Cut Spending, Boost Investment

After we had successfully tackled the effects of the  global financial crisis in 2009, the general euphoria led me to warn about four potential dangers.

    One, that sustaining growth would be a challenge. Two, a higher fiscal deficit saved us from growth collapse in 2008-09 and ensured faster recovery in 2009, but was politically addictive. It had to be brought back to the sustainable level reached in 2007-08 as soon as growth was restored. Three, food inflation was becoming more entrenched because of faster growth in income (demand), rising supply chain constraints and traditionally slow productivity growth. Agriculture, the only unreformed sector, needed decontrol of external and internal trade and land market.

    Four, capital flow volatility, which was known to display surges and sudden stops, had to be tackled by unconventional policy means. Capital inflow surges and exchange rate appreciation had to be allowed or countered, but capital outflow must be allowed unhindered, with the exchange rate allowed to depreciate.

    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.

    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 reform strategy successfully employed in 1991. This has two major aspects which are supplemented by confidence building measures.

    First, is to re-establish the macroeconomic balance using three interrelated policies. They are a reduction in government consumption and subsidies, and compression of revenue and fiscal deficits. This will allow a loosening of monetary policy, particularly through a reduction in medium- to long-term interest rates. An interest rate twist would be ideal, with very short-term interest held steady or increased. The inflation differential that led to a real appreciation of the rupee and undermined competitiveness has been corrected between Rs 62-65/$. Above Rs 65, the currency market is being driven by the misperceived response of the government and RBI to the earlier fall and the perceived inability of the government to act correctly and decisively.

    Second, is to revive corporate investment and growth. The following policy recommendations illustrate the magnitude of the policy reform thrust that is now required to achieve this aim. A dismantling of the government coal monopoly, the central government monopolies in infrastructure sectors like railways, ports, airports and state governments’ monopoly in electricity distribution (open access as per 2003 Electricity Act). A major political thrust on investment enhancing (as against vote enhancing) legislation is now required. The public is not convinced that the ruling party has made a credible effort to do so.

    Other reforms include correction of legal and administrative missteps taken by the revenue department in the last five years. Also, instead of waiting endlessly for Goods and Services Tax, it may still be worth introducing a proper central value-added tax, including services. The new direct taxes code is still awaited.

    These reforms need to be backed by measures to introduce transparency in the system and streamline processes. These include introduction of simple, transparent procedures for auctioning of mineral exploration and production rights, and for government land. Processes could be improved by setting up a professional, independent environmental protection agency and through a transfer of regulatory functions to it.

    Agriculture needs attention. The sector requires comprehensive liberalisation, with decontrol of imports, exports, internal trade and also that of land markets (leasing in and out of land; regulated sale-purchase of land in non-tribal areas). A fixed system of variable import and export duties on major crops should be devised within three months to balance interests of farmers and consumers.

    Rural fertiliser, electricity and kerosene subsidies need to be replaced by free solar lanterns and cookers plus Aadhaarbased cash transfers. FDI should be not just allowed but encouraged in all agricultural-based activities such as retail of agricultural food products, agrirural banking, insurance, including crop and weather. Government must eliminate taxes on processed food. The land acquisition Act must be purged of clauses that restrict the freedom of well-informed private parties to buy, sell and lease land for industrial purposes.

    These reforms must be complemented by measures to restore confidence in government and its weakened credibility. The confidence enhancing measures could include acceptance and subsequent action on election reforms to remove criminals from politics, state funding of elections and auditing of accounts under the aegis of Election Commission (MPLAD funds could be used here), police reforms including a new police Act to break the criminal-police-politician nexus, and legal and judicial reforms to improve respect for law.

    If the macro pivot and some bold policy reforms are not initiated, and conventional monetary policy continues, rising interest rates will trigger a further reduction in the growth rate and decline in stock market, while CPI inflation persists and rupee depreciation continues.

    ( The writer is president, chintanlive.org, and a former chief economic adviser. )