Reflate For Infrastructure

The liquidity hang-up is building up and the RBI seems to have lost control over money supply;

Increased money supply is not being channeled into productive use. It is being sucked up to meet the oil pool account deficit;

The crisis in non-banking financing companies (NBFCs) following the CRB scam has dried up an important source of financing business and industry;

The loss of public confidence in NBFCs has adversely effected the financial savings of the household sector. There are increasing indications that household savings are increasingly flowing into non-productive assets like gold;

The internal surpluses of the companies have shrunk because of their poor performance last year;

Uncertainty over the monsoons has increased; and

The position of reservoirs in South India has become a matter of concern. Any shortfall in hydel generation will seriously constrain the supply response of industry to excess liquidity.

All the indicators suggest that the country is sleep-walking into a state of serious stagflation. Even the continuing inflows by foreign financial institutions has become dysfunctional; in fact, counter-productive. In the short-term, the continuing inflows have done harm. These are increasing money supply and keeping the rupee strong. Exporters are doubly squeezed by a strong rupee on the one hand and high domestic inflation on the other. As a result, Indian exports are being priced out. It is clear that single digit export growth cannot sustain double digit industrial growth for too long.

The Indian economy is currently in a bind. The market on its own cannot break the vicious circle of increased foreign flows, increasing liquidity, appreciation of the rupee, falling exports and physical supply constraints. Three years ago, foreign flow created an embarrassing economic situation. But the situation was saved by three factors. First, there was a lot of slack in the economy. Thus there was adequate supply response. As a result, both inflation and growth were present for a short period.

Second, the first flush of enthusiasm about reforms induced a mad rush of investment. Most of the new investment, however, went sour. Now both entrepreneurs and investors are in a state of once bitten, twice shy. Third, the steep devaluation of 1991 provided a big cushion to exporters to absorb the shock of both continuing domestic inflation and the relative strengthening of the rupee. Those cushions have deflated. Now the rupee must be devalued to Rs 39 on dollar to revive exports.

The two-point objective of the intervention should be to remove physical supply constraints and revive exports. The earlier phase of reflation-based industrial growth could not be sustained for two reasons. First, inflation exceeded the political tolerance limit. So, Dr Singh had to apply the reverse gear too soon. Second, investment flowed in all sorts of sectors except infrastructure, for whatever reasons. Now the day of reckoning has come as a result of neglect of infrastructure.

The continuing inflows can be turned into a source of strength. It would be a totally negative approach to use interventionist measures to discourage inflows. A really positive and bold approach would be to step-up in a big way investment in infrastructure, particularly power -- both in the public sector and private sector. New investment in the power sector should not be counterposed, at least for the time being, to improvement of finances of state electricity boards. In fact, most of the investment in the public sector should flow into central power generating agencies like NTPC.

This scheme of things will require continued increase in liquidity. It can be somewhat moderated if the oil pool deficit is reduced substantially. However, there is cost to be paid for taking this reflationary route. And that is inflation. But it can be moderated if foreign reserves are used to import essential commodities. Dr Singh not only did not intervene to channelise investment into infrastructure, but also dragged his feet in importing commodities to moderate inflation. His way of reflation made short-term gains painful. If the reflationary route is used to increase investment in infrastructure it would mean pains for delayed but more enduring gains. But the million dollar question is whether the present weak leadership can absorb the political shocks of pains. P V Narasimha Rao, even though he 'manufactured' simple parliamentary majority, could not absorb the political shock of a reflationary course pursued by his finance minister. And Inder Kumar Gujral is much weaker than P V Narasimha Rao.