Gaps in reform process need action: Economic Survey

The following are extracts from the ``Issues and Priorities'' section of the Economic Survey 2000-01:

Current situation

The economy is currently at a difficult stage. Some problems of growth are likely to be faced in the coming year. Because of irregular rainfall for the second successive year, agricultural growth was low or absent in 2000-2001. Industrial growth seems to have slowed down and the sentiment for new investment has not improved. The problem is compounded by the persistence of high international oil prices and the slowdown of the American economy, which is likely to affect the rest of the world. Although the major industries of Gujarat have fortunately escaped the worst effects of the recent massive earthquake, the impact of dislocations on the growth process cannot be ignored. It is therefore essential that the unfolding economic situation be watched carefully. Measures need to be taken to instil confidence in the economy so that the growth momentum of the 1990s can be improved upon.

Despite the positive response of economic agents to reforms, identifiable gaps in the reform process continue to cloud the long-term growth prospects of the economy.

The key problem affecting the Indian economy is the persistence of high fiscal deficit at both the Central and State levels. There is need to bring down the overall Centre and States' gross fiscal deficit of 10 per cent of GDP. The persistence of the high fiscal deficit has reflected itself in an increasing share of debt service in the expenditure budget of both the Central and State Governments. Consequently, the ability of Government at any level to undertake significant public investment has been seriously eroded. This has led to a decline in demand for Indian industrial goods. The continued high borrowing, as a result or the high fiscal deficit has also kept real interest rates high in the economy. It is therefore difficult for private industry, both foreign and domestic, to undertake new investment with any degree of confidence.

Key problems

The changes in the components of fiscal deficit over the last decade give an indication of the reasons of as well as potential solutions to the fiscal problem. Gross tax revenues of the Central Government declined between the period 1980-81 to 1991-92 and 1992- 93 to 1999-2000 by 0.9 percentage points of GDP. This decline is primarily due to a fall in the indirect tax revenues by 1.6 percentage points. In contrast, direct taxes have increased by 0.7 percentage points of GDP. This rise compensated partially for the decline in customs revenues but was unable to prevent the overall ratio from declining.

Another significant factor in the current fiscal problem are the administered interest rates on Government pension and provident funds. The nominal inflexibility of these rates means that they have not varied with the rate of inflation, resulting in very high real interest rates on Government debt when inflation declined. With the decline of inflation (WPI) from an average of 11 per cent during 1990-95 to an average of 5.6 per cent during 1995-99, real interest rates on pension and provident funds jumped from and average of 1 per cent to 6.3 per cent.

Possible solutions

In the last half century, the Government's production activity has expanded along with fiscal deficit & dis-saving. At the same time, investment in public goods and basic physical & social infrastructure has been starved of funds and their quality has deteriorated. It is necessary to get the Government out of the business of production and enhance its presence and performance in the provision of public goods. Governments, with their elaborate bureaucratic structures, multiple layers of accountability and complex crosschecks, are unsuited to the demands of commercial production in a competitive, fast growing economy. This has been recognised in principle and a privatisation process initiated. Privatisation will allow the Government's capital expenditure to be allocated to public goods and basic infrastructure that is not commercially viable. A significant portion of the Central capital expenditure could be reallocated this way, if all public sector units producing private goods are sold to the public. The funds received from privatisation would also help in reducing the public debt incurred for setting up these units and will put the debt-GDP ratio on a sustainable path. Most importantly, privatisation would enable the competitive public enterprises to function effectively once again and would help them in contributing to the national economy.

The retention price system in fertilizer is one of the most anachronistic. Various studies have shown that depending on world prices, anything between 50 and to 75 per cent of the fertilizer subsidy goes to the producers. Several committees, such as the Hanumantha Rao Committee and the Alagh Committee, have recommended its disbandment. The sooner this is done, the quicker will normal market incentives for improvement in productivity of investment and energy efficiency come into operation. To minimise the effect on farmers, the prices of fertilizer and natural gas should move towards parity with international prices, through appropriate customs and excise duties. As the current price to farmers is close to the landed cost of urea, this is an appropriate time for aggressive action in this direction.

