The Hindu Business Line : The challenge before the PM

According to the report under Article IV Consultations between the International Monetary Fund and India, which has just been released by the IMF, the state of the Indian economy has never been as promising as it is now. As the Fund's directors see it, "the present favourable economic environment provides a good opportunity for India to make a bold push towards achieving its reform agenda". Consequently, they have urged the authorities to forge a "political consensus" for such a decisive move. This is the challenge that is staring the Prime Minister, Dr Manmohan Singh, in the face.

THE REPORT under Article IV Consultations between the International Monetary Fund and India, which has just been released by the IMF, shows clearly that, in the eyes of the world, the state of the Indian economy has never been as promising as it is now.

The very first sentence of the report says that the country "is on track for another year of robust growth in 2004-05".

It adds that firms "appear to have embarked on a new investment cycle, underpinned by strong credit growth". In view of this, the Fund's staff projects a growth rate of 6.5 per cent this year, "buoyed by the dynamism of industry and services," and adds that, in 2005-2006, "a recovery in agriculture on normal monsoons should support growth in the range of 6.5 per cent."

Sectorally, the report makes a number of observations which, though not surprising in themselves, should nevertheless help to warm the cockles of the hearts of those who attach value to what multilateral organisations such as the Fund or the World Bank have to say on the status of the Indian economy.

Thus, on inflation, the report says that while rising world oil and steel prices and a weak monsoon "temporarily affecting food prices" have seen the wholesale price index rising to 8.7 per cent in August before declining to a more comfortable 5.5-6 per cent range later in the year, the average for 2005-2006 is expected to be 5.5 per cent.

According to the IMF staff assessment, the Balance of Payments position remains comfortable despite the regime of high world oil prices for a large part of 2004-05. On the current account front, 2003-04 ended with a surplus of 1.7 per cent of GDP mainly because of a "strong growth in remittances and services".

During 2004-2005, "continued gains in services and strong remittances" are expected to keep the current account in "broad balance". As far as the capital account is concerned, a strong impact is likely to be made "by renewed optimism" about the economy following a "post-election lull".

The Fund says in no uncertain terms that "rising portfolio inflows are accompanying a pick-up in FDI". On the trade front, there has been a widening (2.6 per cent of GDP from April to December) mainly because of high oil prices and "strong investment demand" despite a buoyant export growth.

The innate strength of the financial market has been referred to by the observation that despite a buffeting received in the early months of 2004-05 (because of election-related uncertainties and an interest-rate tightening in the US), the market recovered by close to 30 per cent between June and mid-January (because of renewed FII interest) following a sterling performance in 2003-04 when it yielded a return of 83 per cent, one of the "highest . . . among emerging markets".

On the monetary policy front, the Fund says, approvingly, that the RBI took measures to curb inflationary pressures while ensuring that there was adequate liquidity to support the growth impulses. On exchange rate policy, the report says that it has become "increasingly flexible with the RBI intervening to smooth volatility."

The flow of good news does not stop here. Regarding the fiscal deficit position at the Centre, the Fund staff makes the point that the deteriorating trend "appears to have been reversed". The report says: "For the first time since the mid-1990s, the central government deficit (IMF definition) came in below target in 2003-2004 at 5.1 per cent of GDP reflecting strong revenues and economic growth".

Expectedly, the dismal State government finances has been appropriately highlighted with the comment that the improvement in the Centre's fiscal position has been "offset" by the poor performance of the States, "causing the general government deficit to rise to an estimated 9.7 per cent of GDP in 2003-2004".

The report implies that, though the deficit for the first half of the year "was in line with Budget plans", the outlook is at best uncertain because "strong efforts" will be needed to achieve "the ambitious revenue targets" for 2004-2005 which, among other things, is expected to reduce the general government deficit to 9.3 per cent of GDP.

The Fund's executive directors have been realistic in their assessment in that the reforms undertaken to strengthen the finances of state governments, which account for about half of the general government deficit, "have so far not led to a decisive turnaround".

Admittedly, the States have drawn up their own fiscal responsibility legislation on the lines of the Centre's Fiscal Responsibility and Budget Management Act (FRBMA), but effective implementation is still very uncertain, not least because of the populist pressures on those states which will be going in for Assembly polls by 2006.

In fact, the executive directors have done well by focusing on the point that the Centre must at all cost attain the first's year's deficit-curtailment objective stipulated under the FRBMA "in order to firmly establish its credibility".

Apart from the credibility aspect, the Fund directors have echoed conventional wisdom on the subject of fiscal deficits in their remark that India's large fiscal and public debt remains "a key constraint on sustained rapid growth".

Among other things, they noted that the gargantuan and increasing appetite for funds of the governments at the Centre and in the States would have the effect of crowding out the private sector's legitimate investment requirements.

In particular, the huge investment needs for the infrastructure sector could be severely affected if the deficits were to continue on the one hand and efforts to enhance tax revenue and cut low-priority spending were not implemented effectively on the other.

Of interest is the fact that the Fund's directors do not think that using a part of the foreign exchange reserves to meet infrastructure investment needs would be a good idea. On the contrary, as the report says, they "emphasised the importance of undertaking any increases in infrastructure spending within the limits of the FRBMA," which is good orthodox theory but which may not produce results in the current Indian situation.

Indeed, recent reports indicate that the Planning Commission Deputy Chairman, Mr Montek Singh Ahluwalia, has finally got his way in getting the grudging support of the RBI and the Finance Ministry for his proposal to use a part of the foreign exchange reserves (to the extent of $5 billion a year) for investment in public sector projects. Certainly, such transfer of resources will lead to increased pressures on money supply, etc., but the solution is not to throw out the baby along with the bath water.

Measures should be devised to insulate as much as possible the monetary impact of using the country's reserves for domestic investment projects, an exercise which will stretch the abilities of the nation's policy-makers to their fullest extent but which will also enable efficient use of a store of value which, in the eyes of the world, measures the international status of a national economy.

The Fund's executive directors have put a premium on the UPA Government going through with certain structural reforms if the promise and potential shown by the country's economic performance in recent years is to be encashed effectively.

Among other things, they have suggested that in order to generate jobs in adequate numbers, the business climate should be improved, "including by easing the burden of regulation and liberalising restrictive labour laws". In the farm sector, certain "structural impediments" to growth should be removed, like "reforming the current system of price supports, guaranteed procurement, and large subsidies for fertiliser and power".

In the oil sector, the cost of running the administered pricing mechanism (which is still very much around, according to the Union Petroleum Minister) could turn out to be unsustainable, and should be replaced by an "automatic pricing mechanism". As the directors see it, "this would protect government revenues, limit losses to state-owned petroleum companies, and provide incentives for more efficient energy use". In the fitness of things, the raising of a number of sector FDI caps and the government's overall policy to liberalise external trade have been lauded.

As the Fund's directors see it, "the present favourable economic environment provides a good opportunity for India to make a bold push towards achieving its reform agenda". Consequently, they have urged the authorities to forge a "political consensus" for such a decisive move. This is the challenge that is staring the Prime Minister, Dr Manmohan Singh, in the face. There is no guarantee that he will be able to accomplish the task within the lifetime of the present UPA Government.

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