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Economic policy -- I -- The interconnected aspects

P. R. Brahmananda

WHAT are the components of economic policy pursued by the government? Are they consistent within themselves? Or are they in conflict with one another? Is the current process of policy formulation the best for the country? Can a correct and relevant polic y emerge even without a satisfactory process for its formulation? Is there any economic theory behind the policy being pursued and its components? These questions have to be examined if the economy is to progress along optimal lines in the current contex t, given the constraints. These issues will be discussed in this and subsequent articles.

Economic policy consists of fiscal, monetary, exchange rate and trade policies. Under fiscal policy, we have the usual measures included in the Budget as well as other measures during the year affecting the fisc. Two aspects of the fisc are revenues and expenditures. Monetary policy consists of actions and measures intended to affect money supply and its growth rate, interest rates in the short and long terms, including the determination of the terms of lending to government, as well as the direct and i ndirect amounts of lending.

Exchange rate policy concerns actions and measures affecting the exchange rate directly and indirectly. Trade policy consists of import and export policies, including import and export duties. In the Indian economy, no single authority determines all the policies together. Though there is a Cabinet and an economic council to the Prime Minister, there is no continuous attention, from the consistency and efficiency angles, paid to the problems and various policy measures.

Fiscal policy is broadly under the Finance Minister, though he does not determine all the direct and indirect factors affecting the Budget and revenue and expenditure. Monetary policy is said to be the purview of the RBI. But the Finance Ministry has an important direct and/or indirect control over it. Interest rates are also under the purview of the RBI. But here, again, the Finance Minister has an important role, explicitly or implicitly.

Trade policy, insofar as import and export quantities are concerned, largely comes under the Commerce Ministry. But as far as the rates are concerned, the Finance Minister calls the shots. There are, of course, other aspects of government policies with w hich other ministries are concerned. Often, the policies adopted by them also affect the general economy and impinge on the fiscal and monetary situation.

We have first to put together the components of the current ongoing economic policies. In view of the diverse authorities formulating and announcing the same, an interconnected perspective is necessary. Looking to the government's pronouncements and poli cy actions in the last two or three years, the current economic policy frame may be characterised as consisting of the following components:

AForemost attention is being paid to industrial investment, and this is thought to be promoted by encouragement for leaders of business and industry. Incentives are also determined largely from this angle. The Prime Minister himself has a council of indu stry and business advising him. The Prime Minister's secretariat is actively involved in discussions on economic affairs. The Finance Minister himself is also involved and frequently consults leaders of chambers of industry and commerce. It seems that in vestment promotion is a common theme

AAgain, topmost priority is being accorded to attracting more external capital to the country, in general to all enterprises, though it is sought to be particularly channelled to infrastructure areas. In the beginning, the Government was very particular about encouragement of foreign investment in lines non-competitive with those favoured by domestic industry and business. Encouragement is afforded to foreign enterprise and capital increasingly in a larger and larger number of lines, including in insura nce and banking.

Foreign-based insurance companies as well as branches of banks may get expanded in the months ahead. The general attitude of government to foreign capital and enterprise has become more permissive and general.

AEfforts are being made to encourage domestic private enterprise and even foreign enterprise to involve themselves in the disinvestment and divestment process. These processes have not succeeded as well as expected. Hence, the policies also are becoming more and more permissive.

AIt is believed that lower tax rates and lower interest rates are conducive to larger investment in the economy. Lower tax rates are expected to yield more revenues through greater tax-compliance. Customs and Excise duties have been reduced and standardi sed. It is believed that these policies will help domestic production favourably. Lower interest rates are said to promote more of investment through reduction of interest charges in gross profits. Investment is deemed to be highly interest-elastic.

ARevenue augmentation measures are sought through expansion of tax coverage, especially through aggressive measures for increasing the number of returns, and through taxes and services. Higher tax rates are deemed to be against the interests of industry and business. Lower tax rates and lower interest rates are expected to provide a level playing ground to domestic industry and business.

AExpenditure reduction measures are no doubt constantly spoken about, though it is realised that this process is very difficult. Though proposals have been made to reduce government staff, subsidies and administrative expenditure, not much progress has o ccurred here.

AWhereas it is sought to give great encouragement to domestic investors, at the same time, encouragement is being given to takeovers and mergers. Such activities are now allowed for foreign concerns as well. It is believed that competitive efficiency wil l be promoted through takeovers and mergers because of economies of scale in production, management and marketing.

AOverall credit policy has been geared to help the private sector to obtain credit from banks and financial institutions at lower and lower interest rates.

AIt is believed that a bullish stock market is a powerful instrument for larger capital issues at home and for larger capital and financial inflows from abroad.

ATo keep the stock market more bullish than otherwise, encouragement is being afforded to mutual funds and banks, etc., to directly or indirectly invest more funds in the stock market.

ASince expenditure reduction and expenditure growth reduction are difficult, and it is not intended to raise tax rates, governments have to borrow more and more. This is recognised by the authorities, and it has been decided to borrow such funds at lower and lower rates of interest.

ASince, in general, the impact of the fiscal policies and credit policies would be expansionary in terms of money supply, and there would be pressures on domestic prices, it has been decided to import more goods from abroad at lower prices through reduct ions in import duties. Hence, trade policy is being pursued as an adjunct of potential anti-inflationary policy.

AThe removal of quantitative restrictions on imports and of the erosion of the negative list are intended to help the goal of keeping down domestic price pressures in the wake of heavy expansions in money supply.

ASince foreign financial funds are coming into the economy, it is sought to allow their monetisation, to keep down the exchange rate and make funds available with banks for lending to the Government. The Government now depends more on banks than on the R BI to fulfil its large borrowing targets. The banks too are keeping high their investment proportion in government securities.

AThe RBI is used as a first resort for placement of securities; at the same time, the RBI's monetary and liquidity policies are sought to be such as to provide sufficient liquidity and re-finance to the banks to enable the latter ultimately to buy up the government bonds. The RBI has opened new windows to achieve a suitable liquidity state in the markets so as to obtain the above result.

ASince trade policy is being viewed as an instrument for inflation-containment under conditions of fiscal and monetary expansion, the need for larger and larger reserves has become inevitable to help the country to be ready to use the reserves for import s. As reserves tend to be run down, it is sought to augment the reserves through millennium deposit inflow arrangements form abroad, even with special liquidity arrangements for the same, and though the interest rates are higher than otherwise.

The above constitute the chief components, according to this writer, of the economic policy current in vogue. It may be noted that whereas in previous regimes the central task of the RBI was to keep down the inflationary pressures through containment of growth rate of money, currently its responsibility has become that of a) creating such liquidity situation as to enable government to fulfil its borrowing targets and b) keep down interest rates from their potential natural levels in order to promote mor e of credit offtake and more of investment by the private sector than otherwise.

The task of inflation containment has been shifted to trade policy. The RBI has to see that the level of reserves is sufficiently high in order to enable the government to import or to allow imports in such quantities and such prices as to keep down the hypothetical inflation rate as would have emerged given the large amounts of government borrowing and the scale of monetisation of exchange inflows. At the same time, the RBI has to pursue a policy of maintaining the exchange rate at such a level as not to cause too high and unsustainable a current account deficit.