FROM BUSINESS WORLD OF 28 FEBRUARY 2008
Glorious past,
clouded future
The Government
of India puts out a small number of figures fairly expeditiously, amongst them
of industrial production, international trade, money supply, interest rates and
prices; figures of national income and balance of payments are not too delayed
though their quality is uncertain. The rest are released in monthly and annual
publications which come out with enormous and variable delays. As a result,
economic analysts keep trying to read sense into the few figures that are up to
date, and forget the rest. Hence analyses tend in general to be lopsided.
Once in a year,
however, the Government collects the most up-to-date figures at its command and
puts them out with some analysis; that is in the Economic Survey. Because it is published a day before the
presentation of the budget, everyone tends to treat it as a macroeconomic
review, and tries to infer from it what the budget would bring the next day.
But since revelations relating to the budget can be construed as breach of privilege,
finance ministry officials strenuously avoid giving any indication of what the
budget will bear. And they tend to present as rosy a picture of the economy as
they can – generally rosier than they should.
This year’s Economic Survey lives up to the
tradition. It boasts of an industrial resurgence, a rise in investment, benign
inflation, growth in international trade, fiscal consolidation, and the
launching of the Employment Guarantee Scheme. It mentions widening current
account deficit, but underplays it. The story it tells has been with us for
some years, and has often been told by private analysts. Its telling by the
finance ministry does not make it wrong; but neither does it make it
interesting. Intelligent people have a good idea of what is happening; what
they would like to know is what will happen next. There the Economic Survey is singularly unhelpful.
In particular, it is studiously silent on how the deterioration of the balance
of payments will play itself out, let alone what if anything the government
intends to do about it. This despite the fact that reserves are lower today
than at the beginning of the financial year – which implies that capital
inflows have not kept up with the current account deficit.
But depending on
the acuity and diligence of their nameless authors, topical chapters can throw
unexpected light on variables. For instance, the low level of inflation this
year is largely due to base effect. The summer of 2004 had seen inflation
shooting up as China’s appetite for commodities caused worldwide shortages, and
as oil prices rose. A year later, point-to-point inflation dipped because it
had been high a year earlier. Why cannot the government devise a measure of
inflation – and of other variables such as industrial production – which would
be swept clean of the base effect and give an idea of the real trend?
Although the Survey does not say so, its figures show
that industrial growth peaked in June last year, and has been drifting down
since. Although the gross classification does not define industries in a
meaningful manner, it is clear that the boom has been led by engineering and
chemicals. Textile products perked up after the dismantling of quotas by
industrial countries last month; but the upturn did not last long. Their exports
could not sustain competition against China; their growth fell to single digits
by the end of 2005.
It is sobering
to know that India’s export growth in all of the past three years has been
slower than the average of developing countries. The most worrisome feature of
the current boom is that it is not led by exports. Their growth has lagged
behind import growth; the difference makes the boom unsustainable. The current
account deficit is widening; at some point it must lead to erosion of reserves,
shrinking of money supply, tightening monetary conditions and an end to the
boom.
Alternative
scenarios can be imagined. For instance, most of the foreign investment has
been portfolio, and it has gone into a small number of companies whose
management and accounting practices foreign investors trust. Seeing all this
money flowing in and inflating the share prices of those few companies, other
companies may also improve their performance and begin to attract foreign
investment. Or as the wave of industrial investment adds to capacity, it may
outrun demand, industries may run into conditions of excess supply, and may
find markets abroad. Such scenarios cannot be ruled out; but some portents of
them must become visible before they become credible.
To sum up, the
economy finds itself in an uncertain and potentially difficult situation; what
one would have expected from policy-makers is some serious analysis of trends
and indication of how they intend to meet exigencies and mitigate the risks.
One looks in vain for this in the Economic
Survey.
Three Views of
the budget
The central
budget can be judged in three ways. First, it is an instrument of macroeconomic
management. The government’s spending comes to 15 per cent of GDP; its revenue
comes to 10 per cent. Its debt comes to three-quarters of money supply, and its
borrowings every year are five times the money raised by companies in the
capital market; in other words, if the government stopped borrowing, companies
could raise six times the risk capital they are raising now.
Its
macroeconomic impact is one way of judging the budget. But it is not the only
one. Taxes and expenditure create incentives and disincentives. These
essentially microeconomic impacts make the budget interesting to businessmen
and consumers, and on their account to the media.
Finally, the
budget is also an instrument of the ruling formation to serve its own
interests, Staying in power is the prime but not the only one. Enrichment of
politicians and their hangers-on is the other one; the candidates for elections
who declared crores each of assets to the Election Commission were not born
rich.
Macroeconomically,
there are four indicators to consider. The first is the growth rate. Everyone
loves a high growth rate; even the Prime Minister, otherwise a cautious
realist, nowadays hopes for long-term growth at 10 per cent. As the finance
minister said, growth is the solution for poverty. Growth creates productive
employment, and working people are less likely to agitate and get into scrapes;
a growing economy is more likely to be peaceful and orderly. GDP is expected to
grow 8.1 per cent this year – very good by historical standards, if not such as
to fulfil everyone’s wishes. A finance minister would like to bolster growth.
