The new finance minister needs more than animal spirits to revive the Indian economy
Bibek Debroy, Economist & Author
PRIME MINISTER (and interim finance minister) Manmohan Singh has talked about animal spirits and their revival. That expression goes back to John Maynard Keynes and his 1936 book, General Theory. There are several ways in which Keynes can be interpreted. But the essence boils down to sentiments. Sentiment-wise, India was never perceived as an East Asian tiger. It was a lumbering elephant. With 6.5 percent growth in 2011-12 and 5.3 percent in the last quarter of the fiscal, the lumbering elephant has now become a squeaking mouse. Instead of 9 percent growth and 6 percent inflation, we have been reduced to 6 percent growth and 9 percent inflation. Surely, Greece cannot be the reason because other economies are growing fairly fast, despite Greece. When the global financial crisis hit us in 2007-08, the government argued that India was relatively insulated (unlike China), because of large endogenous sources of growth and because of clever counter-cyclical policies (read increased public expenditure) introduced by the government. Don’t forget, in 2010, Pranab Mukherjee received two different awards as best global finance minister of the year and now, in 2012, some segments describe him as the worst finance minister since 1991, and celebrate his departure from North Block. If a new finance minister, interim or otherwise, is to spiritedly revitalise the animals, we must figure out what went wrong and whether reversal of negative sentiments is possible.
First, there is the inflation story, distilled into its three components of manufactured, agro and commodities. With the exception of manufactured, monetary policy is singularly inappropriate to address other forms of inflation. What has caused inflation? The main reason is increased public expenditure, which has pumped in liquidity and increased demand. We can look upon this as a desirable objective, provided that supply-side changes are triggered by reforms, especially agro. But if supply is inelastic and there are no reforms, agro-type inflation is inevitable. Inelastic production has been compounded by an increase in transportation costs. With this great economic expertise within government, there is no reason why one should not have anticipated it in 2004 and pushed hard for agro reforms and below poverty line identification, so that poor, who deserve subsidies, are identified. There is not much point blaming states for not introducing agro reforms. There is plenty New Delhi could have done. Second, a prospective job applicant for the finance minister’s job has flagged two deficits (fiscal, current account). True, but no one disagrees fiscal deficits should be reduced. However, a deficit is a symptom, not the disease. There is not much point arguing that deficits should be reduced, unless we agree on how.
That brings us to revenue and expenditure. On expenditure, barring subsidies (read petroleum products), there is not much that can be curtailed. At best, we can control increases (read education, food subsidy). Therefore, it becomes important to increase revenue, either tax or non-tax. Whether non-tax receipts (spectrum, disinvestments) should be used to plug a deficit is a separate point. However, this (especially disinvestments) has stagnated. Had genuine tax reform — read Goods and Services Tax (GST) and Direct Taxes Code (DTC) — been introduced and all exemptions eliminated, there would have been additional revenue amounting to 5.5 percent of the GDP. (Read the revenue foregone statement that comes with Budget papers.) But neither GST nor DTC has materialised, because of the Centre’s inability to talk to the states. When they do materialise, they will be a far cry from their original intended forms. Meanwhile, one could have reduced discretion and standardised rates. None of that has happened and matters have become unnecessarily complicated because of policies like General Anti-Avoidance Rules (GAAR). Third, there is a simple point. Given revenue, one ought to prioritise expenditure. If a gap (deficit) is left, that increases interest costs and crowds out both private investment and consumption expenditure. As share of the GDP, investment has declined by 4 percent. That’s certainly going to be reflected in GDP growth. You don’t have to be a famous economist to figure that out. Public and private corporate savings have also declined and private household savings are being channelled into gold (treated as consumption in our national accounts).
There is not much point arguing deficits should be reduced, unless we agree on how
Let’s state this differently. Where does growth come from? It comes from greater use of inputs (capital, labour, land) or increases in productivity. Capital has suffered because of reasons just mentioned. We have always had problems with labour (education, skills, mortality, morbidity). That’s got compounded by labour shortages and high labour costs (effects of MGNREGA). Fourth, land access has become an issue because of acquisition problems. Add to that forest and environmental clearances causing problems in infrastructure (power, coal). In a simple framework, infrastructure will show up in productivity increases. Thus, the simple story is that input increases don’t contribute to growth, nor does productivity increase. No one is objecting to forest and environmental clearances. However, surely that clearance process can’t be open-ended and once granted, clearances should not be opened up with retrospective effect. Fifth, with all that economic expertise within government, shouldn’t one have anticipated this? The solutions to the growth problem lie elsewhere, not with the Reserve Bank of India (RBI). But since the RBI is the only organisation that seems capable of taking some action, tighten monetary policy. As mentioned earlier, monetary policy doesn’t address inflation. It makes growth worse. However, loosening the monetary policy doesn’t solve the problem either. There is plenty of liquidity in the system. People aren’t investing because of the reasons mentioned. Meanwhile, government spokespersons keep shooting their mouths off about growth and inflation and are invariably proved wrong, suggesting that the government doesn’t know what it is talking about.
SIXTH, WHILE there are reasons economists mention, there is another one that economists rarely mention. This is the complete collapse of decision-making within the ministerial and bureaucratic systems, compounded under UPA-2. RTI and scams have contributed to this. However, everything isn’t about mala fide decisions based on personal corruption. There are bona fide decisions too and the political system needs to insulate the bureaucracy from the consequences of these decisions. That has completely collapsed under UPA-2, both at the bureaucratic and ministerial levels, and rehabilitating the system isn’t going to be easy. Witness the collapse of the Cabinet, plethora of EGOMs and public squabbling among ministers. Seventh, therefore, this isn’t about high- profile reform decisions — FDI in multi-brand retail, pensions, civil aviation, insurance, banks and petroleum product pricing. That can be blamed on obstructionist allies, but not the rest. We have a complete collapse of governance, beginning at the top. Shouldn’t this have been foreseen when RTIwas enacted in 2005? If you accept this diagnosis, you will be forced to accept that there aren’t any miracles that will fix the system overnight and turn the mouse into an elephant. Yes, GAAR can be postponed and penalty and interest waived. Yes, some financial sector reforms can be announced. There might even be some movement on petroleum product subsidies. But licking the governance system into shape will require action outside North Block. At a provocative level, governance is administered by the government after accepting inputs from stakeholders, including NGOs. However, can governance be delivered by NGOs? In dramatised form, that’s the problem and that’s part of the reason why the 12th Five Year Plan (2012-17) document has still not been finalised. The Planning Commission has been reduced to poverty line estimates and toilets. The fact that we are still chugging along at 6.5 percent (or whatever the figure) is because quite a bit of action is at the state level.