Reserve Bank's Report on Currency and Finance is not my favourite reading. But Rakesh Mohan, a colleague when I was in the finance ministry and a good friend since then, went on to be Deputy Governor of Reserve Bank; he sent me a copy, so I had to take it seriously. This is what I gathered from it, published in Business World of 22 August 2003.
A look into the past
Ashok V Desai
The Report on Currency and Finance (RCF) is not as a rule great reading. It is a model of Indian economics – table after table, with interspersed text repeating some figures from the tables – saying, basically, “This went up, and that went down.” But this time I received a personal copy, and with it, an admonition from Rakesh Mohan – “Read it carefully!” So I got down to it, and was suitably rewarded.
The reason for Rakesh Mohan’s note was probably that the RCF contradicted something I had said long ago. Growth slackened after 1996-97, more noticeably in industry. I had once attributed the turning point to the credit squeeze instituted by Manmohan Singh in 1995 after he feared that the economy was overheating, and that rising inflation would hurt the Congress in the general elections (he brought down inflation to a historic 4 per cent in the week before the election, but the Congress still lost). The RCF tries to refute me; it takes the view that overinvestment had made industry ripe for a slackening of investment by 1995, and that slower export growth and heavy capital goods imports tipped the balance. True; but when demand growth falls short of capacity growth in an industrial boom, demand for credit increases. The government has to make up its mind whether counteract the slowdown by pumping in credit, or to worsen it by tightening it. Reserve Bank decided on the latter. Cyclical factors were liable to cause a crisis; but Reserve Bank could have prevented, mitigated or postponed it, and it did not.
The core of this report is the chapter on the real economy; it compares the decades before and after the reforms. RCF separates the crisis year (CY) 1991-92, and takes the decade before and the 11 years after it. It shows that growth before CY was lower, but that the variation around the mean is so large as to make the difference insignificant. What I found interesting was that variability of growth increased in every sector in the 1990s except in agriculture and construction, but variation of GDP growth declined. Liberalization increased microeconomic volatility, but stabilized macroeconomic growth – perhaps because resources moved more freely across sectors.
The boom of the early 1990s saw a rise in corporate savings and investment as a proportion of GDP. After 1996-97, corporate savings fell, but corporate investment fell more, so reinvested earnings came to finance more of it. Intriguingly, companies also came to depend less on trade credit. Earlier, when banks used to follow more rigid rules of credit allocation, money redistributed itself amongst businesses through trade credit. Once banks became freer to lend to whom they liked and companies became more liquid, this redistribution declined. But the big story of the late 1990s is the rise in non-corporate savings and investment; the RCF has nothing to say on what is behind this.
One calculation shows that labour productivity in manufacturing increased an astonishing 45 per cent in the 1990s; even capital productivity increased 11 per cent. But most of these increases were wiped out by relative price changes; at current prices these increases shrank to 6 per cent and 7 per cent. The RCF does not give the source; it is probably the Annual Survey of Industries. The results are important and intriguing, and it is a pity the RCF did not choose to investigate them further.
During the 1990s, growth became increasingly biased towards services: industrial growth declined, and growth of services rose. The RCF tries to mitigate disquiet on this by saying that services that grew were partly services to industry. But when output of services is three times that of manufacturing, it is difficult to believe that most of the services were provided to industry; RCF’s classification is plainly wrong. It also argues that although some of the growth was because of Pay Commission awards of huge wage increases to government employees (the CSO measures their output by what they are paid). But in the Table (3.29) intended to show this, there is a mistake: for the three years affected by the awards, the growth in services is below that in both government and in non-government services; an average cannot fall outside the range of its constituents. The claim that the awards did not affect the long-term trend is, of course, true; but they did cause a misleading increase in growth during the BJP’s first years.
One of my concerns has been that the rapid growth in software exports would cause Dutch disease: that it would make traditional industries uncompetitive and lead to their decline. The RCF asserts that this has not happened; but the evidence of its happening is written all over it. Industry’s share in GDP has drastically declined. Tariffs on industrial consumer goods have doubled and those on agricultural goods have quadrupled since 1997-98. Merchandise export growth has been far lower than in South-east Asia. Despite the high authority of the Reserve Bank, its assertion does not become evidence. The RCF’s argument that the exchange rate is determined by the market is specious: Reserve Bank massively intervenes in the market, and determines the exchange rate. The reversal a year ago of the policy of steady depreciation is proof. It was a mistake; Reserve Bank should go back to depreciating the Rupee. If it does, I do not mind its continuing in the illusion that the exchange rate is determined by the market.