The Hindu Business Line : Managing the economic affairs

THE mantle of the Secretary in the Finance Ministry in charge of economic affairs has fallen on the the Reserve Bank of India Deputy Governor, Dr Rakesh Mohan, with considerable experience earlier as Advisor to the Finance Minister. This is the first time a Deputy Governor goes to the Ministry as Secretary — a reversal of the trend often seen in the past.

In choosing Dr Rakesh Mohan for the position, the Government has signalled that he would have a larger than the strict functional jurisdiction of the Department of Economic Affairs. It does not matter if the designation of Finance Secretary is not formally given to him but to someone else for the present.

The fact is that he would form an important part of the formidable economics team, rich in international experience, in the Ministry and the Planning Commission. Given the presence of political economy and institutional issues, his earlier experience in the Ministry would come to his rescue in performing the much-required balancing acts.

However, he may not need to be acrobatic insofar as this fiscal is concerned. The parameters of this year's Budget are already given.

On the taxation front, there is the shadow of the Kelkar Report. Added to it is the redoubtable presence of the new Advisor, a fiscal expert with vast international experience and work experience in India. On the expenditure side, Secretaries do not have much to say; it would be dictated by the political economy considerations that would normally be taken care of by Finance Ministers.

It is only the developments on public debt — public borrowing — that would keep the Secretary busy since he would have to work out strategies that ensure success of the Government's borrowing programmes, and that would, at the same time, be perceived as within the limits set out by the medium term goal of `fiscal responsibility'. It is here his skills to interact with the central bank, and other financial entities, including banks, would matter, if the budgeted deficit were taken as the minimum that should be observed.

It is when the next year's Budget preparations begin that the Secretary's tasks and challenges would mount. The pronouncements about policy intent in recent months and the dynamics of coalition government would suggest that improvement in infrastructure and extending the range and quality of sanitation, health care and primary education, would be the main focus of the Government's attention.

The new Secretary, being an expert in infrastructure and urban economics issues besides finance and fiscal economics, is eminently suited for the position that he would assume as of November 1. However, he would have to weigh the possibilities of generating additional infrastructure facilities and social sector resurgence within a time-frame against the available finances, along with signals about the fiscal position being within the limits of tolerance.

Infrastructure investments would take away a chunk of public sector resources. The private sector has not been as proactive in this area as one would wish. It is in this context that a proposal has been made, apparently by the Planning Commission, that it would be prudent to use a part of the existing large reservoir of forex reserves for creating new infrastructure and facilitating higher growth over the medium term.

The proposal is based on the premise that the return on the forex reserves is currently low and is hardly comparable to the high `growth dividend' that infrastructure would yield in terms of enhancing growth potential. The logic inherent in the proposal is appealing but overly simplistic. Will the new Secretary bite?

Let us see how the process of using the forex reserves, that form part of the assets in the RBI's balance-sheet, would work. The Government of India would have to buy the foreign exchange from the RBI with rupees at the existing market rate. In case the Government does not have enough rupees at its disposal, it would have to issue securities.

The Bank would create rupees against the newly-issued Government securities and deposit the rupees so generated into the Government's deposit account maintained with the Bank. The Government would run down its deposits and buy foreign exchange from the Bank. The entire exercise would take place almost simultaneously since it entails only book entries. The end result of the exercise is that the RBI's forex assets would decline: They would be substituted by the Government securities on the assets side.

Since Government deposits that form part of liabilities of the Bank would be stable, the net RBI credit to Government would increase exactly to the extent that forex assets are withdrawn, assuming that, in the meantime, there is no variation in the Bank's foreign liabilities. From the angle of the Bank's balance-sheet, there would be no change.

There would, however, be an increase in cash which when spent would aggravate aggregate demand and inflation prospects. The RBI could buy either foreign exchange or Government securities from the market and provide liquidity to markets. In case the RBI buys the former, it could, if it wants to simultaneously neutralise the liquidity impact, undertake open market sales of Government securities or raise the cash reserve ratio. In case the RBI buys the latter, the way to neutralise the liquidity impact would be to either sell its forex reserves or raise the cash reserve ratio.

The forex reserves with the Government would, one expects, be spent on import of infrastructure items. This action could increase the trade deficit, impacting the exchange rate, assuming that capital and invisible accounts of balance of payments are stable. The consequential prospect of depreciation would further enhance uncertainty about the inflation outlook. In general, governments are not known to plan large-sized infrastructure investments with appropriate sequencing.

More often than not, the foreign exchange on hand would be spent across a broad spectrum of goods, and not necessarily on infrastructure alone because of competing pressures from different groups within the Government for larger allocation of foreign exchange all in the name of `public good'.

The new Secretary would, therefore, have to determine before buying foreign exchange from the RBI as to how much infrastructure investment is needed in each year of the medium term and work in concert with other Ministries and the Planning Commission to schedule stage-wise disbursal of investments.

To reduce the incidence of inefficiencies in project planning, there could be an audit of policy and planning decisions and fixing of accountability of actions on those concerned with infrastructure investment.

Since the number of participants in such tasks is likely to be large, accountability will have to be fixed on a committee that is formed out of such participants. To be fair to the committee, a provision has to be introduced to the effect that deviations from the parameters of project planning would be explained by the committee before the Finance Minister along with actions proposed to correct the deviation within a reasonable time schedule.

Assuming for the moment that infrastructure investment would be undertaken only in moderate amounts in the next Budget and the focus would be mainly on the social sector development. In this case too, monitoring the effectiveness of public expenditures through appropriate audits and accountability principles would be necessary. But instituting a sound system of monitoring is often time-consuming.

The new Secretary would have to play a role here. He should advise the Finance Minister about our capacity to undertake social sector projects and to provide sound delivery systems. His recommendations may not be followed and he should, therefore, have a second best option.

That would effectively mean expenditure growth would follow the trend and resources, through both tax and non-inflationary non-tax sources would have to be raised sufficiently to enable the fiscal deficit to be sustainable.

(The author, a former Executive Director of the Reserve Bank of India, can be reached at asurivasudevan@hotmail.com)