The Hindu Business Line : `Cut the fat, not the muscle'

INDIA'S greatest economic challenge is to rein in fiscal deficit, according to Dr Raghuram G. Rajan, Chief Economist of the IMF"It is a problem because people do not see it as a problem," he said last week, addressing students of the Great Lakes Institute of Management.

With a consolidated fiscal deficit over 10 per cent of GDP, the country's debt runs the risk of becoming unsustainable in the long term.

The captive banking sector, comprising public sector banks, buy government debt but they are going to start investing in private ventures when the economy starts booming, he said; then, "there will be competition for money," because of which interest rates will shoot up.

Dr Rajan also advocated that India should eventually ensure full capital account convertibility, which would help make the country a direct player in the booming financial sector, but not before containing fiscal deficit. "It is very dangerous to do so as fiscal deficit is very high."

Terming debt as the "soft underbelly of the Indian state," Dr Rajan said, "We don't take hard decisions... ultimately, today's debt has to be paid off by the next generation (through higher taxes)."

The deficit has not particularly hit India as the interest rates have been quite low for a while, he said, cautioning "now that the rates are moving up, we could have a problem." And, of course, "We should cut the fat, not the muscle."

Dr Rajan also said India should start second-generation reforms as also create rural employment alternatives to agriculture, where growth has virtually been zero.

Services, on the other hand, has registered high growth rates to become the biggest segment of India's GDP.

The creation of employment opportunities in services and manufacturing segments, however, will require investment in rural infrastructure, for which the government has to raise resources.

It can happen by increasing the tax-GDP ratio, which is quite low, as also through sale of Government assets.

While dealing with the latter, the argument should not be whether the company is profitable or not, he said, but whether "there is a need for the Government to be there."

Instead of creating more regulations to protect workers' jobs, the Government should design social safety nets while enabling more flexibility in the labour market, he said.

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`Controlling fiscal deficit is the biggest concern' — — Dr Raghuram G. Rajan, Economic Counsellor and Director of Research, IMF

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