Opinion - News Analysis

A crisis and an opportunity

Though India has been running a current account deficit (CAD), the magnitude of the deficit has remained well within manageable limits, thanks to the vigorous growth of invisible exports, remittances, and large inflows of foreign investments. But the situation is changing rapidly. With the slowing down of exports and rising net outflow of foreign institutional investment, the balance of payments deficit is set to increase even as reserves fall. The bulk of our current rese rves consist of volatile foreign investment in financial assets: these are therefore highly sensitive to changes in both domestic economic conditions and policy, as well as to changes in the international economic and financial environment. A large part of these flows are of dubious provenance and come through tax havens such as Mauritius and Cyprus which offer huge opportunities for tax arbitrage.

The prospect of increased foreign resource inflow, whether through borrowing, foreign institutional investment or direct investment, is hardly encouraging given the current crisis in the world financial system and the expectation that it will take some time for it to be resolved. External commercial borrowings (ECBs) on a significant scale and at reasonable cost will become more difficult to come. Whether we can get large enough loans from international organisations (the International Monetary Fund, the World Bank and the Asian Development Bank) is also uncertain. The ability to attract these loans and direct foreign investments depends on the purposes for which they are used, the country’s credibility with respect to efficient implementation and management of projects, and the capacity to earn a reasonable surplus over costs. On all counts our credibility based on past performance is quite low.

It is therefore important to gear policy to containing the CAD within reasonable limits by creating an environment that gives a strong inducement to export activity and for improving the capacity of domestic industry to compete with imports. The exchange rate policy must be guided by this objective. It is worth noting that the huge reserves accumulated by China, having been built from its export surpluses, are largely owned by it. Besides being far less dependent on foreign loans and volatile financial inflows, China is far better placed compared to India to launch massive programmes to stem declining growth rates of the domestic economy.

The other major problem is to find domestic resources to finance a large enough increase in public spending to stimulate the economy and revive the sagging confidence in the private sector without aggravating inflationary pressures. Given that the level of fiscal deficit in India is already high and that inflation is at levels that are far higher than acceptable, there are serious concerns about the ability of the government to balance the need for increased public spending on investment projects and on provision of relief to the unemployed, with the need to avoid aggravating inflationary pressures. The increase in oil and fertilizer subsidies and the write-off of agricultural loans will, of course, increase government spending, but these handouts will do nothing to stimulate economic activity. They will only increase the fiscal deficit, make the task of containing inflation and the CAD difficult, and minimise the extent of slowdown in growth. The importance of avoiding any increase in fiscal deficit cannot be over-emphasised. On the contrary, what we need, and need urgently, to do is to initiate credible measures to bring it down in a phased manner by reducing subsidies that have done much harm, and by curbing inefficiency, wastage and corruption in public sector Plan programmes.

A major factor contributing to high deficit is the unconscionably high level of subsidies, which do not serve the cause of equity and are in fact inimical to prudent and efficient use of resources. The pattern of petroleum product prices, besides giving hefty subsidies to the top 10 per cent to 15 per cent of the population, is inimical to energy efficiency and contributes significantly to atmospheric pollution and urban congestion. A large part of the fertilizer subsidy goes to meet inefficiency in production and distribution. Subsidised provision of agricultural inputs (fertilizers, canal water, electricity and credit) is sought to be justified as being necessary to help poor farmers and induce wider, faster adoption of technology. However, they are encouraging imprudent and inefficient use of available technology and inputs and contributing to over-exploitation of land and water. Subsidised credit creates huge opportunities for arbitrage by the well-to-do to borrow from institutions and re-lend to others, mostly the poorer segments, at high rates. The benefit of food subsidies accrues only to areas with a functioning public distribution system. The PDS is limited spatially and reaches only a small section of the rural poor.

Nevertheless, all political parties support subsidies as being necessary to protect the poor; they vie with one another in offering to widen their scope. They are reluctant to even consider reduction or rationalisation of subsidies that palpably do not serve the interests of the poor. In reality all of them use subsidies primarily to woo electoral support and retain power. It is time to recognise the harm this has already done. And persisting with this approach can seriously impede efforts to manage the present unprecedented crisis. It calls for political statesmanship of a high order to educate public opinion and to mount a strong and sustained effort to reduce ineffective and counterproductive subsides in a phased manner.

These efforts should focus on (1) automatic indexing of prices of goods and services provided by or through the public sector to reflect any rise in costs; (2) rationalisation of oil pricing; (3) measures to ensure proper assessment and prompt collection of dues from users; (4) improvements in operational efficiency through a combination of better governance, institutional reforms to ensure accountability for performance and phased elimination of subsidies to cover high costs of production and distribution coupled with incentives to improve efficiency. The dramatic turnaround in the performance of the railways shows that there is huge and realisable potential for improvement. Canal irrigation, electricity and fertilizer, and the rural credit system suggest themselves as obvious candidates for these reforms.

Equally important are measures to increase the efficiency of public spending, especially Plan outlays. These measures should include a more rigorous and objective scrutiny of the technical and economic viability of projects, disallowing major revisions in designs and cost estimates of projects, and tighter monitoring of implementation. A second measure should aim to effect a drastic reduction of expenditure on numerous, fragmented and subsidy-intensive schemes that are counterproductive; the emphasis should shift to evolving a broader policy and institutional environment to achieve objectives. A third area should involve rationalisation of rural development programmes and empowering elected panchayats and local bodies for effective decentralisation of planning and implementation. A fourth measure should ensure the setting up credible mechanisms, independent of the government, to evaluate the performance and impact of completed projects for greater accountability.

The potential to cut down avoidable waste and induce greater efficiency is large. Measures to exploit this potential will release substantial resources which can then be used to extend and improve the energy and transport infrastructure, basic social services, and social safety nets for the vulnerable and disadvantaged sections.

That all this poses a huge challenge is obvious. But the crisis is so large that failure to address the challenge can have serious, possibly disastrous, consequences. Tackling it calls for a sea change in the mindset and attitude of the government, the bureaucracy and the private sector. There is ample economic space to manoeuvre; the political space has to be cultivated. Whether that will happen in the required measure remains to be seen. We can only hope that the political leadership will rise to the occasion and show the courage and statesmanship to seize the opportunity for change that the crisis offers.

(Dr. A. Vaidyanathan is an Honorary Fellow at the Centre for Development Studies, Thiruvananatha- puram. The first part of this article was published on November 28.)

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