April 27, 1998

The state of the economy depends on the economy of the state.

Jairam Ramesh

How times change. Less than a decade ago, Indian industry was saying that we should cut back on the fiscal deficit and rein in government expenditure. Today, the unanimous view in industry is that the fiscal deficit does not matter. If getting out of the current "recession" means a higher fiscal deficit for the Centre than the current 6.1 per cent of GDP, so be it. This is not a cry in the wilderness. It has powerful backers within the Government itself, most notably Murli Manohar Joshi, the patron saint of the "Swadeshi Jargon Bunch".

The current industrial slowdown is not a "recession". It is an essential phase of transition and restructuring. You cannot have a fiscal reform programme and hope to post double-digit growth rates year after year. At some point of time, the pains have to show. Indian industry is not facing a recession. It is facing the white heat of competition.

Deficits hit growth. They are bad for private investment. They raise domestic real interest rates. They lead to current account deficits and overvaluation of currencies. And they make public investment non-sustainable.

Is there a "right" level of fiscal deficit? In perhaps the most analytically rigorous and policy- oriented sections of the Ninth Plan document bequeathed to Jaswant Singh by Madhu Dandavate and company, levels of sustainable fiscal deficit under varying assumptions have been estimated. The underlying premise is that the Government debt to GDP ratio and the interest payments to tax revenues ratio should at least remain the same as they are today and, if possible, show a decline.

Assuming the GDP grows at 7 per cent per year in the next five years, nominal interest rates remain at 11.5 per cent and the average rate of inflation is 7 per cent, then the sustainable level of fiscal deficit for the Centre works out to 5 per cent of GDP. The sustainable level of fiscal deficit for the states is around 2 per cent of GDP, as compared to the present level of 3 per cent of GDP.

What the Planning Commission has not done is estimate the deficit for public-sector enterprises as well. If this is done, the fiscal deficit for the entire economy is now around 10 per cent of GDP, as compared to a sustainable level of about 7 per cent. This is at the core of India's economic malaise.

If nominal interest rates rise, then the sustainable level of fiscal deficit goes up. The downward movement of the fiscal deficit will itself ease the pressure on interest rates. But the real answer to this is a reduction in interest rates on the various small savings schemes run by the Government. These are distorting the structure of deposit rates.

The second Joshi-industry mantra is to increase capital expenditure and cut revenue deficit. Easier said than done. Cutting revenue deficit is tough. Money for rural development, education and health are part of revenue expenditure. Everybody wants such expenditure to increase, indeed it has. Some 40 per cent of the increase in revenue expenditure in recent years is on account of increased spending in the rural development and social sectors. Surely this should not be cut.

But there are other elements of revenue expenditure which must be curtailed, most notably interest payments. This year, these will eat up 50 per cent of the Centre's revenue receipts and about 30 per cent of the revenues of the states. There is only one way of dealing with this problem: privatise, sell assets like land, and use the proceeds to repay debt.

Reforming the Food Corporation of India and taking away the affluent from ration shops will cut food subsidies. The replacement of the irrational factory-wise retention pricing system by one based on long-run marginal costs will contain fertiliser subsidy. Next, by not filling vacancies that arise out of the 3 per cent normal retirements that take place annually, establishment costs of the Government can be kept in check.

The Government could well decide to find another Rs 5,000 crore-Rs 6,000 crore to push into the economy to spur industrial demand. Will this "pump priming" help? Hardly likely. It will only push up fiscal deficit and jack up interest rates. Many sectors, particularly power and roads, have reached the limits of absorptive capacity. Public investment cannot increase unless costs of supply are actually recovered. Take the National Thermal Power Corporation, already owed Rs 6,000 crore.

Further, the system of awarding contracts in the public sector is extremely time-consuming. Clearances from various ministries -- Finance and Environment are just two examples -- add six to 12 months to the project cycle. In irrigation, over 75 per cent of the outlay is eaten up by salaries and establishment expenses, leaving little money to place orders that will spur demand.

More than expenditure by the Centre, it is expenditure by state governments that creates industrial demand. But the state governments are bankrupt and will get deeper into the red when they implement the Fifth Pay Commission's report. Reform of state finances, therefore, is imperative. Perhaps the Jaswant-Yashwant (Sinha) duo should restructure the Centre-state financial relationship so as to ease the fiscal adjustment by states. That may be the way out of the tunnel.

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