The coal and petroleum sectors also need to be deregulated so that fertilizer and power producers are free to use any energy input, domestic or imported. Deregulation of the coal and petroleum sectors will also ensure that domestic producers of these products face the rigours of competition on a fair and equitable basis. A competitive system will ensure that fertilizer and power producers get the best inputs at the most competitive prices.

A number of other reform measures need to be taken for ensuring that the profitability of farming is enhanced and that the rural poor share in the gains of efficiency and productivity improvement. The management of the food economy needs comprehensive reforms, including a change in the monopoly role of the FCI (Food Corporation of India) and in the administration of PDS. Food subsidies could be either channelled into guaranteed unskilled manual employment that is self-selecting (incentive compatible) or into a food or income supplement system (for the poor) using the latest smart card technology (including stored fingerprints). The sugar sector (including its inputs) should be decontrolled, removed from the PDS and the tax incidence on sugar manufacturing rationalised. Given the current surplus in production, these measures will ensure that the market price of sugar is close to the price currently being paid by the poor. In the long-term there will be a powerful incentive for increasing efficiency through economies of scale and scope.

Departmental enterprises

Many observers have noted the large size of the Government in terms of number of employees. Few, however, realise that this is largely due to the bloated size of departmental public enterprises (DPEs) whose staff are technically employees of the Government and are shown in budget documents as such. Many would say that this is quite apt as they are infused with the bureaucratic culture, subject to CAG audit and the political pressures of parliamentary oversight. This has resulted in massive overmanning of these enterprises (DPEs), a running down of capital and deterioration in service quality. The conversion of these departmental enterprises into companies is essential for infusing them with a commercial culture and subjecting them to market incentives and competitive pressures.

Downsizing Government

In contrast to the DPEs, downsizing of the Government administration per se, will not result in much, fiscal saving. The primary purpose of such downsizing is to eliminate bureaucratic controls and change the anachronistic command mentality still prevalent in the system. Accordingly, all employee positions of this nature must be identified and eliminated. For this to be fully effective and sustained, divisions, departments and ministries, whose primary purpose was to control and direct the economy, must be abolished.

Domestic reforms

Along with the application of competitive pressure, Indian industry must be provided the right environment for being able to compete. With the economic policy changes that took place in the 1990s, along with the worldwide changes that have occurred in the economic environment, it is essential for industry to become capable of restructuring on a continuous basis.

Measures to promote such restructuring include factor market reforms, an end to any remaining investment controls and provisions for progressive improvement in infrastructure services. These reforms will also help Indian industry in meeting the challenge of imports resulting from the removal of the remaining import restrictions.

These issues assume greater importance in the light of the industrial growth experience of the 1990s. The industrial policy reforms of the 1990s, opening of foreign direct investment, improvement in access to foreign technology, abolition of the MRTP and the phased manufacturing programmes led to an expectation of sustained higher growth in industrial production. After some exuberance in the mid-1990s industrial growth has slowed down. It is likely that his has happened due to the existing rigidities in factor markets. Capital remains locked up in sick enterprises due to dilatory bankruptcy procedures. Labour mobility is hampered by the existing labour laws and land utilisations by the Urban Land Ceiling Act and rent control laws. Consequently, resources in the industrial sector have not been able to move to more productive uses, in particular towards labour using employment generating industries, that could lead to higher industrial growth on a sustained basis.

In view of the many changes that have taken place, it is now quite possible for the Indian economy to attain an even higher growth path. However, as has been outlined above, crucial action is required in a number of key areas in order to obtain the full benefits of the reforms carried out so far. If these measures are accomplished in an organised manner in the near-future, it is quite likely that many of the latent energies would become apparent and a higher level of economic activity would emerge.

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