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| M Govinda Rao: Policy challenges for the year 2010 | | Since general elections are four years away, Centre should act now to meet fiscal challenges |
| M Govinda Rao / New Delhi Jan 05, 2010, 00:29 IST |
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The dawn of the new decade raises many hopes and expectations. Surely, the decade can belong to India and Indians if only the government can get its act together and create an environment for the “animal spirits” of the entrepreneurs to dominate. It is generally felt that growth acceleration since 2001 was mainly due to the spirit of the Indian entrepreneur and with a proactive policy and institutional environment, the growth prospects would be even better. Surely, the government will have to revisit serious policy and institutional reforms.
Although Indian economy has come out relatively unscathed from the global economic crisis, there are several policy challenges warranting attention in order to launch the economy into a sustained period of higher growth. Despite facing severe liquidity crunch and shrinkage in exports, India recorded impressive growth during the period. For the current year, the better-than-expected last quarter growth of 7.9 per cent has prompted observers to revise growth forecasts upwards and most believe that the economy will record at least 7 per cent growth. This shows the resilience of Indian economy.
Going forward, it is necessary to take the economy to high growth path for a sustained period of time and ensure that the excluded sections participate actively in the market economy to make the growth inclusive. This would require creation of favourable policy and institutional environment and policy-makers face several challenges in creating this. In this column we underline six such challenges which would confront the policy-makers in the current year.
The first major concern is that even as the green shoots appear, food inflation has shown an alarming increase. Although this is predominantly a supply side phenomenon, it can fuel inflationary expectations, forcing the exit from accommodating monetary policy stance earlier than desired. The immediate task of the government is to augment the supply of essential commodities. Premature exit could dampen the growth prospects and delay economic revival. The Reserve Bank of India (RBI) will have to follow a cautious policy watch and for the next quarter monetary policy, it could perhaps tweak the CRR to give signals rather than increase interest rates.
Second, the government cannot persist with large fiscal deficits and will have to initiate fiscal consolidation in the next budget itself. Notably, the consolidated fiscal deficit, including off-Budget liabilities in 2008-09, was 10.4 per cent and it is 10.3 per cent in the current year. Much of this was due to additional outlay on subsidies, pay revision, farm loan waiver and increased coverage of employment guarantee. These were not intended as fiscal stimuli per se, but did have significant counter-cyclical impact. Unlike in China, where large fiscal deficit was directed to augment infrastructure spending, the impact of fiscal deficit in India was to increase aggregate consumption. Persistence of high fiscal deficits could crowd out private investment and, therefore, it is necessary to return to fiscal austerity from the next Budget itself. According to the medium-term fiscal policy (MTFP) statement presented along with the Budget, the Central government is supposed to compress the fiscal deficit to 5.5 per cent of GDP in 2010-11. In fact, with careful planning, it is possible to reduce the fiscal deficit to 5 per cent of GDP in 2010-11 (See my November 3 column), and that would provide greater flexibility in the calibration of monetary policy.
Third, acceleration growth requires significant augmentation of infrastructure. Although considerable increase in infrastructure investment will have to come from the private sector, the government will have to substantially augment its own spending. At a time when containing fiscal deficit is a priority, additional spending on infrastructure can come about only by containing subsidies, and undertaking disinvestment. Capital expenditure of the Central government in 2009-10 is budgeted at only 2.1 per cent of GDP and even in 2007-08, when the ratio of government revenues to GDP was the highest and revenue deficit was the lowest, it was just 2.5 per cent. Augmenting infrastructure spending in the wake of the need to contain the fiscal deficit is a difficult challenge the policy-makers will have to grapple with.
Fourth, as mentioned earlier, inflow of both FDI and FII has shown a steady increase in recent months and these could bring to the fore policy trade-off between maintaining a stable exchange rate and calibrating independent monetary policy. Unlike Brazil, which chose to levy the Tobin tax to restrain the flow, in India, as yet, this has not assumed serious proportions. Flooding of foreign institutional investment beyond the capacity of RBI to sterilise could warrant imposition of a more stringent measure like the Tobin tax.
The fifth major policy challenge is to make the growth inclusive. Sustained inclusiveness cannot be ensured through subsidies and transfers, but by making the excluded participate in economic activity. This calls for massive overhaul of policies in education and health care. The government does not have the resources to expand education and skill development. While it is important that it should continue to ensure access to disadvantaged groups to quality education and health care by enhancing both quantity and quality of spending, there is no reason to restrict the entry of private sector investment in higher education and health care to improve both quality and access. Freeing up education and health sectors from bureaucratic clutches is a major challenge which has to be met not only to reap the demographic dividend but also to ensure inclusiveness.
Another major challenge that needs to be highlighted to achieve inclusive growth is the liberalisation of both land and labour markets. Many laws and regulations intended to protect the vulnerable and disadvantaged sections have prevented organised markets and have actually harmed them instead of helping. Even as total employment during 1999 to 2004 increased at an annual average of 2.9 per cent, the organised sector employed rate actually declined at 1 per cent. The reasons are not far to seek, and in order to incentivise labour-intensive growth, it is necessary to correct the anti-labour bias in our regulations.
Indeed, these challenges are formidable, but as the government does not have to contend with a general election for another four years, it is possible to initiate action on them. We live in exciting times and, hopefully, 2010 will usher in rejuvenation in reforms.
(The author is Director, National Institute of Public Finance and Policy. Views expressed are personal. Comments at mgr@nipfp.org.in)
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