Gandhi ji’s saying, “Let the windows of my mind be open to winds from across the World, but let me not be blown away by them.” Like all new institutions, it will be an extremely challenging job for Niti Aayog to fulfill its high objectives.

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A version of this article appeared on the OpEd page of The Hindu of 18^th January 2015, under the banner,” The New Name of Planning”: http://www.thehindu.com/opinion/lead/niti-aayog-the-new-name-of-planning/article6799483.ece

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[i] When I first arrived at the Planning Commission I was shocked to find no sign of “Social Cost-Benefit analysis” (as against Economic appraisal/cost-benefit analysis), the original justification & Sina-Qua-non of “Project appraisal”. The “models” that were sometimes said to be used in Planning Commission were of US undergraduate level.  In 2000s we did commission 3-4 Indian think tanks to build macro/CGE models suitable for policy analysis, but these were quite separate from five year or annual expenditure allocations, which were done by traditional methods.  

[ii] Arvind Virmani, “A New Development Paradigm: Employment, Entitlement and Empowerment,” Economic and Political Weekly, Vol. XXXVII No. 22, June 1-7, 2002, pp. 2145-2154. https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxkcmFydmluZHZpcm1hbml8Z3g6MjQ4ODc3YWI2ZDcxZmE5NQ .

[iii] Arvind Virmani, “Poverty And Hunger In India: What is needed To Eliminate Them,” Working Paper No. 1/2006-PC, Planning Commission, February 2006.

[iv]  Arvind Virmani, “Size and Role of Government: Quality vs. Quantity of Intervention”, Indian Economic Journal,  Vol. 37, No. 4, April-June 1990; and Virmani(2002) op cit

[v] See, http://dravirmani.blogspot.in/2014/08/bharatiya-vikas-niti-sansthan-bvns.html for more on what will happen to planning and what  “Niti Ayog” may do in future.