Whistling in the dark

By Prem Shankar Jha

There is just a sliver of a possibility that the government is getting ready to abandon its false optimism about the progress of the economy and do something to revive it. One good sign is that Mr. Yashwant Sinha has stopped predicting that this year's bumper kharif harvest will automatically revive demand. A second is the decision , taken apparently by the newly appointed Finance secretary, Mr. C. M. Vasudev, not to let the recently appointed chief economic adviser, Mr. Rakesh Mohan, resign from his post. Mr. Rakesh Mohan is known not only for his ability but also his forthrightness. His retention is, therefore, a small but important straw in the wind.

Mr. Vasudev's first public statement, after taking charge, that in India levying economic user charges for the plethora of products and services supplied by the State, and thereby swelling non-tax revenues, is by far the most important reform needed to bring down the fiscal deficit. The Finance Minister has also made it clear that there will be no postponement of the decontrol of petroleum product prices, that is scheduled for the next budget.

These signs of a new resolve have not come a day too soon, for the Business confidence index, weighted by the importance of the industry, has fallen to an abysmal 46.4. This is the lowest it has been in five years. To those who have been watching the economy closely this can hardly have come as a surprise. Last year the companies in IDBI's portfolio of investments suffered a fall in their net profit of more than 65 per cent. In May, the price-earnings ratio on shares had fallen to a six-year low of 6.72. It is even lower today.

If ever industry needed a shot in the arm it is now. For the home market is open to the fierce winds of global competition, and high quality consumer goods are flooding in to replace domestic manufactures. Manufacturers know that they have a far better chance of surviving if the home market is expanding, than if it is stagnant. Unfortunately for them the domestic market is not just stagnant but shrinking. In money terms, consumer demand grew by 7.2 per cent in 1999-2000, 4.2 per cent in 2000-01, and seems to have stopped growing altogether this year. In real terms, these figures mean that demand has actually been contracting for the past three years. The government's first task is, therefore, to revive demand.

There is only one sure way to do this: pump purchasing power into the economy in a way that ensures that the recipients spend their money and do not simply put it away in a bank deposit. But as recently as three months ago, there was no clear consensus on this. After he had held ten meetings with the leaders of various groups in society, when the Prime Minister, Mr. Atal Behari Vajpayee, summoned his panel of economic advisers to assess the validity of their suggestions, the majority of them warned him against taking this road because it might spark inflation and worsen the external payments deficit. Instead they advised him to stick to the well trodden path of lowering the interest rate and the cash reserve ratio in order to lower the cost of borrowing. This, they maintained, would stimulate hire-purchase consumption and revive investment. Add a good harvest, and all would soon be well with the world again.

Two rate cuts later, it is clear that if cheap credit could revive investment and consumption, then the credit is still not cheap enough. The reason, as some of us kept pointing out, was that the inflation rate was not 5 per cent as believed by the Government, but between 2 and 3 per cent. This was because the former was the rise in the wholesale price index, and therefore an index of the cost of manufacture. The real measure of inflation is the consumer price index, and this had risen by less than 3 per cent. That made the real rate of interest in the economy nine percent or more - by many orders of magnitude the highest in the world. No one was prepared to borrow money for investment in an uncertain market at such rates.

Today most of this conservatism has dissipated and the government is anxious to step up spending. But this has brought it face to face with an altogether unexpected and far more serious hurdle: the government departments have literally forgotten how to spend more. They are now so utterly entangled in bureaucratic red tape and so afraid of vigilance procedures if they cut any corners to speed up investment, that they simply cannot raise the rate of disbursement of money even if the country's life depended on it.

This is apparent from the fact that despite every exhortation to spend more, from the Ministry of Finance, and despite a genuine improvement in the pace of implementation of road projects, the overall level of government spending during the first half of this year is precisely what it was last year!

The contrast with China could not be greater. Faced with a 3.5 per cent fall in prices in the second half of 1998, the first it had ever experienced, the Chinese government did not think twice before adopting Keynesian measures to reflate the economy. The route it took was to speed up the implementation of its $1.2 trillion infrastructure development plan. By late June 1998, the Chinese government had approved 72 large and medium-sized projects involving an outlay of 124.5 billion yuan ($14 billion). Various State authorities had also approved and were preparing feasibility reports for another 308 project proposals with an investment of 446.2 billion yuan. The government also released money to speed up the implementation of projects that were already under construction. In September 1998, it issued $12 billion worth of treasury bills to finance the completion of infrastructure projects. In March 1999 Zhu Rongji announced another sale of treasury bonds of $18.2 billion for the same purpose at the tenth meeting of the National Peoples' Congress. China has continued to do so till today.

This policy yielded several immediate dividends. Investment in fixed assets rose by 22.7 per cent in the first quarter of 1999 over the same period of the previous year. The sharpest rise was in agriculture (122 per cent) followed by transport and telecommunications (46 per cent) and housing (35.5 per cent). GDP growth touched 8.3 per cent according to official statistics in the first quarter of 1999.

The driving force was industrial growth, which in value added terms grew by 10.1 per cent in the first quarter and 9.5 per cent in the first five months of the year. Within the industrial sector most of the growth occurred in the heavy industries.

India can not only emulate China but do the job better. China accelerated its spending but at the cost of a huge increase in sub-standard work and a good deal of corruption. New Delhi and the state governments, on the other hand, could identify a sizable number of incomplete projects - say the hundred most important and most nearly completed hydel and other projects - and take their completion completely out of the hands of the Central and State departments concerned, and invite a foreign partner to take over their completion on a BOT (build, operate, transfer) basis. As a token of its commitment the partner could be asked to invest, say, 5 to 10 per cent of the project cost. This could become the first charge on the project after it is completed. The balance of the resources needed could come from a specially created capital fund financed by the sale of treasury bills. This could become the second charge on the future revenues of the project. The capital already invested, which is in any case dead, could be treated as a subsidy given to make the services provided by the project affordable.

The fear that this may spark inflation is exaggerated, but in any case India needs an inflation rate of at least 6 per cent a year. This is because with the bulk of pension funds and other personal savings invested in provident funds and bank deposits more and more people now rely on a reasonable rate of interest to provide them with a reasoable income in their old age. Thus there is a limit to how far interest rates can be cut. While announcing the last round of cuts, the Reserve Bank of India Governor, Dr. Bmal Jalan, hinted that it may have been reached.

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