There are some signs that growth may be slowing down. In particular, industrial
growth has come down after the summer of 2005. The government should be worried
about the incipient slowdown.
Another is
inflation. It does not affect people on the average; but there will always be
people whose money incomes do not keep up with price increases; consequently,
they get poor – which they commonly attribute to inflation. There will be
others who get better off in inflation. But they are likely to keep quiet,
whilst those who suffer complain. So inflation often causes an increase in net
discontent; it reduces Gross National Contentment, that nebulous quantity that
Jaswant Singh invented just before he fell from power. The finance ministry’s
way of measuring inflation, in terms of year-on-year, point-to-point increase
in a price index, is not perfect; but however one may twist the figures around,
the conclusion is that inflation is around 4 per cent – high by world standards
but low by our standards. We passed through a burst of high inflation last year
when two things coincided – a commodity boom fuelled by China’s imports, and a
rise in oil prices. But both have eased. So inflation does not create any
pressures on policy at the moment.
The third is the
balance of payments. The government can print Rupees, and its subjects would
accept them as long as prices are not rising too fast. But foreigners would
not. If the government wants to keep foreign trade and investment moving, it
has to ensure that there is a market in which Rupees can be exchanged for
foreign currency and vice versa, and that the prices of currencies do not
behave too chaotically. It obtains the necessary control on exchange rates by
maintaining inventories of foreign currencies. And it must ensure that it does
not run out of foreign exchange reserves – which can happen if the balance of
payments is persistently adverse. Our balance of payments is going rapidly more
adverse; the government ought to be worried about it.
Finally, there
is the cost of finance, measured by the interest rate and the price-earnings
ratio. Cheapness of capital encourages investment; besides, the government
borrows considerable amounts. So it would like the cost of capital to be as low
as possible. The cost of government borrowings has been creeping up over the
last year; mortgage interest rates have begun to rise more recently. This marks
the end of a period of falling interest rates which coincided with the rise in
exchange reserves and the concomitant rise in money supply. So it is reasonable
to think that the rise in interest rates is connected with the worsening
balance of payments.
Looking at all
the factors together, the deterioration of the balance of payments emerges as
the strongest threat to sustained growth. It could be addressed by taxing
imports; but such taxes also raise the cost of value-added exports and are
therefore inadvisable. The best thing to do is to use the budget to disinflate
the economy, either by raising taxes or reducing expenditure. Although the
finance minister has budgeted for a small decrease in the ratio of fiscal
deficit to GDP, it can hardly have much of a macroeconomic impact. If the
finance minister had for two years given every ministry just the money it got
last year, he could have achieved fiscal surplus by next year, achieved
significant disinflation and gone far towards correcting the balance of
payments.
Let me now come
to microeconomics. The year began with a peak rate of 15 per cent; the finance
minister reduced it to 12.5 per cent. He is aiming at an ‘East Asian’ level;
that probably means 10 per cent. A reduction of 2.5 per cent was hardly worth
the bother; he should have gone on to his ultimate destination of 10 per cent
this year. With the new ‘countervailing’ duty of 4 per cent (which countervails
nothing), he has actually raised the peak rate to 16.5 per cent for importers
who do not produce excisable products. Besides, 10 per cent has no rationale.
The correct rate
to aim at is zero. If the finance minister had frozen expenditure for one year,
he could have abolished customs duties altogether. At that level, there would
be no discrimination against imports; and above all, the government would no
longer need to give exporters and others privileged access to duty-free imports
of inputs and machinery. All the bonded warehouses and customs officers and
harassment would become redundant. Even if the finance minister did not dare
espouse such a heretical view, he could have followed it in bits and pieces. He
has, for example, been reducing import duties on inputs into steel drip by drip
for the past two years. If he abolished duties on steel and its inputs at one
go, he would give a tremendous fillip to value-added engineering exports. And
the BJP raised agricultural duties to absurd heights; the finance minister
should at least have begun to bring them down.
The finance
minister very active in terms of either macroeconomic or microeconomic policy;
has he, then, been serving the political interests of his party efficiently?
That is nothing new, but politics is written all over the budget. There are
half a million villages in this country; taking electricity to 10,000 or
telephones to 17,000 can benefit only a carefully selected few. Gender
budgeting and Safai Karmachari Finance and Development Corporation are
gimmicks. Grants to Indian Telephone Industries and Heavy Engineering Corporation
are sheer waste; these were amongst the biggest failures, and should have been
closed down. Who needs a Special Tea Industry Development Fund? And who profits
from the Textile Technology Upgradation Fund? Why have our textile exports done
so badly after years of infusion from this fund? On the expenditure side, this is an old-style
Congress budget replete with handouts for hangers-on.
There have been
times in the past when I have deplored Mr Chidambaram’s bright ideas. So I
should this time welcome their absence. What I do miss, however, is the
penchant he – and his Prime Minister – displayed 15 years ago for rethinking
old policies, eliminating rents, introducing fair competition and imparting
dynamism to the economy. It is such breaking of old moulds that will raise the
growth rate, not this indiscriminate rewarding of the faithful and the
politically useful.
